What are the arguments for and against joining the Euro

What are the arguments for and against joining the Euro

The Euro is a single currency arrangement that came into theoretical operation between 11 members of the European Union in January 1999. On January 1st 2002, 12 EU members got rid of their own currencies and introduced the Euro as their sole currency. If Britain joins the Euro, it will likely be in 2003.  The government has offered the British public a referendum on Britain's entry into it though some ministers have clouded the issue as to whether Britain's entry (or not) will be a political or an economic decision. Jack Straw, Home Secretary, has stated that a decision will almost certainly be a political one whereas the Chancellor, Gordon Brown, has stated that the 'Five Tests' will determine whether we join the Euro - i.e., any decision will be an economic one.

The Euro’s record since its introduction has been poor as measured by its value against the pound and US Dollar, and the relative performance of the European and UK/USA economies. It has only been in the summer of 2002, that its value against the dollar has picked up. However, unemployment in Germany, once the economic power-base of Europe, is high. In July 2002, Germany had a symbolic 'no-shop day' by Germans to protest about the tendency of firms, shop keepers etc to push up prices of commodities as against their price pre-Euro.

A single currency means that there are no longer separate national monetary policies, and instead a new central bank has been set up – The European Central Bank – that conducts a Europe wide monetary policy, in particular the setting of interest rates. That means a loss of separate national monetary policies – interest rates and exchange rates. Should Germany want to introduce an economic policy to fight back against unemployment, it cannot do so as this can only come from the European Central Bank.

These are some of the arguments put forward for Britain joining the Euro

Opposition to European Monetary Union (EMU) from the left, is grounded in stories from the past - a belief that EMU continues a tradition of overvaluing sterling in fixed exchange rate regimes. Though such over-valuation has occasionally been imposed, there is no clear evidence that periods of floating exchange rates have actually delivered the flexibility that is theoretically promised.

Gordon Brown’s ‘Five Tests’ for UK participation are largely met, particularly the advantages to the Financial Services sector.

Even without a floating exchange rate, relative labour costs can still adjust by changes in the wage rate and labour markets are currently attaining a flexibility that makes this feasible. Opponents of the EMU offer only textbook systems as an alternative, in reality floating exchange rates do not deliver stable and well-aligned exchange rates.

Reduced exchange rate uncertainty for UK businesses and lower exchange rate transactions costs for both businesses and tourists will bring an increase in economic welfare. Eliminating exchange rates between European countries eliminates the risks of unforeseen exchange rate revaluations or devaluation.

The EMU will be stronger and more resilient than the Exchange Rate Mechanism and will not be susceptible to the speculative attacks on the currency seen during the 1990s. The failure of the earlier ERM is not evidence against a currency union since individual countries possessed separate currencies and monetary policies within that system.

A European central bank will focus on economic conditions across the community and so will have a less volatile interest rate policy than the Bank of England, or other central banks. The credibility that attaches to the monetary policy of a European-wide central bank will render the Euro a strong currency and thus permit lower interest rates than at present within the UK – investment and growth are obvious beneficial consequences.

The prospect of sustained low-inflation under the responsibility of an independent European Central Bank should reduce long-term interest rates and stimulate sustained economic growth and competitiveness. The UK has a successful flexible labour market that would be highly effective inside a single currency area.

Though the EMU might restrain independent fiscal policy, it will not totally remove the opportunity.

Since around 20% of UK transactions are already dominated in US dollars, the demise of sterling will not produce totally unfamiliar circumstances. A common currency removes a significant barrier to free competition across national borders. A single currency promotes price-transparency – customers can readily assess the relative prices of similar products from anywhere within the union.

The large Euro zone will integrate the national financial markets, leading to higher efficiency in the allocation of capital in Europe. The UK will benefit from an increase in intra-European trade flows and higher capital investment resulting from the development of a single currency. The UK has been a major recipient of foreign direct investment in recent years. Some commentators believe that this would be threatened by non-participation in the currency union.

A single currency will be an important complement to the Single European Market, which would make the European Union a more powerful player in the global economy, and the UK might benefit from full-scale participation in this.

One country can no longer devalue its currency against another member country in a bid to increase the competitiveness of its exporters.

