Benefits versus costs of adopting the Euro for the UKAn Optimum Currency Area Theory

approach

Introduction Optimal Currency Area framework

Three economic criteria: 1. Labor Mobility

2. Production Diversification

3. Openness

Three political criteria: 1. Fiscal Transfers

2. Homogenous preferences

3. Commonality of destiny The Economist survey: 67% of macroeconomists – favor

joining EMU, 75 % of monetary economists – are against

Labor Mobility Importance of asymmetric shocks

Movement of labor from recessionary to expansionary countries

Irrelevance of exchange rates assuming perfect labor mobility

Labor Mobility Low movement of people in Europe as

compared to US ( language, culture, legal barriers )

UK vs. Continental Europe - Different market regulation philosophies( e.g. difficult lay offs in France )

Labor mobility across European countries is lower than the one within countries

Conclusion: Labor Mobility criterion- unfulfilled

Production Diversification Kenen : Exports and Production

diversified and of similar structure

Response to asymmetric shocks

Decreases in demand or supply of one product are leveled off by increases in the demand and

supply of another product

Production Diversification UK’s market – “sectoral liberalization” in

housing and retail – more diversified than Continental Europe

Major structural differences:UK -mortgage debt 57% of GDP > EU’s 33% in 1997 -short term debt & equity issuance UK – exporter of OIL ( e.g. high demand in Italy and

Germany) not sure for how long

Conclusion: Kenen criterion- unfulfilled

Openness McKinnon:countries trade heavily with

each other, then- monetary policy insignificant- prices adjust rapidly

Is UK heavily engaged in trade with the rest of the EU member states?

Core-periphery dichotomy

Openness UK’s ratio of exports and imports to GDP

towards the rest of the Euro zone UK periphery Benefit of joining: low exchange rate uncertainty Insurance from exchange rate fluctuations

Conclusion: McKinon criterion- unfulfilled

Fiscal Transfers Money is transferred to countries affected

from the asymmetric shocks theory of economic needs – money

allocated based on wealth not the impact of adverse shocks – UK would suffer

No fiscal transfer mechanism

Conclusion: Fiscal Transfers criterion- unfulfilled

Homogeneity of preferences

criterion countries must agree on the policies the

Central Bank will use

Germany – inflation averse, UK more tolerant

Gordon Brown – UK prefers flexibility

Conclusion: Homogeneity of preferences criterion criterion- unfulfilled

Commonality of destiny vs. nationalism

criterion willingness to sacrifice for fellow

members

EU – a union of nations – political quarrels

Jacque Chirac : “EU is not a United States of Europe but rather a Europe of United States”

Conclusion: Commonality of destiny vs. nationalism criterion- unfulfilled

CONCLUSION

UK’s current optimal choice is to continue to opt out

• However the costs of opting out should be re-evaluated on time to time basis