Mini Case 1: Assessment of the prospect of British joining the euro club

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MINI CASE: Will the United Kingdom Join the Euro Club?

 

When the euro was introduced in January 1999, the United Kingdom was conspicuously absent from the list of European countries adopting the common currency. Although the current Labor government led by Prime Minister Tony Blair appears to be in favor of joining the euro club, it is not clear at the moment if that will actually happen. The opposition Tory party is not in favor of adopting the euro and thus giving up monetary sovereignty of the country. The public opinion is also divided on the issue.

Whether the United Kingdom will eventually join the euro club is a matter of considerable importance for the future of European Union as well as that of the United Kingdom. The joining of the United Kingdom with its sophisticated finance industry will most certainly help propel the euro into a global currency status rivaling the U.S. dollar. The United Kingdom on its part will firmly join the process of economic and political unionization of Europe, abandoning its traditional balancing role.

Investigate the political, economic and historical situations surrounding the British participation in the European economic and monetary integration and write your own assessment of the prospect of British joining the euro club. In dong so, assess from the British perspective, among other things, (1) potential benefits and costs of adopting the euro, (2) economic and political constraints facing the country, and (3) the potential impact of British adoption of the euro on the international financial system, including the role of the U.S. dollar.

 

Suggested Solution toWill the United Kingdom Join the Euro Club?

 

Whether the U.K. will join the euro club will be a political as much as economic decision. Recently, the U.K. economy was converging with those of euro-zone countries. Economic conditions in terms of government budgets, interest rates, and inflation rate are becoming similar to those in euro-zone countries. On an economic ground, this convergence is creating a condition that is conducive to U.K.’s joining the euro club. As recently pointed out by Wim Duisenberg, the President of the European Central Bank, British opposition to joining the euro club is more “psycho-political” than justified on economic grounds. Since many political leaders in France and Germany consider adoption of the euro as a step toward the European political union, the U.K. is likely to join the euro-zone if it is prepared to join the European political union as well. Once the U.K. joins the euro-zone, the euro will no doubt become a global currency at the expense of the U.S. dollar.

Mini Case 1: Assessment of the prospect of British joining the euro club

 

1.          Potential benefits and cost of adopting the euro

 

1.1     Potential benefits of adopting the euro

 

The very first benefit of adopting the euro as the currency in the economic circles for UK is the stability of exchange rate. According to several economies, by joining the euro club, Britain would benefit from a more stable exchange though the British companies could still be vulnerable to changes in the value of the euro against the dollar, yen and so forth (Mankiw & Taylor 2005, p. 786). Secondly, the FDI (Foreign Direct Investment) from EU countries would be enhanced due to the reduction of transactional cost and money exchange costs. Because by joining the euro club, it would be easy for other investors from other EU member countries to invest directly in UK without any necessities to make any money exchange. Also it would be easier for the UK based firms to do international business because EU is a more welcome international currency accepted by the MNCs (multinational corporations) compared to sterling.

 

1.2     Potential cost of adopting the euro

 

While stability is anticipated by joining the euro club, cost could also be obvious. The most eminent cost is the loss of monetary sovereignty which greatly affects the flexibility in the monetary policy making (Grauwe 2007, p. 102). In the most recent EU debt crisis, the importance of monetary sovereignty has been greatly reflected. For example, in the case of Greece which suffers a lot from the debt crisis, according some economies, the results are partially because of the fact that the Greece government had limited flexibility (telekommunisten.net 2012). When the debt crisis had been witnessed, it was well believed that governments with monetary sovereignty could have handled similar scenarios in a better and more effective way. In the most direct way, governments could print out more money and deliberately devalue the currency to offset the impacts of the debts. But for a member country of the EU, Greece had no better choices and only waited for responses of the EU.

 

2.          Economic and political constraints facing United Kingdom

 

2.1     Economic constraints facing United Kingdom

 

According to R. Pettinger (2007), the nature of the UK housing market means the UK economy is sensitive to changes in interest rates. And because it is the basic requirement for an economic to reduce the interest rate to get closed to the euro interest rate, for the UK to reduce the interest rate further could mean that the money would be driven away from the bank deposit into the business sector and real estate industry could be the top choices. And because of the existence of the market sensitivity to the change of interest rates in UK, the inflow of capital into the housing market would be enhanced, and therefore another undesired economic bubble cause by the hot property market could be caused.

 

2.2     Political constraints facing United Kingdom

 

While some claim that political status changes usually with the need of the economic interests, but in contrast, even the economic life could not be absolutely rational and it could be constrained by the current political status. As in the case of UK, the linguistic and cultural ties between the United States and the United Kingdom together with the long term based closed political cooperation between these two nations has actually posted a dilemma for the UK government because UK and US historically have shared a lot of common political interest but joining the euro club would mean that the UK has closer relationship with EU and could probably counter some interest conflicts in which the government has to choose between EU or US.

3.          The potential impacts of British adoption of euro on the international financial system

 

3.1     Impacts on the role of the U.S. dollar

Table 1 GDP ranking based on 2011 data

Source: tradingeconomics.com 2012

 

As shown in the table above, United States still lead the world economic in term of GDP volume by achieving a 15,094 billion USD in the last year following by Euro Area’s 13,076 billion USD. But because UK’s economic volume accounts for about one fifth of that of the economic scale of Euro Area’s GDP volume, its adoption of euro would make the euro zone the largest economic by GDP volume. And this will certainly bring impacts over the leading role of US dollar because of the wide acceptance of euro in one of the most developed area, i.e. the euro area.

 

3.2     Strengthening of the leading international currencies

 

International currencies are usually referring to those currencies that are widely used by the cross-national economic activities, US dollar, euro, sterling and yen are usually talked about when this noun is mentioned. With the joining of UK into the euro monetary system shaping a highly integrated euro zone would on one hand benefit the intra-euro zone business activities, but on the other hand, this event would strengthen the adoption of the leading international currencies as the two major currencies are combining into a single currency.