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UK Membership of the European Monetary Union

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UK Membership of the European Monetary Union

1. Introduction

In January of 1999, eleven from fifteen members of the European Union

(EU) irrevocably locked their currencies together to become the

European Economic and Monetary Union (EMU). Their new common currency,

the euro, is now the currency for most of Western Europe. Now one of

the biggest questions on the minds of the population is: Should the

UK join with the rest of Western Europe in monetary union?

2. Arguments For UK membership:

o Lower transactions costs and transparency

Joining the Euro would reduce exchange rate uncertainty for businesses

and lower transactions costs for companies and tourists. Nearly 60% of

UK trade is conducted with other members of the European Union - a

figure that is likely to grow in future years. Price differences,

especially on big-ticket consumables such as cars, TVs, and washing

machines, will become less sustainable and there will be greater price

transparency.

o Increased trade and investment

The Euro is vital to the success of the Single European Market. This

should lead to an increase in intra-European trade flows and higher

inward investment within the EU region. Britain stands to gain from

this, particularly if it can maintain low inflation and raise

productivity in European markets. Britain's flexible labour and

product markets would be highly effective inside a single currency

area and would help to attract even more inward investment from

outside the European Union.

o Lower inflation and long term interest rates

The UK might gain from a period of sustained low-inflation delivered

by an independent Europe...

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PCM). If they wanted to stabilise output (perhaps it was already at

potential output) they would have to also reduce their money

supplies.

c) How would your answers to a) and b) change if the non-member

countries had fixed their currencies to the Euro?

As in the ERM…

a) Demand for their currencies would fall (and supply increase), as

investors move their wealth into Euro bonds. The non-member central

banks would then be obliged to buy the relevant domestic currency at

the agreed exchange rate. Taking this currency out of the market

means that the domestic LM curve has shifted to the left (recall LM

curves are endogenous under fixed exchange rates). Output will

therefore fall.

b)Under fixed exchange rates they might use expansionary fiscal

effects which would shift the IS curve to the right.
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