Question:
Should the UK join the Euro?
The Euro is a single currency arrangement that came into theoretical operation between 11 members of the European Union in January 1999. On January 1st 2002, 12 EU members got rid of their own currencies and introduced the Euro as their sole currency. The 3 ‘old’ member states not yet using the Euro are Denmark, Sweden and the United Kingdom. A single currency means that there are no longer separate national monetary policies, and instead a new central bank has been set up, The European Central Bank, that conducts a Europe wide monetary policy, in particular the setting of interest rates. That means a loss of separate national monetary policies, interest rates and exchange rates. The Treasury outlined five economic tests in 1997 that need to be met before the UK can adopt the Euro, these tests are: Convergence, are the UK business cycle and economic structures compatible with euro interest rates on a permanent basis? This will test whether a single interest rate will be suitable for all Member States, whether each economy would react in the same way and whether or not Members would be vulnerable to country specific shocks. If the latter applies, the government would not consider there to be sufficient convergence for the UK to join. Second test: flexibility, is there sufficient flexibility to deal with problems? This test looks at the ability to respond to economic change efficiently and quickly and at ensuring that shocks do not have long-lasting effects. Thirdly, Investment: for firms wishing to invest long-term in the UK, would joining the euro create more favourable conditions? Fourthly, Financial services: what effects would joining the euro have on the competitive position of the UK’s financial services industry, particularly on the City of London’s wholesale markets? Finally, Growth, stability and employment: will joining the euro promote higher growth, stability and a long-term increase in jobs? In 2003, the government assessed whether the conditions of these tests had been met. They concluded that the first two tests of convergence and flexibility had not been met, but that the other three tests had been met. The key test is Convergence, all the other tests are, effectively, dependent on the first one working out. Therefore, the government decided that it was not currently in the national interest to join the euro. They announced reforms including a new inflation target, reforms to housing, planning to promote flexibility in the economy, and consultation on a new fiscal regime in order to meet all five economic tests. However counties wishing to join the single currency must meet four convergence criteria: Stable prices, inflation must not be more than 1.5% point higher than the average in the three member countries with best price stability, i.e. lowest inflation. Stable exchange rate, the national currency must have been stable relative to other EU currencies for a period of two years prior to entry into the monetary union (ERMII entry). Sound government finances, gross government debt must not exceed 60% of GDP and the annual government budget deficit must not be greater than 3% of GDP. Finally, low interest rate must be met, the 5 years government bond rate must not be more than 2% points higher than in the three member countries where inflation is lowest.
