Britain and the European Single Currency Term Paper

Excerpt from Term Paper :

Euro had a positive effect upon its members?

The euro has been the currency of the European Monetary Union (EMU) since January 1, 1999 (Auswartiges Amt, 2004). The euro was introduced slowly for member states. It has been a deposit currency since January 1999 and notes and coins have been in circulation since January 2002. Since March 2002 most European countries have exclusively used euro and cent as their currency.

The euro has become a new global currency as a transaction currency for trade and a reserve currency alongside the dollar (Auswartiges Amt, 2004). Thus, its benefits are vast, opening new doors for the euro zone representing a population of nearly 300 million, about 20% of global output and a 16.6% share of world trade. According to estimates by the IMF (International Monetary Fund) and the OECD (Organization for Economic Cooperation and Development) the euro is more than just the sum of its parts. Europe's voice in the further development of the world trade and finance system has been increased considerably by the single currency.

However, not all countries in Europe have joined the single currency to date. Along with Sweden and Denmark, the UK elected not to join. The UK negotiated an opt-out of joining the euro when it signed the Maastricht Treaty. The current Labour government has, however, demonstrated a commitment to holding a referendum when it determines that the economic conditions for joining are right.

This paper aims to analyze the impact of the UK's decision not to participate in an effort to conclude if the UK would be benefited by joining the single currency.

Hypothesis

Recently, Britain's Labour party was re-elected with a policy of holding a referendum to decide whether or not Britain should adopt the European single currency (Euro Facts, 2004) in future years. British Prime Minister Tony Blair describes the decision over whether or not to join the euro as a priority for future generations. In an effort to determine whether economic conditions are right for joining the euro, the British government issues a series of 5 economic tests. As of 2003, the tests had not been passed, halting the UK's membership. Still, the British government remains committed to promoting membership of the euro.

Because the 5 tests were not passed, the debate over whether to adopt the single currency remains (Euro Facts, 2004). Statistics show that the UK has much to gain from joining the euro, as European monetary union means much more than just sharing the same notes and coins as other countries in the eurozone. Adoption of the single European currency would bind the economic fortunes of the U.K.more tightly to those of continental Europe. With the expansion of the EU and new members committed to joining the euro, it seems that the UK will eventually be isolated from Europe if it does not join.

This paper will examine the positive and negative sides of the decision to join the euro, hypothesizing that the UK could benefit from membership. The main objective of this paper is to provide a recommendation for the future of the UK in relation to Europe's single currency.

Methodology

Membership of a country in the Economic and Monetary Union (EMU) promised members valuable changes (Rinkinen and Hannu, 2004). This study takes a look at the effects of membership. This report will show how Britain could prosper by joining the single currency.

Literature Review

Soon, the UK will need to decide whether or not to join the euro. For the British, this raises many important questions. Will the Government lose control of the economy if it joins or will it lose investment and weaken our international voice if it does not? When, if ever, will the time be right to join? Paul Temperton, in The UK and the Euro (2001) provides an excellent source for this literature review as he explains the pros and cons of the UK joining the euro.

As members of EMU, eleven European Union countries introduced a single currency - the euro - in January 1999. The United Kingdom did not join the single currency, but British companies are still affected, especially the majority that buy and sell products in the euro zone. Also, UK businesses that do not export or import have been affected through their supply chains. Thus, UK businesses must consider how the euro might affect them and why it is important to join the single currency.

When looking at the European single currency, it is easy to image a loss of British identity and the creation of a European superstate. However, this is a misguided image, mainly the result of claims appealing to nationalistic sentiments. This draws attention away from the true nature of the debate: the economic case for and against the euro. Thus, it is important to examine the pros and cons of the UK's implementation into the single currency.

The euro stands to benefit the UK in many ways (Templeton, 2001). A single currency should end currency instability by irrevocably fixing exchange rates and reduce it outside of Europe. Because the euro would have the enhanced credibility of being used in a large currency zone, it would be more stable against speculation than the pound is now. An end to internal currency instability and a reduction of external currency instability would allow exporters to project future markets with greater certainty, unleashing a greater potential for growth.

Secondly, British consumers would no longer have to change money when traveling and would have fewer problems transferring large sums of money across borders. Also, if a family made a large purchase or transaction across a European border, such as buying a holiday home or a piece of furniture, the transaction would occur more smoothly.

In addition, businesses would no longer have to pay hedging costs in order to insure themselves against the threat of currency fluctuations, as they must do today. Businesses, involved in commercial transactions in various member states, would no longer have to face administrative costs of accounting for the changes of currencies, plus the time involved.

Finally, a single currency would likely result in lower interest rates as all European countries would be locking into German monetary credibility. The stability pact (the main points of which were agreed at the Dublin summit of European heads of state or government in December 1996) will force EU countries into a system of fiscal responsibility which will enhance the euro's international credibility. This should lead to more investment, higher employment rates and lower mortgages.

On the other hand, there are some disadvantages (Templeton, 2001). Fifteen separate countries with widely differing economic performances and different languages have never before attempted to form a monetary union. It works in the United States because the labor market is mobile, assisted by the common language and financial systems across a large geographical area. Language in Europe is a huge barrier to the employment market.

Also, all EU countries have different cycles or are at different stages in their cycles. The UK is growing relatively well, Germany is having difficulty. Thus, one central bank cannot set inflation at the appropriate level for each member state.

Loss of national sovereignty is perhaps the greatest disadvantage of monetary union. The transfer of money and fiscal competencies from national to community level, means that economically strong and stable countries would have to cooperate in the field of economic policy with other, weaker, countries, which are more tolerant to higher inflation.

Finally, it is expensive to introduce a single currency. According to the British Retailing Consortium, British retailers will have to pay between £1.7 billion and £3.5 billion to make the changes necessary. These changes include educating customers, changing labels, training staff, changing computer software and adjusting tills.

Despite the disadvantages, the UK still seems to have much to gain from joining the euro. "It seems safe to conclude that the common currency has had and will continue to have large benefits for European finance. At a minimum, the single currency eliminates exchange-rate risks that exist when securities are denominated in different currencies. The single unit of account seems also likely to reduce transaction costs and eliminate a portion of the fixed costs involved in issuing similar securities in multiple currencies. These factors are already serving to moderate home bias in borrowing and lending, leading to larger, more-liquid, and more-diversified financial markets."

Basically, the British government is in favor of UK membership of EMU; however, leaders do not feel that economic conditions are quite right. The key factor is the national economic interest and whether the economic case for joining is clear and unequivocal. For assessment purposes, the British government will take a decision on whether the five tests have been met. If the government recommends UK entry, it will be put to a vote in Parliament and then to a referendum of the British people. Government, Parliament and the people must all agree to join.

The euro has enjoyed great success thus far, so it…

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