(ii) the economies of Italy and France
The weakness of the euro relative to the pound also reaps benefits for EU countries such as Italy and France. The number of British Tourists into these two countries has rocketed due to the low prices relative to the UK. The article states that the number of British tourists in France has risen by 31% and by 54% in Italy. The increase in demand for holidays in these two destinations has had a ripple affect to a number of industries within the 2 countries. The restaurants, supermarkets, real-estate and many other industries have benefited from increased tourism and greater disposable income of the Britons. However, due to this increased demand for the Euro it can lead to the appreciation of the common European currency in the long run as a result, this is due to upward pressure.
(b) Examine one possible reason why the euro has ‘dropped by more than 10% against the pound’.
A possible reason for the fall of the euro against the pound could be due to the monetary policy.
A fall in interest rates can have a significant effect on the exchange rate. In a world where financial capital moves freely between countries a fall in interest rates may cause a currency, the euro in this case to depreciate. If a nation’s interest rates fall, and the interest rate is lower than in the UK there is likely to be a outflow of ‘hot money’ to gain higher returns on savings in a country with higher interest rates. This will cause the demand for the currency to fall, the exchange rate will as a result depreciate.
(c) (i) Why has ‘the strength of the pound posed problems for British firms’?
The high value of the pound relative to the euro has caused British firms to find exporting their products increasingly more difficult.
UK goods have become less competitive abroad due to the international trade effect, the price of UK exports relative to exports from France or Italy for instance has been higher, as a result it has become less competitive and fewer UK goods have been demanded abroad. This has hit certain industries particularly hard, which depends on export a great deal such as limestone industry. However, one has to keep in mind that we assume the goods exported from Britain are elastic, if there were price inelastic a higher price would not affect demand. The high value of the pound has resulted from the supply of the currency exceeding the demand for the currency. To correct this current account deficit in which goods imported into the UK exceed goods exported from the UK an expenditure switch of expenditure reducing policy has to be implemented.
(ii) Explain one way in which British firms might respond to the situation.
A way in which British firms could respond to the problem of imports exceeding exports in the UK is through an expenditure switching policy.
British firms could introduce tariffs or other types of import controls to make imports more expensive and reduce demand. However this assumes that other countries will not set up similar trade barriers, for if this does occur no advantages will be gained. Tariffs are taxes levied on imported goods. The impositions of a tariff will have a number of effects on the UK market.
In a pre-tariff situation the UK price of a particular product could be P, and domestic supply would be Q1 and domestic demand would be Q4, the difference would be met by imports. However with the imposition of a tariff, the price of imports will rise to P1, and the demand for imports will fall to Q2-Q3, while domestic demand will expand to Q2. As a result the imposition of a tariff or any other type of import control can reduce a country’s current account deficit and domestic firms will benefit.
(d)In the light of the passage critically examine the case for Britain adopting the euro.
If the UK was to adopt the euro it would experience a number of advantages.
Due to Britain carrying out over 50% of its trade with the EU, the creation of a common currency would simplify trade, euros will not have to be bought and sterling will not have to be sold on the exchange rate market. Also due to the pound being of greater value that the euro, an adoption of the common European currency in Britain would benefit firms who heavily rely on exports. The abolition of Sterling is likely to lead to a depreciation making UK goods more competitive on the international market. However, this will hava trade off effect. A depreciation will discourage speculative ‘hot money’ being invested into the UK economy for they look for the highest rate of interest on savings. If the UK were to join the euro it would share a common interest rates with its fellow EU members who have also adopted the euro, as a result ‘hot money’ will no longer be attracted. As a result the Bank of England will lose its autonomy over the setting of the interest rates, the European central Bank sets interest rates for all EU countries who have adopted the euro.
If the UK were to join the euro it would also be committed to a single fixed exchange rate within the Euro-zone which would make trade easier and less time consuming and no longer prone to price fluctuations, firms would no longer have to sell and buy currencies on the foreign currency market. It is important to take into account however that the Euro can fluctuate with currencies outside this zone such as the US Dollar or the Japanese Yen.