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Arguments against the UK joining the euro Critics of the Euro argue that the new currency does not meet the requirements of an optimal currency area and that structural economic differences between countries will undermine the success of the project. Other economists believe that the UK can continue to prosper as an economy outside the Euro Zone whilst still deriving some of the benefits from participation in the single European market. Risk of deflation and higher unemployment Currency unions have collapsed in the past. There is no guarantee that EMU will be a success. It may prove to be a recipe for economic stagnation and high unemployment if the ECB pursues a deflationary monetary policy for Europe to keep inflation within the 2% limit. Many economists have been critical of the reluctance of the ECB to cut interest rates during its first three years in operation. The ECB seems to have been trying to build up anti-inflation credibility - but this has depressed economic growth in the Euro Zone Euro not an optimal currency zone The Euro Zone does not meet the conditions required for an optimal currency area. By this we mean that within the Euro Zone countries there is geographical immobility of labour and there is insufficient wage flexibility inside European labour markets to cope with external economic shocks Member economies have not converged fully in a real or structural sense. Although there has been a substantial amount of nominal economic convergence during the run up to the establishment of the Euro, there are still huge differences in the economic performance of member nations. And, at some stage in the future, there is a risk that excessively high interest rates will be set across the Euro Area because of an inflationary fear in one part of the zone that is unsuited to another area. Loss of monetary policy autonomy Joining a single currency reduces Britain's monetary policy autonomy. Britain might be better off if she retains the flexibility to set interest rates to meet her own economic objectives. Entry to the Euro Zone means a permanent transfer of domestic monetary sovereignty to the European Central Bank. Member countries have signed up to the fiscal stability pact that means there is little scope for fiscal policy to cushion the effects of economic shocks affecting different countries in different ways. The stability and growth pact limits national budget deficits to 3%. And the EU budget is not big enough for international transfers to take the strain instead. Britain is more sensitive to interest rate changes than other EU countries - in part because of the high scale of owner-occupation on variable-rate mortgages. Joining a currency union with little monetary flexibility requires the UK to have more flexibility in labour markets and in the housing market. But the rented housing sector is too small to be a good substitute for owner-occupation and major changes will have to be made to the structure of housing finance. " British companies rely more heavily on debt finance to pay for their investment projects rather than the issuing of new equity (shares) through the capital markets. They are more exposed to changes in interest rates than businesses in other EU countries. Demand for European Fiscal Transfers Substantial fiscal transfers will be needed to aid poorer countries within the EU along with a more activist European Regional Policy to reduce structural economic inequalities. The UK might not feel able to afford such large-scale intra-European transfers. " The change over process to the introduction of the Euro will involve substantial menu costs for businesses and banks. These menu costs will bear heavily on small-medium sized enterprises. " Britain can continue to attract capital inflows outside of the Euro Zone. Favourable supply-side factors in both product and labour markets make the UK an attractive venue for foreign investment. Europe's labour and product markets are too inflexible to deal with the economic strains that EMU will put on them. If interest rates, exchange rates and fiscal transfers cannot be called on to deal with economic shocks such as a burst of imported inflation, then wages and prices will have to do the job. " The European Central Bank is too secretive and operates with an inflexible non-symmetrical inflation target. By contrast, the Bank of England's success in keeping inflation within target and at the same time cutting interest rates aggressively to avoid recession in 1999 may have undermined the case for early entry into the Euro Zone for the UK. |