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.