The European monetary..

The European monetary union (EMU)

When a member of the European Union (EU) joins the EMU its central bank loses some power.

It gives up:

• The ability to determine monetary policy and fix interest rates; it accepts the one set for all the members of EMU.

• The management of the exchange rate of its own currency. The country henceforth uses Euros which are set to the national currency at a fixed rate.

The UK is not currently a member of EMU but it is a member of the EU.

The costs of joining EMU

• The UK would lose some sovereignty and power – we would be in the hands of the decision makers for the EMU countries.

• If what is decided about the interest rate is good for most of the EU, but happens to bad for us, we would lose. It might mean that if we were in a recession but the other members were booming, interest rates might be set to curb the boom. This would be inappropriate for our situation and it might force us to stay in recession or even worsen it. Germany was like this in 2003 and still is. It is unlikely that the average rate of interest set for all will be perfect for everyone: it will almost certainly be set too high for some, and too low for others.

The benefits of joining

• We would have a fixed price of our exports to and imports from Europe. We would not have to undertake currency exchange each time we import and export involving other members. We would also not have to worry about the possibility of future currency movements, as there would not be any.

• This means that there would be fewer shocks and fewer risks, as business people would know what price they would get when they sell.

• This should lead to an increase in trade, lead to a reallocation of resources along comparative advantage lines, help to increase the standard of living, speed up economic growth, encourage more employment and help the balance of payments.

• We would still be able to use fiscal policies to counteract undesirable changes in our economy.

Fiscal policy for those in the EMU

Fiscal policy can be set independently by the members – but some suggest that in the long term, tax rates will have to be roughly similar, if not identical (tax harmonization).

What would happen if a country’s tax rates were well out of line with the others?

• Labour or capital might flow from the high tax regime country to one where taxation is lower.

• People might appeal to the EU or courts to obtain equal treatment under an EU- wide piece of legislation and if successful could get a different tax rate applied.

It seems probable, however, that different countries would be able to retain their own tax rates safely as long as they were not seriously out of line.

Opposition to joining the EMU

Many people are against joining the EMU, just as many are for it. The economic case was presented above. Currently, the political opposition to joining is a worry to the government, which has been going slow on the issue for some years.

Remember! This is an economics course and exam, not a political one. This means that you can mention that there is both political support and opposition but you should not go into much detail. For you own information here are a few points.

• Many people who have the vote fear that we would lose autonomy, which is true
(see above).

• The Conservative press is largely against joining.

• Prime Minister Tony Blair seems to be nervous about public reaction; the current
Chancellor of the Exchequer, Gordon Brown, might be in favour of joining, but
he has seems to have concerns that it would limit his power over the economy. In addition, some allege there is a long-standing rivalry between these two
politicians for power and influence and internal Labor Party factionalism complicates the issue.

• Some people suffer from xenophobia and feel that we cannot trust foreigners in general.

• Some believe that we cannot trust the bureaucrats in Brussels to do the right thing.

• Some believe we should only join when the conditions are right; this can be meeting the Five Tests of Gordon Brown, or merely a way of ensuring that we never join, by permanently claiming that conditions are still not right.

The five tests are concerned with:

• Convergence: is our economic cycle, as well as our rates of interest, in line with the other countries in Europe?

• Trade and investment: would our firms get better access to capital and export markets in
Europe and would European and other investment increase in Britain?

• Flexibility: has the EU sufficient flexibility to cope with problems like inflation?

• Finance and the City of London: will the financial sector do well in the EU, especially with the single currency?

• Economic growth and employment: will we do better if we join?