Should the United KingdomJoin the Single Currency?

Should the United KingdomJoin the Single Currency?

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Should the United KingdomJoin the Single Currency?

Introduction

This project will concentrate on analysing the arguments put forth in
favour of adopting the Euro as our currency, as well as those against
it. A conclusion will then be drawn that weighs both the pros and cons
and decides whether it would be beneficial to the UK economy if we
adopted the Euro or continued to opt-out.

Theory

The major economic theories that will be used are the following:

* Macroeconomic objectives.

* Governmental macroeconomic policies.

Analysis

Arguments for the Euro

The arguments put forth for membership of the "Euro zone" (countries
that have adopted the Euro as their currency) are split into two
groups: political and economic. A move towards a Federal Europe
(Churchill's ideal of a "United States of Europe") that is governed in
a similar way as that of the U.S.A. is the primary political argument.
A Federal Europe would be governed as a whole with member countries
retaining a few powers but losing almost all political sovereignty. It
is argued that this reason is one of the driving reasons for the
setting up of the Single European Currency. France and Germany in
particular want to integrate the core European economies more closely
and move towards a single European Economy. The economic arguments are
further sub-divided into three groups: transaction costs, trade
competition and investment. Ultimately, if the United Kingdom does not
adopt the Euro higher costs will be incurred as far as transaction
costs are concerned. The commissions involved in buying the Euro when
trading with European countries will remain and the uncertainty
arising from a floating exchange rate will also continue to be
apparent. Whilst this is unlikely to make a significant difference for
UK businesses buying continental European exports, it could well
affect the number of UKexports being purchased by continental European
companies. Basically, UK exports will be more expensive to Euro zone
countries compared to exports of other Euro zone countries due to the
changing cost of buying the pound. The UK's membership in the Euro
zone would eliminate these costs. Trade competition refers to the fact
that if exports from Euro zone countries are all priced in the same
currency then it is easier for companies to see price differences
between companies across borders, ultimately increasing competition
between companies. In effect, with the lack of tariffs or quotas for
import and export between Euro zone countries, it is almost like an
integrated single European Economy as buying from a company in a
fellow Euro zone country is exactly the same as buying from a company
in your own country. This is called price transparency: it will become
far easier to compare prices across the markets of the Euro zone.

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This
has the advantage of creating competition between countries (which
leads to prices levelling out), perhaps even providing competition for
existing monopolies. For example, with borders being opened up between
Euro zone countries, the traditional telecom monopolies that plague
most European countries could be opened up to include foreign
competition as networks expand across borders.

The Single European Currency goes one big step further to the
completion of the Single European Market, by opening up the markets of
each member and linking them with one currency. Labour markets are
also linked and the economies of the Euro zone can become more
synchronized, lending themselves to full-on integration. The
completion of a Single European Market has one major advantage - there
will finally be a major competitor to the U.S.A. in the global
economy. Economists predict that the U.S.A. and Euro zone Europe will
become the two major players with Japan as a junior partner in the
world economy. This has particular relevance now, since many economies
at the moment, particularly our own, hinge on the US economy. If it
slows down, like it is about to, then those other countries are likely
to do the same. With another competitor to the US, the global economy
can become much more balanced and with it brings more stability.

Obviously a key factor in Britain's decision to join the Euro would be
whether or not it would help reduce unemployment. Unemployment is
currently falling within the United Kingdom as can be seen from
appendices fig 1.1, and figures from the Euro Zone can be seen in fig
1.2. As you can see from figures 1.1 and 1.2, unemployment within the
Euro zone is currently higher than that within Britain. However, if
the downward trend in figure 1 continues then it should be at UK
levels within a couple of years.

In theory, once at these levels, unemployment should stay low since
there will be a far wider labour market where workers can seek
employment. Also, demand should increase due to the competition
created by lower transaction costs, so output will be higher. This
should create more jobs and thus lower unemployment or at least keep
it low.

