Will UK Adopt Euro?
Since the formation of the European Union it had argued that countries participating in the union would adapt the EMU (Economic and Monetary Union), which was first discussed in the 1957 Treaty of Rome and subsequently in the Maastricht Treaty of 1992, Amsterdam Treaty of 1997 and Lisbon Treaty of 2007. The EMU aims on single currency, which has already attained by the twelve countries that joined in the EU in 1999.
Part of joining the single currency policy is the efficacy of these countries to adapt certain changes that might flag down their economy in the transition period and in a larger part, to contribute in the EU’s global market trade. UK, which gains immunity from the EMU along with Denmark and Sweden, has managed to survive in the fangs of European Union but that just happen in a few years. It was shown in the record of UK that during the year 1990 to 1998, their inward FDI (Foreign Direct Investment) is actually 20% total inflows to the European Union.
It was in this year that the Euro-Zone has total inflows of 60 to 75%. In the year 1998 UK FDI inflows has no longer feasible, 25 % of it goes to Euro-zone. By 2001, it gradually decreases into 13% and 6 % in 2003. That same period, EMU rose to 84 % (Foad, 2007). How did this happen? These somehow suggest that part of joining in the EMU will enhance stability particularly in relation to exchange rates and inward manufacturing investment (Ibid. ). But what is the foremost reason why had UK refuse to join the euro-zone when the EMU had first established?
UK has attained is highest optimum growth during the recent years and considering that sterling’s value has achieved its height, it would be hard for UK to exterminate the sterling as a legal tender since this money had brought their economy’s growth and stability and country’s improvement in the first place. However during the EMU mantra, there was a gradual oscillation of foreign investment in UK; however a little phase of UK’s economy was affected, it had managed to ascend in the global monetary competition against EUR.
Now as foreign investors now prefers to invest in the euro-zone, this pose a threat on the growth and stability of the country. The effect of investments towards foreign investors includes currency risks, as both suggested by the economists and investors themselves. The FDI inflow is another factor. Yet, not only considering the FDI inflow, there are some other consequences of either joining or refusing to synchronize in the EMU. Part of joining in the EMU several requisites has been laid out in case of UK’s decision to be a part of the EMU.
There are five ‘Economic Tests’ that must be undertaken by the three remaining countries in joining the EMU. These are: 1. Are business cycles and economic structures compatible so that others and we could live comfortably with euro interest rates on a permanent basis? 2. If problem emerge is there sufficient flexibility to deal with them? 3. Would joining EMU create better conditions for firms making long-term decisions to invest in Britain? 4. What impact would entry into EMU have on the competitive position of the UK’s financial services industry, particularly the City’s wholesale markets?
5. In summary, will joining EMU promote higher growth stability and a lasting increase? (HM Treasury, 2003). These requisites were able to meet by Britain, however factors has been considering in order to ensure that Britain will have no any single loss in the long run. The question now is if Euro can achieve its sustainability and financial growth in the long term possible? In the present years, euro zone accounts half of the UK’s foreign trade; this was shown in the FDI fluctuation that had brought the crisis to UK since EMU has expanded his dominions.
As a result thereof, existing business whether that is in the import or export has been drastically affected. In an example of the Toyota’s rebuff to build factory in Britain, it was stated by the General Manager itself that their common goal is to minimize currency risks. The proposal to build factory turn rather to France in consideration for currency risks insulation. This decision can greatly affect the businesses of UK. In the matter of export, if Euro will be successful in the next few years, the sterling would be devalued.
Since theirs usually relies on ROI, if the value of euro gain momentum as against sterling, importation form the euro zone countries would be more expensive, thus causing the business to gradually elapse as Return on Investment is low. Businesses that cater on importing would prefer euro, thus pushing forth for more euro reserves. Now it would be bias if we are only stressing in the efficiency of euro, we must have also to deal with the previous efficiency of sterling and to scrutinize if this would survive in the currency competition against euro.
For over the recent years, UK has attained its leverage into that of EU, but the question is whether this would persevere. Accordingly, there are three main factors that this will be sustained. First is the sustainability of the exchange rate between euro and sterling, as both are keeping off their feet on inflationary pressures. Second is the trade relationship and macroeconomic convergence, if that is possible for succeeding years. Third is the compatibility of macroeconomic policy of UK and Euro such as banking policies.
