Economic and Monetary Union (Euro)

The euro is the official currency of 16 of the 27 member states of the European Union; the countries that use the euro are collectively known as the Eurozone  The euro has been officially adopted by Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.  It is used daily by some 327 million Europeans and it is the currency with the highest value of cash in circulation in the world.

 

The euro was introduced as an accounting currency to the world financial markets on 1 January 1999 and notes and coins entered circulation on 1 January 2002.

 

In order to be allowed entry to the euro each member state are meant to meet the growth and stability pact –an annual government budget deficit of less than 3% of GDP and total government debt to be less than 60% of GDP –, low inflation, stable exchange rates and interest rates close to the EU average.

 

With the UK remaining outside of the Eurozone, there is great debate as to whether the UK should join.  There are a number of advantages that have been highlighted of joining the euro:

  • Reduced transaction costs for firms and individuals.  Transaction costs are the costs of changing one currency into another.
  • Reduced exchange rate uncertainty will help with business planning.
  • Increase trade with member countries.
  • Greater price transparency as firms and consumers will find it easier to compare prices as they will be quoted in the same currency.
  • Being a member of the euro should lead to increased foreign direct investment as firms will want to trade within the Eurozone.
  • The UK can only hope to have greater economic and political influence if it is a member of the Eurozone.
  • The optimum currency theory suggests that geographical areas would benefit from having the same currency.
  • Lower interest rates were often quoted as being a reason for joining the euro, however recent months have seen the Bank of England’s base rate fall below the ECB’s.

 

There are also some disadvantages of the UK joining the single currency:

  • The Bank of England would lose control over monetary policy.  Interest rates would be set by the ECB and they may not be set at the most appropriate level for the UK at any particular point in time.
  • The Bank of England sets monetary policy with the secondary objectives of sustainable growth and high levels of employment in mind.  This would not be the case if interest rates were set by the ECB.
  • Other countries have not stuck to the growth and stability pact.
  • The UK is more sensitive to changes in interest rates than other European countries due to its high percentage of home ownership.
  • There are very high conversion costs of switching over to the euro; these are one off sunk costs.

 

The UK government has used five tests to make a decision on euro membership, they are:

  • Convergence.  Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?
  • Flexibility.  If problems emerge is there sufficient flexibility to deal with them?
  • Investment.  Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?
  • Financial Services.  What impact would entry into EMU have on the competitive position of the UK’s financial services industry, particularly the City’s wholesale markets?
  • Growth and employment.  Will joining EMU promote higher growth, stability and a lasting increase in jobs?

 

On 9th June 2003 the Government published the assessment of the five economic tests.  The Treasury’s assessment was that since 1997 the UK has made progress in meeting the five economic tests.  But, whilst it acknowledged the potential benefits of increased investment, trade, a boost to financial services, growth and jobs are clear, it could not conclude that there was sustainable and durable convergence or sufficient flexibility to cope with any potential difficulties within the euro area.  Therefore the government decided that despite the risks and costs from delaying entry, membership of EMU at that time would not have been in the national economic interest.

Do you think the UK should join the euro?

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