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Student name: Minh Quyen Pham (Q) Class: IPE1 Title of essay: An evaluation of the advantages and disadvantages

of adopting the Euro. A case study of The UK


1. Background of the Euro.

According to Szasz (1999), after the second World War, European politicians had a idea of European integration. In 1957, the treaty of Rome was signed by Belgium, France, West Germany, Italy, Luxemburg, and the Netherland, and the European Economic Community was created. In 1969, the European Monetary Union (EMU) was formed by the European Community as a milestone in the whole process of monetary integration. Unfortunately, it did not succeed.

The year 1979 was one of the most important points on the process of monetary integration in Europe. The European Monetary System (EMS) whose cores are the Exchange Rate Mechanism (ERM) and the European Currency Unit (ECU) was created. In this system, a central rate was calculated and used to find out a grid of mutual central rate. The oscillation bands at 2.25% on the side of the central rate were set for the most currencies except some weak currencies with margin of 6% (Szasz). After 1992-1993 ERM crises, the European Community decided to increase the bands to 15% in most currencies except Deutsche Mark and Dutch Guilder, which remained at 2.25% (Buckley, 1996).

Maastricht Treaty signed in 1992 was a turning point of European monetary integration (Eric, Pentecost and Poeck, 2001). The treaty divided the integration process into three stages.

The first stage was from July 1990 to December 1993. At this stage, with regard to the capital movement liberalisation, a enormous process had been made. The members decided the European System of Central Bank was

combined of the European Central Bank (ECB) and the national central banks of the members. The target of this stage was single market, which concerns free movement of goods, services and capital (Eric, Pentecost and Poeck, 2001).

The second stage would happen between January 1994 and December 1998. This time was final alteration for national legal systems to adapt a new currency. The European Monetary Institute (EMI) was founded with the

introduction of the new common currency. The EMI was to compose and publish operational framework for the single monetary policy. At the end of this stage, on May 1998, at the European Union summit in Brussels, the EMI was changed into the ECB, and the permanent mutual exchange rates between the currencies of the country members was broadcasted as well as the first production of euro notes and coins Eric, Pentecost and Poeck, 2001).

The last stage of the integration process was from January 1999 to July 2002. This stage would be separated in two phrases. The first phrase was from 1999 to the end of 2001. It started with the legal introduction of the euro in eleven country members. However, there were no coins and notes distributed at this time. In addition, the ECB has had responsibility for common monetary policy and all governments began to be issued in the euro (Scheller, 2004). The last phrase of this stage was the first six months of 2002. In this phrase, the euro notes and coins performed for the first time and national currencies were withdrawn. During this phase Greece, after fulfilling convergence criteria, joined the EMU.

3. The disadvantages of joining the Euro 3.1 Difficult in getting out of recession 3.2. Sensitivity to interest rates. The countries using the Euro are set one interest rate for the whole of the Euro Zone by The European Central Bank. This policy will affect significantly on the economy of most members countries, in particular those with a weak currency and higher interest rates than the interest rates of the Euro such as Greek, Ireland, Italy, Portugal, and Spain (Lane, 2006). As a result of the 2

lower interest rates, the banks within these countries are easier to borrow huge amounts (a budget deficit above 3% of GDP imposed on the Eurozone initially) and rise their public debit and levels of privately held consumer debt (Redwood, 2011). After the financial crisis in the late 2000s, these countries government recognized the necessary of bail and nationalisation in their privately held banks to prevent systemic failure of the banking system (Godement and Klau, 2011). Via growing government bond interest rates, it rose the high levels of public debt to a level the markets began to deliberate unsustainable. According to Cameron (2005), The nature of the UK housing market incomes the UK economy is sensitive to changes in interest rates. In fact, most UK householders own their own house, their variable mortgage is a high percentage of their income. Thus even a 0.25% change in interest rate can significantly affect disposable income. If the UK had adopted the Euro, interest rates would be set by the European Central Bank. But the ECB looks at the whole Euro, not only the UK. Consequently, the interest rates would fall dramatically. It would cause a further boom in the housing market, which would lead to an inflationary boom.

3.3 Loss of independence of Fiscal Policy.

Fiscal policy is used to control total demand and it is related to monetary policy closely. Fiscal policy regulates the amount of taxation and government spending (Valdez and Molyneux, 2010). If a country adopts the Euro, it will lose a part of control in fiscal policy. The country will depend on the EMU fiscal policy, which is limited in public sector debt to income at 60% and public sector borrowing to income ratios at 3% (ElAgraa, 2002). The countries, which participated in EMU, must follow the policy. It is not permitted to adjust taxies, borrowing and money creation, which is the best for each country. Again, it is another difficult to leave the recession because when the recession happens, the government needs

to increase taxes to expand income. But it is impossible because the EMU does not look only the country to alter the policy, it looks whole the countries which in the Euro.

In case of the UK, if the UK joins the Euro, it will lose the flexibility in controlling fiscal policy. The UK must adopt the monetary policy, which is decided by the ECB, such as fixed interest rates and exchange rates. Although bank of England will have a seat on the board of ECB, it only has a slight control, about a thirteenth voting power. Instead of complete control in the UK economy,

Reference:

Mercado, S., Welford, R. and Prescott, K. (2001), European Business, 4th Edition, Prentice Hall. http://www.ecb.int/stats/monetary/rates/html/index.en.html Lane 2006 http://www.eabcn.org/research/documents/lane.pdf Redwood 2011 http://www.investmentweek.co.uk/investment-

week/opinion/2076100/redwood-origins-euro-crisis Godement and Klau 2011 http://www.ip-global.org/wp-

content/uploads/2011/02/211_Godement-Klau.pdf Cameron http://hicks.nuff.ox.ac.uk/users/cameron/papers/ukhousingmarket.pdf House price crash 2011 http://www.housepricecrash.co.uk/graphs-base-rateuk.php 2005

Valdez and Molyneux, 2010 An introduction to global financial markets http://prism.talis.com/northumbriaac/items/1508599?query=financial+introduction&resultsUri=items%3Fquery% 3Dfinancial%2Bintroduction

Szasz

1999

http://prism.talis.com/northumbria-

ac/items/853140?query=european+monetary&resultsUri=items%3Fquery%3D european%2Bmonetary

Buckley 1996 The essence of international money, Prentice Hall, London 1996, p. 140147

Eric,

Pentecost

and

Poeck,

2001

http://prism.talis.com/northumbria-

ac/items/965466?query=european+monetary+integration&resultsUri=items%3 Fquery%3Deuropean%2Bmonetary%2Bintegration

Scheller http://www.ecb.int/pub/pdf/other/ecbhistoryrolefunctions2004en.pdf

2004

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