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The Euro.

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Introduction

The Euro: In November 1997 Gordon Brown outlined five economic tests (and passed or failed them) that would be used by the Government to gauge whether the UK economy was ready to join the Euro.4 This essay seeks to analyse these five tests and explore the issue of which will be the biggest problem for entry into the Euro. To do this I will address each of the five tests in turn and briefly comment on how the UK has fared against them. I will then conclude as to which is the most problematic test and detail why I think this is the case. The 5 tests are: Convergence - Is there sustainable convergence between the UK and the Euro-zone economies? The UK has moved much closer to the Euro-zone since 1997, when this test was failed by Gordon brown. From the chart below it can be seen interest rates between the UK and Germany are clearly converging. The gap between interest rates in the UK and the Euro-zone was 3.75 points it is only around 1.5 points now (though the recent UK rise widened the gap). ...read more.

Middle

Gordon Brown has said himself that the UK could gain billions of pounds by joining the Euro-zone.2 However I think it is important to note that joining without sufficient convergence and flexibility would damage the economy and investment. Financial services - What will be the effect of the euro on the UK financial services industry be? This test primarily concerns the city of London, if the effects of joining the Euro are good for the city the test will be passed. The key issue is whether Frankfurt will overtake London as Europe's top financial centre.1 This was the only test passed in 1997, it is intuitive to me the benefits of cost reduction and convenience of the Euro mean this test would be passed now as well, though there has been little evidence to conclude London's position as a leading financial centre has been damaged by opting out of the Euro. Jobs and growth - How will the euro affect UK unemployment and prosperity? This test is about whether and how economically beneficial it would be to join the euro, whether it would promote growth and employment. ...read more.

Conclusion

The UK also needs to reform its housing market as it is highly sensitive to interest changes, so much so that they could be a source of economic shock in themselves. With control of interest rates being handed to the ECB, the UK needs to be able to cope with a 'wrong' interest rate. For example Euro-zone rate are at 2% at the moment, the UK's have just gone up to 3.75% to cool off the housing market. Joining the Euro-zone now would cause house prices to soar leading to a boom and bust that would be destabilising to the whole economy. This illustrates why reforms are necessary, the UK needs to be less dependent on variable interest rates before this test could be passed. I would say this is also linked to the convergence test, the UK housing market needs to be more like the German one where only 40% of households are homeowners compared with 70% in the UK.6 In summary the fact that the Euro-zone labour markets are highly inflexible, and the rigidity of Euro-zone fiscal rules makes the flexibility test the hardest to pass. Though both are undergoing reform and look likely to become similar to the UK's rules5, which is a step in the right direction. 1 ...read more.

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