Now several convergence has appeared which seemingly can proved that UK can somehow survived in the Euro era, but considering that this would only last a moment, UK would face a lot of risks and crisis as gradual decline and the oscillation of inflation would greatly affect the country’s financial condition. Now, almost 70 % of its population has trying to quash the possible entry of UK into EMU, how would marketability achieved its optimum scale of success and financial rewards if the question was being sought politically?
Euro was more concerned on economic stability rather than on the monopoly issue of EU, as being manifested in the latter’s conditions of single currency policy. But that is however can be refuted. In several studies conducted by different economists and professors, they have launched the probability of success UK will attain in case of adapting the EUR. The foremost concern is international trade and promoting smooth foreign relations among neighboring countries. One factor for sterling being defeated by EUR is the issue on exchange rate volatility.
Exchange rate can be affected by different factors including the GDP, export materials especially made by export-oriented establishments, FDI and other related factors. Now the problem is that even if sterling resists the EUR intrusion, EUR transactions is present in the country only on non-cash basis. That is the problem with dual monetary transaction. The county is producing sterling as legal tender but they cannot just defy the EUR presence, since they are open to international trade and traders are usually found in the Euro-zone.
A foreign investors investing in UK also prefer if he was going to be paid in euro. R. Pettinger has stressed on the possible advantages and disadvantages of UK suppose the UK will be adapting the euro. The following are the advantages: 1. Exchange rate stability. There will be a reduction on exchange rate volatility within the main EU trading partners. However, in the recent years, sterling displayed a quite exchange rate fluctuation but has recovered thereafter. Even in the succeeding years, it can maintain its fluctuation rate not within the marginal rate.
That is why UK economy can survive and can procure reparation process in cases of high inflationary movement. 2. Inward Investment. UK has managed to attract a couple of Inward Investment even not opting to adopt Euro. But this can be least when Euro will be adopted and sterling ceases to be a legal tender. 3. Low Inflation. There is a possibility that joining the Euro-zone can guard UK against inflation. But inflation rate range only to 2%, this was foresee by the government. But there can be no alarming gist of UK’s falling economy.
That is why until the sterling performing spectacularly and providing a fortified economic framework, why would UK adapt Euro? Furthermore, if joining the Euro-zone would benefit only a handful but providing for greater exchange rate stability, that would consist of only and small portion of economic success compared to the total costs of conversion process. To balance, the following are the disadvantages: 1. Loss of Independent Monetary Policy. If UK decided on joining the Euro-zone, the whole financial and monetary system of the EU bloc will be pertaining to the ECB (European Central Bank).
The problem now is since the ECB focuses on financial and monetary issues, it wouldn’t matter if UK will face inflation or recession. The ECB decides on what is upright, generally but not specifically. It cannot address each Euro-zone countries monetary problems, but will do what it sees fit. 2. Difficulty in getting out a recession. Since the monetary policy is centered on ECB, they were drawing interest rates. In case UK’s economy experiencing a gradual recession, it would be difficult for them to cut interest rates and augment their condition.
This instance would aggravate their condition. 3. Sensitivity to Interest Rates. A slight change in the interest rates can stimulate an inflationary movement in the UK economy. One concrete example is the nature of housing market in UK. Since most UK households own their house, their variable mortgage is a high percent of their income. A relative change of 25% can significantly affect disposable income. If interest rates fall into say 5 % this would cause a boom but on its parallel side can cause inflation.
This implies that UK in order to achieve balance maintains the degree of interest rates and the growth of housing market to prevent any inflationary movement. 4. Loss of Independence of Fiscal Policy. In case of recession, the government borrows a percent specified by the Banking Institution to defray the loss being attained in the recession period. Now if UK adopts the Euro, the ECB shall post an entirely different fiscal policy. Accordingly, it is summed to a maximum amount UK can have to defy the recessive period. The problem now is the amount of GDP.
(Pettinger, 2007) Similar on the Forum of Private Business, they posted several advantages of UK joining the Euro zone. It is stated in the following: a. The currency risks in dealing with the Euro member countries will be eliminated. This is obvious, since there is a single currency denomination, then currency risk and exchange rate volatility will be eliminated. b. UK businesses will be subject to the same interest regime as businesses in other euro zone countries. Not all countries within the euro bloc have certain similarities nor differences.
A sick country with a sick economy has a little chance to be cured, but the EU monetary policy can somehow address this. Since every export and import oriented countries outside Europe prefers the Euro monetization, it is possible that the sick country with the sick economy can perhaps be cured by certain ‘special’ policies of ECB. The command of ECB to induce foreign investors can equitably pacify the sighs of a sick country. c. A period of dual pricing will probably precede the changeover. All prices would have to be given in both sterling and euros.
