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The UK and the Euro The Euro represents a huge step for member states, both economically and politically, and was adopted by 11 countries of the European Union in 1999. These countries have given up their own currencies, and have instead given control of currency to the European Central Bank (ECB). Some would argue that when joining the Euro, some countries did not consider economic impact as a priority, instead supporting it on political grounds, in order to enhance the European Project. There are now 15 member states using the Euro, with more set to join once they meet the convergence criteria. The Euro is used by around 320 million citizens, and is now a very major world currency. The single currency was the final stage of the EMU, Economic and Monetary Union. The first stage was free capital movement, closer coordination of economic policies and closer cooperation between central banks. The European Monetary Institute was initially created, but this then became the ECB, and the euro became the fledging currency it now is. To join the Euro, states must meet the convergence criteria. This is because if countries with unstable economies or significantly different economies to the rest of Europe join the Eurozone, then this could result in a destabilization of the currency, and economy of the Eurozone. However this policy is less than effective in ensuring its aims, as of course all economies are dynamic, not static, so as time goes by the economies may easily drift apart and away from the initial convergence criteria, and it seems foolish to accept an economy into the Eurozone based on economic performance of a short period of time, which may not be sustainable. However despite its shortcomings, the convergence criteria are an important attempt to try to keep the currency stable throughout its expansion. The convergence criteria includes the following: the ratio of government deficit to GDP must not exceed 3%, and the ratio of government debt to GDP must not exceed 60%. There must be price stability and an acceptable inflation rate, judged over one year, and must not exceed 1.5% difference to the 3 member states with best price stability. Interest rates must not exceed by more than 2%, the interest rates of the three best performing states. Finally, the exchange rate of the currency needs to be fairly stable. Once a nation has fulfilled these criteria, it can join the Euro. The criteria reduces tension between Eurozone states, and creates more balance within the Eurozone. So why would we want to join the Euro? It is fair to say that there are a good number of economic reasons for doing so. Considering that 60% of our trade is with the EU, these benefits would be particularly applicable to our situation. Firstly, lower transaction costs in terms of currency exchanging will benefit businesses, encouraging more investment, and also be good for tourists and travelers who will no longer need to change to another currency. Using a single currency will also eliminate risks for businesses associated with exchange rate fluctuations. This makes it easier for businesses to plan, increases confidence, and thus increases investment. This investment not only increases demand, but will lead to an increase in supply, and productivity, keeping inflation low, and allowing our economy to grow. If the ECB could give Britain low inflation and interest rates, then we would also stand to gain. Low inflation will lead to low interest rates, stimulating faster growth and improving competetiveness. As a larger currency, the Euro should also become less susceptible to speculative currency attacks by foreign traders. It is believed that the UK would probably receive more foreign direct investment if it joined the Euro, and Japanese multinationals have urged Britain in the past to join the Euro. The single currency will increase price transparency, and increased competition will keep prices down. These will be major benefits to the consumer, and to society. We could also become more politically isolated if we chose to remain outside of the single currency. However there are equally significant reasons for not joining the single currency. Some would argue that the Eurozone economies are structurally different, and this will undermine the success of the project. The blanket interest rates of the ECB could be very damaging to our economy, as the ECB cannot have an interest rate to suit all member states. However by maintaining monetary independence, we can optimize our interest rates to suit our country. The ECB has been quite draconian about controlling inflation, which has led to growth stagnation and high unemployment in the past. Britain is also affected more by interest rates than the rest of Europe, because we have a higher percentage of homeowners with variable rate mortgages. Also our businesses rely more heavily on debt to fund investment, rather than issuing new equity. Another problem is fiscal transfers. We would be expected to fund more development in other parts of the Eurozone in order to help balance the member state economies. However our government may not be willing or able to undertake this burden, as we already have a large budget deficit, and Northern Rock liabilities absorbing much of our public finances. We must also look at the success of our economy outside of the Eurozone. The independent Bank of England has successfully controlled inflation, with aggressive changes in interest rates, and apparently astute monetary decisions with hindsight. Other European economies are also doing well outside of the Eurozone and indeed the EU, for example Iceland, Norway and Switzerland. Iceland has some of the highest living standards in the world, and Norway owns the world’s second largest sovereign wealth fund in the world, bigger than China’s, Singapore’s, Kuwait’s or Saudi Arabia’s. The government proposed five economic criteria that must be met in order to justify joining the Euro. Until these are met, it seems we will be maintaining the pound as the currency of the UK. The first of these is economic harmonization. This refers to the fact that the UK must be experiencing similar economic cycles to the Eurozone, in order to be compatible with interest rates from the ECB. The second test is flexibility. This tests whether the UK government would have enough power left to deal with a recession. Its not only monetary policy that would be restricted, the Stability and Growth Pact also puts limits on government borrowing and fiscal policy, which would further impede the government’s ability to cope with a UK recession. The third test is the effect on investment. Here in the UK we need investment from overseas for growth and economic progress, therefore we want to remain competitive, and this test will analyse the impact on this sector of joining the Euro. The fourth test is the impact it will have on our financial services industry, as this is a major sector of our economy, London being a top global financial centre. The last test is the effect on growth and jobs- will it help promote higher growth, stability, and sustainable job increases? I personally think that the UK should not join the Euro until it really needs to. It seems that our economy simply isn’t a close enough match to the rest of the Eurozone for the Euro to make sense, as things stand. If we join now we are subjecting ourselves to risks to our economy, as no one can reliably predict exactly what effect it will have on us, and once we are in, we will find it very hard to leave the single currency. Why join when we are doing perfectly well outside the Euro? However the global credit problems will put an interesting slant on the debate, as maybe our economy will not be as fortunate this time compared to the rest of Europe. We could find ourselves in a situation where we are more compelled to join. The five tests for joining the Euro are an effective instrument for measuring the incentive to join. They are free from political bias, and should indicate when it will be a good time to join the Euro. However it shouldn’t be rushed into, and if it takes 10, 20, or more years until we do join, this is not a problem as long as these tests have been followed. We must not allow political agenda to damage the prosperity of our economy. We must not join the Euro, in order to ‘further the European Project’. I believe this would be a terrible mistake for our country. |