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Economic and Monetary Union

 

 

EMU Convergence Criteria

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price stability : a sustainable inflation rate which does not exceed by more than 1.5% the lowest 3 rates in the EU

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long term interest rates within 2% of the best 3 performing i.e. lowest

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a government deficit of no more than 3% of GDP

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total government debt of no more than 60% of GDP

 

Advantages of EMU

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Increased Credibility

With a single currency, there is far greater anti-inflation credibility. This is because all of the EMU nations are linked with Germany’s Central Bank’s very successful anti-inflation policy, therefore expectations of inflation will be lower which leads to lower actual inflation.   It will also increase a currency's stability on the markets, therefore, there is no interest rate premium on the currency which may lead to interest rates being  reduced.

 

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Reduction in Costs

a) Transaction Costs and Information Costs - estimates have put these costs at    1.6% of EU income each year.

b) Reduced Uncertainty - from multi (flexible) currencies. Companies may insure against this happening, but this is still an expense.

c)   Increased Investment  - with increased certainty both internal and international direct and portfolio investment should increase, hopefully increasing economic and productive efficiency and promoting economic growth.

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The Optimum Currency Area Theory

If all of the factors of production are mobile, economic polices are similar and there are no barriers to trade then it makes sense to have a common currency.

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Increased Trading

As firms will have a greater certainty about future costs and revenues they will be more willing to partake in international trade.  This will lead to increased competition which results in lower prices.  Costs for firms may lower as well as they take advantage of economies of scale and strive to lower costs in the face of increased competition.

 

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Independence of Monetary and Fiscal policy

No one Government will have control which will lead to more long-term economic planning.  This argument holds for an independent European Bank as they will not alter the rate of interest for political gain e.g., lowering unemployment at the expense of inflation, decreasing interest rates just before an election to increase the feel good factor.  Government Policy will hopefully follow the business cycle rather than the election cycle.  European policies should have:

a) better long-term planning

b) more efficient use of taxes (as cannot simply raise taxes, as people will move elsewhere).

 

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Lower Capital Flows

It is often argued that due to the existence off many separate currencies, short term speculation leads to de-stabilisation of them, with the ECU this is less likely.

 

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Effects on Wages

Wages should converge and become more competitive, as workers will realise that they are competing at only with other British firms, but also with European Firms.

 

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Inflows at Capital to Europe

The ECU will be a major world currency and it is estimated that there will be a one-off purchase of ECUs by non-Europeans that will result in a revenue of up to $35bn.


 

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Protection of the City of London

The City of London ranks with N.Y. and Tokyo as the major world financial centres. It is doubtful if the City would maintain its pre-eminence outside a single currency area, formed by the rest of Europe.

 

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Balance 0f Payments

With a single European currency it will be easier to finance a deficit as interest rates will be lower as no interest rate premium. (Overall borrowing will be easier as large sums of money available).

 

Disadvantages of EMU

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Ability to set Interest Rates

Since the UK withdrew from the ERM we have followed a strict anti-inflationary policy.  This stance against inflation was compounded when the Bank of England was given independence over interest rate policy.  By joining EMU the UK will be losing control over one of its main economic instruments.  No longer will the UK be able to react to inflation by raising interest rates, it will have to wait until inflationary pressures across Europe become too strong.  If the trade cycles of different countries across Europe do not converge, some nations will suffer as central policies may amplify any problems they already have.

 

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No Devaluations

This will mean that domestic countries will have reduced powers to control their economies. European regional policies will have to compensate.

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Central BankThe administration of the European General bank is controversial. Will it simply be a means of the Bundesbank continuing to control monetary policy? lt. will have to be accountable and democratically controlled.

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Regional changes

There may be massive problems (unemployment, balance of payments deficits, etc.) caused by a free market. Fiscal policy is under European control in the medium term, and it is unlikely that large Government expenditure and a large PSBR would be allowed in the long run. Therefore, regional aid from Europe would be required, but this would dramatically increase the size of the budget, or other areas would have to be cut.

 

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Taxes

If too high, a nation will experience a brain-drain, therefore countries may be unwilling to tax which can lead to a decline in the provision of services.

 

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Infrastructure

This is a problem of the EMU not due to EMU itself, but the domestic problems of Britain (and its geographical position). If Britain is to compete, its rail, road and communication network must be improved.

 

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Level of Currency on Entry to EMU

Arguments took place on the level of a country’s currency as it has implications on its exports and imports.

 

Further Reading

Q&A: Is The UK Ready For The Euro?
My five extra tests for Euro entry (Observer 13.1.02)
Is Britain Falling for Europe's Charms (Sunday Times 13.1.02)
Blair can not now be honest about the Euro (Times 10.1.02)
China backs the Euro at the Dollar's expense (Telegraph 7.1.02)
Euro Soars Against Major Currencies (bbc 3.1.02)
The Costs and Benefits of the Euro (bbc 2.1.02)
The UK's Euro Battle (bbc 19.12.01)
The Economics of the Euro (bbc 18.12.01)
Who's in and who's out (FT 11.7.01)

Links

The EU on-line
Financial Times Euro guide
Guardian Euro Guide
ICAEW Euro guide
No Campaign Website
Yes Campaign Website
The Labour Party
UK Independence Party
Conservative Party
The Liberal Democrats
Britain in Europe

 

 

E-mail Steve Margetts