Should Britain Ever Join the Euro

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Should Britain Ever Join the Euro?
2
Why Monetary Union?

• Saving government from their own mistakes and
  those of others?
• Macro To tie hands of governments so they can't
  destabilise the economy because they risk causing
  inflation not reducing unemployment
• ie to set external constraints so control of
  inflation becomes sole priority of monetary
  policy, and limits set to borrowing
• reduce speculative instability impact in exchange
  rate
• Micro To promote trade by lower costs of doing
  business
• Political to promote deeper union

3
How do we work out effects?

• Compare two unknown scenarios one in and one
  out
• In is easier than out as EMU rules are fixed
• Out is harder as we dont know how we would
  actually exercise freedom of choice
• Counterfactual
• Even 30 years after accession we dont know what
  would have happened if wed stayed out of the EU.

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Economic theory of monetary union (1) Keynesians

• if policies don't work, give them up. Keep them
  if they do
• Keynesian economists believe governments can
  (maybe) control growth and unemployment by
  varying some or all of
• interest rates
• exchange rates
• government spending and taxation
• But some Keynesians believe that you cant
  control exchange rates so you should fix them and
  only use other policies. (Buiter)
• Monetarist economists believe government
  policies will always fail, because unemployment
  is fixed by market forces and attempts to do so
  only provoke inflation. And politicians will be
  tempted to create inflation. We should leave it
  to central bankers to keep inflation down.
• If policies dont work then risk of their misuse
  may destabilise markets so governments should tie
  their hands.
• Monetarists and exchange rate sceptics agreed on
  EMU but not on how it should run.
• Monetarist model won politically at Maastricht

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Economic theory of monetary union (2) Monetarists

• Monetarist economists believe government policies
  will always fail, because unemployment is fixed
  by market forces and attempts to do so only
  provoke inflation. And politicians will be
  tempted to create inflation. We should leave it
  to central bankers to keep inflation down.
• If policies dont work then risk of their misuse
  may destabilise markets so governments should tie
  their hands.
• Monetarists and exchange rate sceptics agreed on
  EMU but not on how it should run.
• Monetarist model won politically at Maastricht

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The Rules of the game Eurozone

• Maastricht Treaty 1992 and Stability Pact 1997
• 1) Eurozone
• ECB sets interest rates for all Eurozone to
  ensure price stability
• Member governments set fiscal policy (national
  tax and spending) but subject to fairly rigid
  rules

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The Rules of the game UK

• 2) UK
• In UK Treasury sets inflation target and then
  Bank of England sets interest rates
• Treasury sets medium term macro policy
• British government is not legally bound by
  Stability Pact
• UK has been growing slightly faster than Eurozone
  since 1998
• Government has dilemma can only advocate entry if
  its own policies are seen to fail.
• UK government since 1997 officially committed to
  joining Euro if it is in UK economic interest.

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5 tests (1)

• 1) Convergence Are business cycles and economic
  structures compatible so that we and others could
  live comfortably with euro interest rates on a
  permanent basis?
• Overall, at the present time, while the extent of
  convergence with the euro area has significantly
  increased, the convergence test is not met.
• 2) Flexibility If problems emerge is there
  sufficient flexibility to deal with them?
• Overall, at the present time, we cannot be
  confident that UK flexibility, while improved, is
  sufficient. Reflecting this, at the present time,
  the achievement of sustainable and durable
  convergence has not been demonstrated.

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5 tests (2)

• 3) Investment Would joining EMU create better
  conditions for firms making long-term decisions
  to invest in Britain?
• If sustainable and durable convergence is
  achieved, then we can be confident that the
  quantity and quality of investment would increase
  ensuring that the investment test was met.
• 4) Financial services What impact would entry
  into EMU have on the competitive position of the
  UK's financial services industry, particularly
  the City's wholesale markets?
• Overall, the financial services test is met.

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Growth, stability and employment (1)

• will joining EMU promote higher growth, stability
  and a lasting increase in jobs?
• EMU membership could significantly raise UK
  output and lead to a lasting increase in jobs in
  the long term. As noted above, the assessment
  shows that intra-euro area trade has increased
  strongly in recent years as a result of EMU,
  perhaps by as much as 3 to 20 per cent that the
  UK could enjoy a significant boost to trade with
  the euro area of up to 50 per cent over 30 years
  and that UK national income could rise over a
  30-year period by between 5 and 9 per cent..
  Overall, we can be confident that the growth,
  stability and employment test would be met once
  sustainable and durable convergence has been
  achieved.

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Growth, stability and employment (2)

• Overall the Treasury assessment is that since
  1997 the UK has made real progress towards
  meeting the five economic tests. But, on balance,
  though the potential benefits of increased
  investment, trade, a boost to financial services,
  growth and jobs are clear, we cannot at this
  point in time conclude that there is sustainable
  and durable convergence or sufficient flexibility
  to cope with any potential difficulties within
  the euro area. So, despite the risks and costs
  from delaying the benefits of joining, a clear
  and unambiguous case for UK membership of EMU has
  not at the present time been made and a decision
  to join now would not be in the national economic
  interest. 

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Economic Performance Eurozone, UK vs USLittle
obvious superiority of Eurozone or sign of
improvement
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Has better UK performance been achieved by more
inflation or more debt?
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UK EMU verdict

• Economic tests cant really predict future of in
  vs out for anyone.
• You must compare 2 scenarios
• in over next 40 years vs out.
• For 1950-1990 wed have been better with Germans
  running our macro policy but not since 1990
  what will next 40 years be like?
• It depends on whose policy judgements you trust
  most and whether you think governments can
  control the economy
• If you dont think government policy can work,
  you want a MU with all power to central bankers.
• If you think go it alone is fine, go it alone
• Financial instability since summer 2007 may
  reopen debate