This is the transition period, where euro emerged as another currency and sterling still in the market has to cease as legal tender, and euro will proceed. Thus, it is not a gradual changeover, but a specified timeframe is allotted for changeover. d. There will be no charge for converting funds in accounts. This is an easement purpose, if a certain charges shall burden the people why would they convert in the first place if their funds were still feasible? e. There will be no charge for converting small amounts of notes and coins. There is likely to be a charge for converting substantial amounts.
f. The banks will no apply ‘discriminatory charges’ to euro accounts. Uniform charges on similar accounts are practiced. (Forum of Private Business, 2005) The pre-plan of UK to adopt Euro as a legal tender is stimulated with many inward factors. The first one to be tackled is on the issue of FDI, currency risks and exchange rate. There are several studies conducted that Foreign Direct Investment account for the volatility in exchange rate. Since there seems to be diminishing FDI inflows within UK, we must have to find out what accounts for this.
In study by Markusen he clearly states that firms will engage in FDI to avoid the costs of international trade, including currency risks (Markusen, 1995). In a similar study conducted by the three students in South Bank University, they have found out that investors prefer stable macroeconomic policy, this is true with UK but currency volatility seems to be the problem. Thus, joining the Euro is unlikely to deter either domestic or foreign firms from investing in the UK and may become more helpful in the medium-term (Ardy, Begg, Hodson, 2002).
Furthermore, De Menil finds that a sustained 10% increase in exchange rate volatility will eventually increase the level of FDI by 15 % (De Menil, 1999). The record was also supported by different researches of Pain and Van Welsum and Sung and Lapan who finds a positive relation of exchange rate fluctuations on inflows of FDI into the UK, Germany, Canada and US (Pain, and Van Welsum 2003). Even when certain studies advocated for the direct relationship of FDI and exchange rate volatility, there are some that proved the otherwise.
Campa find that input price and product demand shocks have a large effect, especially in the European Union (Campa, 1993). Byrne and Davis find that a sustained 10 % increase in the monthly volatility of the real effective exchange rate lowers the total volume of investment by 1. 5 % (Byrne and Davis 2003). This was however refuted by Ricci. In his study he found out that the effects of currency risk on FDI vary across country size, with nominal exchange rate volatility having a significant positive long run relationship for a subset of large countries, but a significantly negative long run relationship for small countries (Ricci.
1998). This justifies that the correlation of FDI and exchange rate volatility is substantial as in the case of UK. In the similar studies of Foad, he has found out that the adoption of the euro has eliminated nominal exchange rate volatility intra-union and the Stability and Growth pact has greatly reduced price variability within the union (Foad, 2007). Export activity yields a positive effect on FDI inflows; this caused the increase in FDI to euro countries.
Even if considering the positive effects on FDI if UK will cede sterling for euro, there will be a little benefit compared for the greater benefit on autonomy of UK in managing its macroeconomic affairs. Bush and Leach had actually foreseen three problems that might affect UK. First The common monetary policy might have different effects on the UK; in particular the UK might be more sensitive to interest rate changes. Second, the UK could be subject to different shocks from other euro zone countries so that the common monetary policy would be ill suited to economic conditions in the former.
Third, joining requires the UK to give up an efficient system of macroeconomic policy making for a less efficient one (Bush and Leach, 2001). It was thus further stressed that there can be no similarities of UK to other countries that might as well affect UK in terms of transmission of monetary policy to output, such as structure of banking, interest sensitivity of output, household debt, size and composition of household assets, openness to trade, bank finance to business and the structure of firms.
Even if in the recent years certain convergence were shown upon by UK as against the Euro, this would perhaps mean that sterling could outpace euro even for the slight convergence. And since the sterling was not entirely devalued through the fluctuations of exchange rate between the euros, then there was a little tendency of submitting the sterling to complement for euro as much as possible. The arguments of the different economists shows a relatively accession of euro as against sterling as they have shown out figuratively the ‘might-be effect’ just in case UK would adapt the euro.
Probably because this is purely economics matter, but that do not thwart the governments to speak on their idea about the possible adoption of euro. The government’s decision is the foremost consideration of EMU to adhere on. Thus it is important to know the different views and reactions of governments as well as noted debate of the public to know as well the public’s reaction on this matter that would in the end greatly affect them.Sample Essay of EduBirdie.com