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

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.