Book Report: UK Membership of the Euro Macroeconomic Implications

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UK Membership of the Euro

Macroeconomic Implications of UK Membership of the Euro

Macroeconomic Implications of the United Kingdom's Membership of the Euro

Britain joined the European Economic Community (EEC) in 1973, later transformed into the European Union (EU). Today, the 500 million residents of the EU generate a 30% share of the nominal gross world product. The EU operates as a single market through a uniform legal system that fosters the free movement of people, goods, services, capital and common policies on trade, agriculture, fisheries, and regional development. In 2002, 12 EU members retired their own currencies in favor of the euro. Four more member states have since adopted this common currency, constituting a 16-state "eurozone." ( HM Treasury, http://www.hm-treasury.gov.uk/euro_index.htm)

For complex reasons the UK is not yet among them, although its stated policy is to eventually join in. The decision on membership of the single currency will be based upon the national economic interest. The government is committed to ensuring that the UK retains a genuine option to join the single currency, if that is what the government, Parliament and the people, in a referendum, decide. On the one hand, Britain stands to lose political and economic influence if it remains outside the EU monetary system. HM's government's policy on membership of the single currency is a set of five tests first set out by Gordon Brown in 1999, centrally whether the UK economy is blending with those of countries in the eurozone and whether this can be sustained in the long-term. The second test is whether there is sufficient flexibility to cope with economic change. The remaining three tests assess the impact of joining the euro on jobs, foreign investment and the financial services industry. (HM Treasury 2003)

So why the reluctance? The Euro's performance over recent years has been poor as measured by its value against the pound and U.S. Dollar, and the relative performance of the European and UK/USA economies. While a currency union can offer economic benefits under "boom" circumstances, the absence of exchange rates removes the best tools for adjusting imbalances between countries when their economies face hardships, e.g., Greece in 2010. History demonstrates that necessary devaluations will pull an economy up -- and many argue that the UK should retain this option. (Garganas 2003)

Also 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, inadequate for an effective system of re-distributive taxation. So long as the UK market has periods of inflation, a low European interest rate regime could prove to be very damaging. With capital mobility, flexible exchange-rate changes are unavailable to policy-makers, and the more often they are used, the less reliable a pegged exchange-rate system. (Wesley 1999)

In policy analysis terms, the implication of the Mundell-Fleming model is that monetary policy and fiscal policy constitute two separate policy instruments. However, government spending derives from taxation, borrowing, and/or money creation, so any analysis of monetary policy arguably must make consistent assumptions about fiscal policy. Monetary policy and fiscal policies under this view are not independent of one another, and must operate together in the EU. A workable exchange-rate regime depends upon the fair-dealing and trust between countries, the rule of law, respect for contracts and a stable political system. Tall orders indeed.

Macroeconomic forecasts are used by governments and large corporations for development and evaluation of economic policy and business strategies. What are the specific macroeconomic implications of UK's membership of the euro? The macroeconomic indicators influenced by such a decision include GDP, unemployment rates, and price indices. Macroeconomists develop models for such decisions that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. (Minford 2002)

A single currency obviates separate national monetary policies, and required the creation of a new central bank -- the European Central Bank -- that administers EMU monetary policy, in particular the setting of interest rates. That means a loss of separate national monetary policies -- interest rates and exchange rates. For example, should Italy want to fight back against unemployment, it cannot do so as this can only… [END OF PREVIEW]

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