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Should Britain Ever Join the Euro

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In' is easier than out' as EMU rules are fixed ... Monetarists and exchange rate sceptics agreed on EMU but not on how it should run. ... – PowerPoint PPT presentation

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Title: Should Britain Ever Join the Euro


1
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.

4
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

5
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

6
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

7
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.

8
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.

9
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.

10
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.

11
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. 

12
Economic Performance Eurozone, UK vs USLittle
obvious superiority of Eurozone or sign of
improvement
13
Has better UK performance been achieved by more
inflation or more debt?
14
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
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