Benefits of Membership of a Monetary Union - Coursework Example

?“The UK is a member of the European Union but has not adopted the euro as its currency. To what extent do the benefits of membership of a monetary union such as the Eurozone outweigh the costs”? The euro is the official currency of the Eurozone, and is used by the majority of countries within the European Union, including France, Germany and Spain. As the second largest reserve currency in the world (after the US dollar), it is one of the most important and influential currencies in usage today (Grange, 2002). Despite this, there are still ten EU member states which do not use the euro, including Poland, Sweden and the United Kingdom. There are a number of reasons to join (or to not join) an international shared currency such as the euro, each of which have more influence depending on the state of the national currency. The purpose of this essay is to evaluate the reasons why the UK has not adopted the euro as its primary currency, and the benefits of joining such a monetary union. The purpose of this is to form an understanding of how a monetary union works and how it can be beneficial or detrimental to partner nations. Perhaps the most commonly cited reason for the UK to join the Euro is so that it can benefit from reduced transaction costs for businesses and consumers (Chapple, 2011). If the UK is part of such a monetary union, there will be no cost for changing currencies before completing a transaction in any country which is part of the Eurozone. Evidently, this will benefit tourists and those travelling to the Eurozone on a regular basis, as exchange rates and commission on currency exchange can be extremely high (Pettinger, 2011). The lack of currency exchange would also benefit a number of companies which trade in the Eurozone or have trade links with other firms which do. The frictional cost involved in currency exchange is high, and exchanging the pound for the euro as daily currency is estimated to save about 1% of GDP (Pettinger, 2011), a staggering amount of money. It would also help the UK to prepare for international trading if the euro gains strength as an international trading currency (Chapple, 2011). Another benefit of the euro is that it would make costs in the Eurozone more transparent. If a tourist goes to the Eurozone and buys souvenirs or other products, accurate costing requires them to translate the euro price into pounds. The benefit for businesses is that the price of a product in the Eurozone would remain fixed (as long as the price itself is fixed). This would mean that there would be no speculative decisions that need to be made about the best time to buy large amounts of product from the Eurozone dependent on current exchange rate (Chapple, 2011). Additionally, companies purchasing large amount of product from the Eurozone could provide more accurate revenue information based upon cost of product without the need to account for these fluctuations in the exchange rate – predictability would be higher. Exchange rate volatility can also mean that exporting products can become unprofitable, which has the potential to have a huge impact on GDP. Adopting the euro could also mean more inward investment for the UK. This would occur as the cost of transactions internal to the Eurozone, as outlined above (Grange, 2002). Inward investment a term used to describe the input of money from outside an economic region into another economic region, and can occur when a company moves part or all of their activity into that region (Grange, 2002). The potential for inward investment is one of the biggest benefits of adopting the euro, particularly in the UK’s current economic climate. Inward investment often leads to the creation of a number of employment opportunities within the economic region (Wikipedia, 2013), which would be hugely beneficial to the UK which is currently struggling with unemployment figures (BBC, 2013). Inward investment is also an attractive way of boosting the economic situation of an area, as it can often be more reliable than investing into small local businesses (Grange, 2002). Despite all these reasons for joining a joint currency, especially a well-established one such as the euro, the UK has still made no plans to adopt the currency and many financial experts believe that it will never do so (AP, 2011). Although there are fierce supporters of the euro and suggestions that these benefits outweigh the costs, it is important to discuss reasons why join currencies can often be detrimental to an area’s economic success to truly understand the UK’s position. The issue that has often been discussed in the media recently is that of currency devaluation. Devaluation is the process of reducing the value of a currency in proportion to the prices of goods and services (Pettinger, 2011). The ability to do this gives more flexibility when a currency becomes uncompetitive and inflation is high (Pettinger, 2011). Many of the countries currently struggling economically within the Eurozone (such as Spain and Greece) would potentially benefit from the devaluation of currency, but this cannot occur without the agreement of all euro-using countries (Pettinger, 2011). Joining a currency like the euro also means that there is no independence with respect to currency-related issues. For example, interest rates for the Eurozone are set for the entire area. In an economic crisis, however, it can be beneficial to quickly cut interest rates as a response (as the UK did during the financial crisis of 2008 []). Quantitative easing was also carried out in the UK as a response to the financial crisis, a term used to describe the process of a central bank purchasing assets from commercial banks in an attempt to stimulate the economy and increase the money base (Grange, 2002). Whilst this is controversial, it can form part of an effective way of avoiding or getting out of a recession, but would not be easily possible without an independent money policy. Similarly, the UK has a unique housing market which is based on highly variable mortgages (AP, 2011), which are sensitive to changes in interest rates (AP, 2011). This means that being at the mercy of Eurozone interest rate changes could have more of an effect on the UK economy. Another important economic concept here is that of the “lender of last resort”, a term used to describe a financial institution which will lend out money when no other institution will do so (Pettinger, 2011). This type of institution is commonly a central bank, a public institution concerned with currency and interest rate issues (Wikipedia, 2013). The importance of having a “lender of last resort” is controversial, as they are often used to bail out companies such as commercial banks, the failure of which would have a negative effect on the economy as a whole (Rogers, 2011). The UK is one of several countries to use the central bank as a “lender of last resort” during the recent financial crisis, a measure put in place to stop the failure of several banks such as Lloyds TSB and the Royal Bank of Scotland (Rogers, 2011). The move is controversial because it appears as though the taxpayer is paying for financial mistakes made on the behalf of these institutions (Rogers, 2011), but is an important option to leave open for economic crises. Another reason that the “lender of last resort” is so important is reflected in the current state of the Eurozone. The fact that the Eurozone does not have this lender means that it can become a victim of rising bond yields, because the lack of this safety net means that any government selling less than expected bonds could cause investors to panic and sell bonds (Pettinger, 2011). The UK has a “lender of last resort” in the Bank of England, which has been known to buy bonds to prevent a crisis of liquidity (Wikipedia, 2013). Without this support, investors in the Eurozone may feel more panicked about liquidity and react more strongly to bond issues, so the currency can be quite volatile and risky for a country to join if there is already a strong central bank in place to act as a “lender of last resort”, as in the UK. A final problem with joining the euro is very simple – it is extremely difficult to leave the euro after having adopted it as currency (Pettinger, 2011). In conclusion, there are a number of different reasons why adopting the euro as currency could benefit the UK, including reduced costs of currency transactions in the Eurozone, increased transparency of costs within the Eurozone, and the potential for inward investment. These are all very important, particularly inward investment, and could help benefit the UK in the current economic and political climate. However, it could not be argued that these benefits outweigh the costs, because the costs are so complex and detailed. These costs include the fact that it is an expensive decision to reverse, the lack of a “lender of last resort”, inability to devalue the currency and the loss of financial independence for the UK. Overall, whilst there are definitely some benefits, these do not appear to outweigh the costs in any way. References AP, 2011. U.K. to eurozone nations: We’re out, good luck [WWW Document]. CBS News. URL http://www.cbsnews.com/8301-201_162-57339959/u.k-to-eurozone-nations-were-out-good-luck/ (accessed 5.16.13). BBC, 2013. UK unemployment up to 2.52 million. BBC. Chapple, I., 2011. How the euro became a broken dream [WWW Document]. CNN. URL http://edition.cnn.com/2011/09/23/business/europe-euro-creation-maastricht-chapple/index.html (accessed 12.05.13). Grange, M., 2002. Is Britain ready for the euro? BBC. Pettinger, T., 2011. Should the UK Join The Euro? - Economics Blog [WWW Document]. Economics Blog. URL http://www.economicshelp.org/blog/771/euro/should-uk-join-the-euro/ (accessed 15.05.13). Rogers, S., 2011. Bank reforms: how much did we bail them out and how much do they still owe? The Guardian. Wikipedia, 2013. Euro. Wikipedia, the free encyclopedia [WWW Document] URL http://en.wikipedia.org/wiki/Euro (Accessed 11.05.13). Read More