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Benefits versus
costs of adopting the
Euro for the UK
An Optimum Currency Area Theory approach
Introduction

Optimal Currency Area framework

Three economic criteria: 1. Labor Mobility
2. Production Diversification
3. Openness

Three political criteria:

1. Fiscal Transfers
2. Homogenous preferences
3. Commonality of destiny
The Economist survey: 67% of macroeconomists – favor
joining EMU, 75 % of monetary economists – are against
Labor Mobility



Importance of asymmetric shocks
Movement of labor from recessionary to
expansionary countries
Irrelevance of exchange rates assuming perfect
labor mobility
Labor Mobility




Low movement of people in Europe as
compared to US ( language, culture, legal
barriers )
UK vs. Continental Europe - Different market
regulation philosophies( e.g. difficult lay offs in France )
Labor mobility across European countries is
lower than the one within countries
Conclusion: Labor Mobility criterion- unfulfilled
Production Diversification



Kenen : Exports and Production diversified and
of similar structure
Response to asymmetric shocks
Decreases in demand or supply of one product
are leveled off by increases in the demand and
supply of another product
Production Diversification


UK’s market – “sectoral liberalization” in
housing and retail – more diversified than
Continental Europe
Major structural differences:
UK -mortgage debt 57% of GDP > EU’s 33% in 1997
-short term debt & equity issuance
UK – exporter of OIL ( e.g. high demand in Italy and Germany)
not sure for how long
Conclusion: Kenen criterion- unfulfilled
Openness

McKinnon:countries trade heavily with each
other, then
- monetary policy insignificant
- prices adjust rapidly


Is UK heavily engaged in trade with the rest of
the EU member states?
Core-periphery dichotomy
Openness




UK’s ratio of exports and imports to GDP
towards the rest of the Euro zone
UK periphery
Benefit of joining: low exchange rate uncertainty
Insurance from exchange rate fluctuations
Conclusion: McKinon criterion- unfulfilled
Fiscal Transfers



Money is transferred to countries affected from
the asymmetric shocks
theory of economic needs – money allocated
based on wealth not the impact of adverse
shocks – UK would suffer
No fiscal transfer mechanism
Conclusion: Fiscal Transfers criterion- unfulfilled
Homogeneity of preferences
criterion



countries must agree on the policies the Central
Bank will use
Germany – inflation averse, UK more tolerant
Gordon Brown – UK prefers flexibility
Conclusion: Homogeneity of preferences criterion criterionunfulfilled
Commonality of destiny vs. nationalism criterion



willingness to sacrifice for fellow members
EU – a union of nations – political quarrels
Jacque Chirac : “EU is not a United States of
Europe but rather a Europe of United States”
Conclusion: Commonality of destiny vs. nationalism
criterion- unfulfilled
CONCLUSION

UK’s current optimal choice is to
continue to opt out
• However the costs of opting out should be re-evaluated on
time to time basis