Arguments against the Euro

The arguments against the UK's membership in the Euro zone are also
split into political and economic arguments. Political arguments
include the loss of Britain's individuality as a separate country, as
well as the loss of nearly all control over the UKeconomy.
Furthermore, adopting the Euro more or less ties Britain into any
future plans of a Federal Europe. It would be hard to back out of such
plans with so much integration already set in motion. This, of course,
would mean the loss of political sovereignty for Britain. It is the
economic arguments against the Euro that are the most important and in
many ways the most compelling. Economic theory states that the macro
objectives for a government are as follows:

* Low unemployment

* Low inflation

* Economic growth

* Balance of Pay Equilibrium

In order to succeed in these objectives, governments use policies to
control various aspects of the economy:

* Monetary Policy

* Fiscal Policy

* Supply-side Policies

* Exchange Rate Policies

In the analysis that follows, it will be shown that three of these
policies would be rendered unusable to control the UK economy:

1. Monetary Policy

Monetary policy involves the raising and lowering of the base rate to
control aggregate demand. For example, if aggregate demand is rising
too quickly and raising prices (demand-pull inflation):

In this situation, the government could increase the base rate. This
would have the effect of lowering consumer expenditure since there
would be a higher incentive to save and a higher cost of borrowing.
The introduction of the Euro in the UK would make this policy unusable
because interest rates for Euro zone members are set by the European
Central Bank (ECB) and is the same for all member countries. Of
course, the ECB is able to operate Monetary Policy over the whole Euro
zone, but an increase or decrease in aggregate demand might have a
positive effect on one economy but a negative one on another.
Economists argue whether the economies of the Euro zone are suitably
synchronized to allow policies such as this to be used universally.

2. Fiscal Policy

Fiscal policy is closely linked to monetary policy and is also used to
control aggregate demand. However, it does so by controlling the
amount of government spending and taxation. Increasing government
spending will increase aggregate demand:

AD = C + G + I + X - M

Increasing taxation means that incomes are lowered, which causes
consumer expenditure to go down which means that aggregate demand,
goes down (see above). Of course, both can be applied vice versa as
well.

Fiscal policy becomes more or less useless with the adoption of the
Euro, since one of the convergence criteria for joining the Euro zone
is a low government debt. This means that the government cannot
increase government spending to increase aggregate demand.

3. Exchange Rate Policy

Exchange Rate Policy is the devaluation and revaluation of a currency
in order to deal with a balance of payments deficit. Little needs to
be said here, since obviously with membership of the single currency
this will be out of the control of the British government and in the
hands of the ECB.

This leaves only Supply-Side Policies, which are rather limited in
their applications. They involve deregulation to lower costs of
production for businesses, and increasing labour productivity to
increase growth rate (by promoting competition, privatisation,
reducing strikes, etc.)

The main reason behind setting the Euro in the first place is to
promote economic growth within Euro zone countries.

Conclusion

Having analysed both the pros and cons of membership in the Euro zone,
I conclude that at this time it probably is not beneficial to join.
This is for two main reasons.

Firstly, the UK economy is at its strongest at the moment and has
still has prospects despite opting-out of the Euro for the moment.
Capital inflow is likely to continue even if we stay out of the single
currency and the UK still has attractive supply-side factors in both
product and labour markets for foreign investors. Particularly, the UK
will remain attractive for Far Eastern countries such as Japan and the
so-called tiger economies.

Secondly, I think that currently the risks outweigh the advantages
that would be gained. As mentioned before, the UKeconomy is at its
peak and is doing considerably better than other Euro zone members. If
the UK joined the Euro then it is highly possible that the less
fortunate countries will drag the UK down with them, as it were.
Furthermore, the ECB will likely have to take relatively drastic
action to keep some of the poorer economies in the Euro zone in check.
This could have adverse effects on the otherwise sound economy of
Britain. The problem is that the economies of the Euro zone are not
suitably synchronised to allow economic control to be universal over
all of them. Universal measures are the only option with a single
currency. If Britain opts-out for the time being until the single
currency has had a chance to both synchronise and improve the
economies of the Euro zone, then it might be in a better position to
offer advantages that outweigh the risks. On the other hand, if the
Euro fails miserably and its economies go into recession, then we will
be suitably distant from it to avoid unnecessary damage to our own
economy.

Bibliography

* Nuffield Economics & Business - Students Book

* Eurostat - www.europa.eu.it

* Bized - www.bized.ac.uk
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