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Macroeconomics
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There are numerous reasons for introducing a common currency. For most EU countries today, the majority of international trade is with other EU members. The euro-zone will become an area of monetary stability in Europe. The new currency removes exchange rate risks from the internal market, cuts the costs of transactions and encourages firms to trade across national borders. It also forces EU states to adopt responsible economic policies that contain inflation and increase real living standards.Currency unions have collapsed in the past. There is no guarantee that EMU will be a success. Indeed the Euro may be a recipe for economic stagnation and higher structural unemployment if the European Central Bank pursues a deflationary monetary policy for Europe at odds with the needs of the domestic UK economy. It is quite possible that the monetary union will not be sustainable; countries that discover themselves to be in difficulty may cancel their membership and re-establish an independent currency and an inflationary monetary policy. The example of Ireland’s departure from the sterling currency area suggests that leaving a currency union is beneficial, rather than joining one. In theory, a currency union can offer economic benefits – but only under fortunate circumstances. The lack of exchange rates removes a very effective mechanism for adjusting imbalances between countries that can arise from differential shocks to their economies. History demonstrates that well-chosen devaluations can help an economy out of difficulties – the UK should retain this option. In a recession, a country can no longer stimulate its economy by devaluing its currency and increasing exports. The EMU is a step in a process that will cut Europe off from the rest of the world. It is bureaucratically motivated – a further advancement for European policy makers. Entry would mean a permanent transfer of domestic monetary autonomy to the European Central Bank implying giving up flexibility on exchange rates and short-term interest rates. Domestic monetary policy would no longer be able to respond flexibly to external economic shocks such as a rise in commodity price inflation. The UK is thought to be more sensitive to interest rate changes than other EU countries – in part because of the high scale of owner-occupation on variable-rate mortgages in the UK housing market. Joining a currency union with no monetary flexibility requires the UK to have more flexibility in labour markets and in the housing market. The UK rented sector is too small to be a flexible substitute for owner-occupation. The UK has instituted within the Bank of England a very effective apparatus for managing interest rates. The EMU will remove this policy lever, along with removing the opportunity for exchange rate policy. Substantial fiscal transfers will be needed for poorer countries within the EU along with a more activist European Regional Policy to reduce structural economic inequalities. The UK might not feel able to afford such large-scale intra-European transfers. The lack of any coordination between European monetary policy, emerging from a committee of central banks, and European fiscal policy, emerging from a committee of finance ministers, will further lessen the possibility for alleviating local economic difficulties. This can be shown with the South-North migrations of millions of American and Italian citizens in the early years of their currency unions. The Euro will not be an optimal currency area – the European economies have not converged fully in a real structural sense and at some stage in the future, there is a fear that excessively high interest rates will be set because of an inflationary fear in one part of the zone which is unsuited to another area. There are economic costs and risks arising from losing the option to devalue the domestic currency in order to restore international competitiveness. This might lead to growing social dislocation and rising economic inequality within the European Union. There are fears about which countries might dominate the workings of the Central Bank and the effects on monetary policy within Europe if there are different inflation psychologies between member nations. There are obvious structural differences within the countries of Europe so, even if EMU begins in a state of convergence, economic shocks, such as crisis of supply of primary products, will lead to imbalances and there will be no mechanism to restore the balance. Since there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries.
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