A European currency will strengthen European identity. Federal Europe is not necessarily going to be a consequence of a shared single currency.

The new Euro will be among the strongest currencies in the world, along with the US Dollar and the Japanese Yen. It will soon become the second most important reserve currency after the US Dollar. Britain stands to lose political as well as economic influence in shaping future European economic integration if it remains outside a new system.

These are some of the arguments put forward against Britain joining the Euro

Currency unions have collapsed in the past. There is no guarantee that EMU will be a success. Indeed the Euro may be a recipe for economic stagnation and higher structural unemployment if the European Central Bank pursues a deflationary monetary policy for Europe at odds with the needs of the domestic UK economy.

It is quite possible that the monetary union will not be sustainable; countries that discover themselves to be in difficulty may cancel their membership and re-establish an independent currency and an inflationary monetary policy. The example of Ireland’s departure from the sterling currency area suggests that leaving a currency union is beneficial, rather than joining one.

In theory, a currency union can offer economic benefits – but only under fortunate circumstances. The lack of exchange rates removes a very effective mechanism for adjusting imbalances between countries that can arise from differential shocks to their economies. History demonstrates that well-chosen devaluations can help an economy out of difficulties – the UK should retain this option.

In a recession, a country can no longer stimulate its economy by devaluing its currency and increasing exports.

The EMU is a step in a process that will cut Europe off from the rest of the world. It is bureaucratically motivated – a further advancement for European policy makers.

Entry would mean a permanent transfer of domestic monetary autonomy to the European Central Bank implying giving up flexibility on exchange rates and short-term interest rates. Domestic monetary policy would no longer be able to respond flexibly to external economic shocks such as a rise in commodity price inflation.

The UK is thought to be more sensitive to interest rate changes than other EU countries – in part because of the high scale of owner-occupation on variable-rate mortgages in the UK housing market. Joining a currency union with no monetary flexibility requires the UK to have more flexibility in labour markets and in the housing market. The UK rented sector is too small to be a flexible substitute for owner-occupation. The UK has instituted within the Bank of England a very effective apparatus for managing interest rates. The EMU will remove this policy lever, along with removing the opportunity for exchange rate policy.

Substantial fiscal transfers will be needed for 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 lack of any coordination between European monetary policy, emerging from a committee of central banks, and European fiscal policy, emerging from a committee of finance ministers, will further lessen the possibility for alleviating local economic difficulties. This can be shown with the South-North migrations of millions of American and Italian citizens in the early years of their currency unions.

The Euro will not be an optimal currency area – the European economies have not converged fully in a real structural sense and at some stage in the future, there is a fear that excessively high interest rates will be set because of an inflationary fear in one part of the zone which is unsuited to another area.

There are economic costs and risks arising from losing the option to devalue the domestic currency in order to restore international competitiveness. This might lead to growing social dislocation and rising economic inequality within the European Union.

There are fears about which countries might dominate the workings of the Central Bank and the effects on monetary policy within Europe if there are different inflation psychologies between member nations.

There are obvious structural differences within the countries of Europe so, even if EMU begins in a state of convergence, economic shocks, such as crisis of supply of primary products, will lead to imbalances and there will be no mechanism to restore the balance.

Since there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries. EU countries may have to increase their intra-EU transfer payments to help regions in need.

It may prove more difficult to sustain a currency union than to begin one. The EC tax revenue is only 1.5% of the gross domestic product, which is an insufficient basis for an effective system of re-distributive taxation. In the event of differential prosperity within Europe there can be no confidence that the more fortunate countries will permit a greater degree of re-distribution. For so long as the UK market structures remain susceptible to bouts of inflation, the move to a low European interest rate regime could prove to be very damaging.

There is no reason why the UK should not continue to attract foreign capital inflows even if initially outside the new currency arrangement.

Adjusting to a new European currency will involve substantial costs for businesses and banks. Adjustment to economic divergence by migration of labour or capital will be costly; there is no clear EC commitment to relieving these costs.

There are almost no instances in modern times of a newly formed fixed exchange rate regime surviving for more than five years.


MLA Citation/Reference

"What are the arguments for and against joining the Euro". HistoryLearningSite.co.uk. 2005. Web.






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