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Assume that the UK joins a monetary union with a single European currency... Examine the likely economic effects of this on : The UK s pattern of trade.

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Introduction

Daniel Evans Assume that the UK joins a monetary union with a single European currency... Examine the likely economic effects of this on : (a) The UK s pattern of trade. At the moment, different currencies act as barriers to trade to member countries. Joining the single currency would get rid of uncertainty associated with fluctuating exchange rates and eliminate transaction costs. For example, firms would not have to incur the costs of changing money, therefore increasing income, output and employment. Britain's economic cycle tends to be 'out of sync' with the rest of Europe. UK interest rates stand at the moment at around 4.5%, but in 'Euroland' the figure is closer to 2.5%. Therefore if the UK were to join, it would have to drastically cut its interest rates. This of course would result in an inflationary boom as people will borrow and spend more, increasing the price level by shifting the AD curve to the right. This will result in UK exports being relatively less competitive than in Europe, and so reduce the demand for them, ultimately also resulting in structural unemployment. ...read more.

Middle

Firms will therefore find it very difficult to segment the market and charge the desired higher price. We've already mentioned that entering a single currency will further lower barriers to entry, and this will also increase competition within the EU. Domestic firms will be under pressure to cut costs and so produce more efficiently then before, further benefiting the consumer in the form of price cuts. There would be mixed opinions about the Single Currency among firms. In the short run, there would be massive menu costs. But this would be a one-off cost to firms, and so is myopic and superfluous. However, firms can only achieve full Economies of Scale once different currencies are abolished, and firms are happy to expand into Europe without the fear of exchange rate fluctuations. Economies of Scale are an example of dynamic gains of being apart of the common market. The absence of barriers should also result in information being exploited faster, and perhaps benefit firms in the form of more R & D, and so higher productivity. ...read more.

Conclusion

For low inflation, again the UK is fairing well in comparison to other European countries, however, joining the Single Currency wouldn't change that too much as the German style anti-inflationary bias of the ECB is likely to result in low inflation anyway. In terms of Economic Growth, the UK could benefit. Firms are generally in favour of the move towards the Euro, as they will be able to exploit full Economies of Scale, and produce at a lower unit cost, therefore maximising revenues. With firms retaining higher profits, they may give wage increases, and so increase the amount workers have to spend, or firms may decide to spend their revenue on R & D, or increase investment. Either way, there is an increase in aggregate demand in the economy, and so economic growth could well take place. Joining the Euro will make UK goods more competitive as they will have decreased in value, and so demand for exports may well increase, so too will the demand for imports decrease, as they have become relatively less competitive. Therefore the balance on the current account will improve. But with lower interest rates, fewer firms will be encouraged to invest in UK financial businesses, and so the capital account balance will probably worsen. ...read more.

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