Overview, Knowing the Euro, Factors affecting the EU economy and the Euro

Overview of the EMU Economy

The European Monetary Union (EMU)

The EMU consists of 15 European countries except the United Kingdom, Sweden & Denmark. With a GDP of about US$12.18Trl (2005), the EMU is the second largest economic power in the world. The Euro is the common currency in the EMU. The economy of the EU is dominated by the Service sector (71% of GDP), followed by Manufacturing (22% of GDP).

There is a recent trend is to outsource Manufacturing activities to Asia and focus on niche segments like Research & Innovation. With its high rate of returns, the Euro is giving the US$ a run for its money. Dodging the US, the EU with well-developed Equity & Fixed income markets, is increasingly becoming a favourite destination for International investors (currently it stands second, next only to the US).

The capital inflows into the EU were about US$110 Bln in 2002. The EU economy is heavily dependant on Trade & Capital Inflows, and with a share of 19% of world trade, its bargaining power has been continuously increasing (like US). This has also led to a surge in the number of countries adopting the Euro as a Reserve currency (against the US Dollar).

The Regulatory Authority - European Central Bank (ECB)

The ECB frames & implements the monetary policy for the member countries of the EU. Policy decisions are taken by the Governing Council & implemented by the Executive Board of the ECB. While the latter comprises of the President, Vice President, & 4 other members, the former includes the Governors of National Central Banks and the Governing council members.

The main function of the ECB is to control inflation & achieve sustainable economic growth. The ECB along with the ESCB (European System of Central Banks) is immune from any kind of interference (political, financial or otherwise) from any organizations or governments inside the EU.

To achieve its aims, the ECB lays down strict economic guidelines for its member states and can heavily penalize them for any violations. The ECB controls the rate of inflation and manages adequate liquidity of the Euro in the following ways:

1. The Repo Rate: This is the rate of interest to be paid to the ECB by the member countries on borrowings. The ECB increases this rate if the inflation is high & vice versa.

2. Open market Operations: These are further classified as:
- Weekly refinancing operations which provide liquidity by reverse dealings
- Monthly refinancing operations to increase liquidity
- Refining liquidity of the Euro by momentarily adjusting the interest rates
- Adjusting the monetary position of the Euro against the financial sector by issuing Outright & Reverse Transactions and Debt Securities.

Overview, Knowing the Euro, Factors affecting the EU economy and the Euro