Monetary policy in EMU (European monetary Union) Essay

Monetary policy in EMU (European monetary Union) - Essay Example Initially, the European Union included 12 countries, but since its inception in 1992, the area has expanded to include 17 countries in total (European Union, 2012). The financial crisis of 2007-08 had enhanced the importance of the austere economic regulation by the European Union. This essay covers the monetary policy that has been adopted by the European Union, keeping in mind the various pressing issues that have been a matter of concern in the European countries like, price stability, real economy stabilization and its future plans regarding inflation targeting. Monetary Policy of the European Monetary Union Rationale behind price stability and real economic stabilization Price stability implies that the purchasing power of citizens and the value of their savings will be independent to the exchange rate fluctuations in cross-border travels and investments. The Monetary policy in the Euro zone is conducted by the European Central Bank and has direct impact on the price stability a nd the interest rates. The main objective of the monetary policy by the EMU is to keep the rate of inflation hovering around 2%, so that the value of Euro can be protected (European Union, 2012). This is achieved by altering the rate of interest of lending by the banks. The objective of price stability in monetary policy is an integral part of maintaining moderate levels of inflation, so that the economy can avoid the risk of running into deflation. The European Central Bank and EMU have always tried to maintain the price stability because of the strong notion that by maintaining the price stability, the economic activity and employment levels of the country can be improved. The maintenance of price stability by the EMU ensures that the price level of any particular good or service acts independent to the general price level of the economy. Price stability also ensures that the creditors can be relaxed as the prices will not rise in future and there will be no need of inflation risk premium to compensate the losses from inflation. Unnecessary hedging activities and distortions in the tax and social security system can also be avoided by maintenance of price stability (European Central Bank, 2011). The price stability contributes to the stabilization of the real economy. Monetary Policy prior to the crisis Before the onset of the financial crisis, the EMU had been successful in maintaining the inflation rate, averaging to 2.04% from January 1999 to August 2007 (European Central Bank, 2012). This bears a testimony to the fact that since the formation of Euro, the Euro Zone has been quite successful in achieving its preliminary goal of maintaining price stability. The most interesting fact about the price stability in the EU was that the inflation rates were not only low, but also had low macroeconomic volatility compared to other advanced countries of the world. Figure 1: Inflation Rates in the Advanced Economies (Source: European Central Bank, 2012) The above f igure shows the inflation rates in the industrialized economies of the world from 1999 to 2011. It can be seen that the monetary policy followed by the European Union, prior to the global financial crisis of 2007, has been in line with its objectives. In the course of time between 1999 and 2007, the European economy had undergone a lot of turmoil like, increasing global oil and food prices, increases in