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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Daniel Evans

Assume that the UK joins a monetary union with a single European currency...

Examine the likely economic effects of this on :

  1. 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.  The Government would want to raise interest rates to combat the inflation, but they would no longer have this power. The harmonisation of currency would increase UK trade with Europe with the reduction in transaction costs to the firm, and so further develop the eco/political relationship with Europe; however, it is likely that the increase in trade with Europe will affect the trade the UK does with America.

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        As well as our interest rates being too high, so too is the value of our currency. To join, we would have to first devalue sterling to the equivalent of being in the narrow band of the ERM for at least two years.  The J curve demonstrates the problems in the short term of a devaluation of a currency. That is, in the short run, demand for exports and imports is price inelastic.  It takes time for foreigners to react to the devaluation, so export values often remain unchanged.  Import values however would rise.  The price of imports would ...

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