Report on the UK adopting the single currency

The European Union has been embarking on a critical phase in its evolution towards greater economic and political integration with the formation of an economic and monetary union (EMU).

Great confusion exits in Britain when considering this issue. The British Government holds a wait and sees policy, whilst the citizens remain uncertain with no definite leads from either of the main parties. With regards to Britain’s past involvement in European Integration, it is continuing to show reluctance by remaining two steps behind everyone else. Consequently in this report I will critically assess the economic issues raised by the Single Currency for both the EU as a whole and the UK, in doing so it is important to The concept of greater economic co-operation began to take shape when the European Economic Community (EEC) was created in 1957 from the Treaty of Rome. However, it was not until 1970, when the Werner report was published, that the process of introducing several stages for an EMU was developed. The Werner report set out three stages, but the process did not take off, due to the lack of convergence in the economies of the member states.

The Delores Committee report of 1989 was thought by many, to have taken the EMU to the forefront of the European debate. The report defined the EMU, as a once and for all locking of exchange rates, leading to the adoption of single currency, in three key stages.

Stage 1. The aim was to remove the restrictions of all capital movements between member states, the strengthening of competition policy, accelerating the single market program, increasing regional funds, and improving economic and monetary co-ordination within the framework of the EMS.

Stage 2. Emphasis was placed upon closer economic policy co-ordination. The European Monetary Institute was created which had two main two main tasks:

To strengthen co-ordination and monetary policies between EU central banks, with the objective of ensuring price stability.

To prepare for stage three, including the establishment of the European System of Central Bank (ESCB), which is the institutional structure required by the Maastricht Treaty for conducting the common monetary policy for all the Euro member states.

Stage 3. Would commence with the move to irrevocably locked exchange rates and the introduction of a single currency to replace national currencies. The ESCB would be responsible for the implementation of monetary policy, and exchange rate.

The Maastricht treaty, which was established in 1991, adopts the, Reports Proposal for a single European currency, and European Central Bank. It also defines a timetable for the establishment of a Monetary Union and most importantly provides convergence criteria for the member states, which must be achieved before the last stage of the monetary union can be entered.

EMU has become a dominant issue in British politics. The UK’s past political leaders have had difficulties dealing with EMU. The issue has contributed to the downfall of the three most senior and influential figures in British politics in the 1980’s, Margaret Thatcher, Nigel Lawson, and Sir Geoffrey Howe

There has been great uncertainty as to the intentions of Britain. The EMU has provoked a, “sitting on the fence,” reaction. The chancellor made the decision to opt-out of the start of stage three on the basis of five economic tests, which UK economy had to meet before entry would be considered

Advantages for UK adopting the Euro

An initial benefit is that transaction costs would be substantially reduced. As a single currency would be circulating in the community having replaced the various national currencies, companies and individuals would no longer have to transfer between currencies as they make purchases or invest in countries around the EU.

Interest rates could be lower. The stabilization of exchange rates would reduce the risks to investors. This will then enable governments to decrease the risk premium they are required to pay on government securities. Intensified price stability in some of the member state countries, along with an improved EU average inflation performance would also encourage lower interest rates. The European Commission has estimated that such reduced borrowing costs, resulting from EMU, could increase the overall output of the EU by 2%.

Internal EU exchange rate stability would be achieved once and for all. With advantages for investment, and improvements in the productive capacity for European industry.

The introduction of a single currency would eliminate certain speculation against individual European Currencies. An example of this is when the currency crisis threw the Pound out of the EMR, causing a cost of billions in lost foreign exchange reserves. This type of risk would completely disappear.

The single currency of Europe, the Euro, would become a leading world currency, alongside the dollar or yen. This would lead to increased interest world- wide.

It would also make it easier to achieve and sustain more growth-orientated macroeconomic policies.

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.

A single currency will eventually produce a European GDP, which is higher than that of the USA or Japan and thus will be extremely powerful in economic terms.

The economic arguments are further sub-divided into three groups: transaction costs, trade competition and investment. Ultimately, abstaining from the Euro means higher costs (as far as transaction costs are concerned) than if we joined. 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 UK exports 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. This has the advantage of creating competition between countries (which leads to prices leveling 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 removal of transaction costs associated with exchanging currency has another effect. Intra-European investment flows would likely increase. This means that companies across the Euro zone would benefit from increased investment from other Euro zone countries.

Ultimately a 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 possibly more stability.

Disadvantages For UK adopting the euro

One of the main advantages of staying out of the EMU would be retaining the use of the exchange rate, as a macroeconomic tool. The UK would also lose the ability to set it’s own interest rates to suit her domestic economic conditions. The ECB would conduct monetary policy to stabilize prices in the EMU are as a whole. If the UK’s economy were in line with the rest of the EMU area, then the ECB’s monetary policy would be suitable. But if the UK’s economic conditions were contrary to those in the rest of the EMU area, then the interest rate would be unsuitable for the UK’s economy, and it would possibly destabilize the economic conditions

Those who oppose the EMU, argue that it will threaten our sovereignty, impede growth and employment, reduce our purchasing power, and dangerously split the EU into two tiers, and eventually collapse leaving an economic mess.

With regards to the question of sovereignty, “Where a parliament is sovereign it has an unlimited authority, recognized by the courts, to make any law or to amend any law made. ” In Europe, abandoning the national currency in favor of the proposed Euro appears to many, to signify a loss of nationhood. By joining an EMU a nation will hand over its monetary policy to the ECB, and consequently loss its control over national money.

There will also be change over costs, including the process to change from national currencies to one single currency which will effect both business and trade, these are essentially short term costs, but are of some significance.

The main cost associated with the EMU is the loss of monetary independence, and adopting to a, “one fits all” approach. Accepting a single currency requires giving up the use of the nominal exchange rates as a tool for macroeconomic adjustment and as a means of gaining competitiveness. Exchange rate adjustments can help to stabilize economies through the booms and slumps of an economic cycle, or unusual shocks, but once a, “one fits all,” policy is implemented this will not be possible. Asymmetric shocks could lead to deep regional recessions and increasing unemployment, creating social burdens that is politically unacceptable to many governments. Consequently alternative mechanisms in adjusting to asymmetric shocks in EMU will need to be found. In the case of asymmetric shocks where there is a shift in demand from country A to country B, then an aggregate demand would go up in country B and down in country A.

If there is a shift in relative demand across countries, and real exchange rate does not adjust, there will be unemployment in the country where demand has been reduced unless there is migration towards the country where demand has increased. However labour movements across EU countries are very limited. And while it might be argued that labour mobility might increase as economic and monetary integration proceeds, it should be acknowledged that numerous historical, cultural and linguistic differences in European countries would prevent migration. Thus due to low labour movements and mobility migration will be an extremely limited tool to cope with asymmetric shocks in EMU.

If labour markets are flexible then this problem will resolve itself quickly, e.g. if wages were flexible, country A would lower its wages thereby allowing prices to fall, which would make its products more competitive and consequently stimulate the demand required to restore equilibrium to the economy. However wages and prices are not flexible enough to cope with asymmetric shocks in the EC, and therefore Fiscal policy would be used to control the situation, by either raising taxes, or cutting government spending. But evidence shows that national governments pursuing active demand management policies have often conducted poor measures, making the economies far more volatile. “Fiscal austerity in, ‘good times’, would thus be price to pay to be able to exercise fiscal flexibility in, ‘bad times’