1. Economics in a European Context
The euro
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2. Microeconomic pros and cons of euro
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3. Microeconomic pros: issues
The full benefits of the Single Market can be realised
Consumers benefit from:
the lower prices brought about by greater competition and price transparency
increased consumer surplus
lower interest rates reduce the cost of borrowing
lower transactions costs associated with tourism in the eurozone
Producers benefit from:
ability to source inputs at cheaper prices (price transparency)
higher profit margins for some
new market opportunities from reduced entry barriers
greater levels of intra-eurozone trade
greater foreign direct inward investment
economies of scale from supplying an enlarged market
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4. Microeconomic pros: analysis
MRuk
Duk
MCuk
Quantity
Price
Dez
MC1
Puk q1
Pez q3
Sez q2
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5. Microeconomic pros: analysis
Cost
LRAC
Quantity
Dez
Duk q1 C2 C2 q2
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6. Microeconomic pros: evaluation
Extent to which euro promotes competition is dependent upon:
effectiveness of European Commission Competition Policy
contestability of markets and barriers to entry
national governments policy on state aid, for example
the Single Market programme in terms of opening markets (such as energy, postal services, financial services, telecommunications) up to competition
behaviour of firms in terms of restrictive practices and collusion
For examples, make sure you use the ‘News’ section of the departmental website:
EU row over state aid (Friday 03/05/2002)
Concern over postal competition (Wednesday 01/05/2002)
Single or segmented market? (Sunday 19/05/2002)
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7. Microeconomic cons: issues and evaluation
There are costs in joining a single currency zone for both consumers and firms. These include the costs of changeover to the new currency:
menu costs
need to change accounting systems
staff training costs
initial lack of information on the part of consumers
firms may take advantage of changeover to raise prices see website
Costs of euro conversion (Monday 13/05/ :22:59 AM)
Not to be underestimated - some have claimed that, for the UK, this could be as much as £3.5 bn
Since these costs are largely fixed they represent a heavy burden for small and medium sized firms and the retail sector in particular
However, they are a one-off cost and to some extent faced by EU countries who choose to remain outside the eurozone
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8. Macroeconomic pros and cons of euro
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9. Macroeconomic pros: issues
The microeconomic advantages have implications for the performance of the eurozone economy has a whole
There should be higher AD in the eurozone:
an expansion of trade amongst eurozone economies is an increase in eurozone consumption (price transparency, elimination of exchange rate uncertainty and reduced transactions costs)
the enlarged market should attract higher levels of FDI
if economies of scale raise the competitiveness of eurozone firms there should be an increase in net trade
The euro should lead to an improvement in the supply side of the eurozone economy:
lower costs of production
greater factor mobility
impact of competition on productivity
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10. Macroeconomic pros: analysis
Price level
Real GDP
Labour
AD0
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Employment
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The consequences should be higher GDP (growth), higher employment, improved current and capital account balances without an increase in the eurozone price level.
AD1
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11. Macroeconomic cons: issues and analysis
Loss of macroeconomic policy instruments
interest rate is set centrally for the eurozone by the ECB and may not suit the economic circumstances of an individual country
there is no longer an exchange rate for each country to compensate for differences in competitiveness
greater reliance on fiscal and supply side instruments
Fiscal policy is constrained by the Stability and Growth Pact
PCNCR must be kept within 3% of GDP
National debt must be no higher than 60% of GDP
Eurozone has no mechanism for ‘fiscal transfers’ between countries
There are concerns about the operation of eurozone monetary policy
lack of transparency and credibility
reliability of eurozone data
deflationary bias caused by asymmetric inflation target
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12. Macroeconomic cons: evaluation
Costs of membership are greatest when there is:
a lack of economic convergence between countries
countries suffer from asymmetric shocks
there is a lack of labour market flexibility and mobility
Loss of exchange rate policy may not be significant
does nothing to address root cause of lack of competitiveness
risks imported inflation
may lead to ‘competitive devaluations’
is really only a shock absorber
Improvement in long term economic performance unlikely unless measures are introduced to tackle supply side / productivity problems
Economic convergence may take place once a country joins the single currency area
it is only by joining that convergence will happen
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13. Macroeconomic cons: evaluation
What is meant by economic convergence?
monetary convergence
measures such as inflation, budget balance and government debt for existing members
additional measures for non-members include short-term interest rates and exchange rate stability
real convergence
economic growth and business cycle convergence
employment and unemployment
measures of productivity
pattern and significance of extra-eurozone trade
housing market
structure of borrowing by both firms and consumers
structure of the economy
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14. Macroeconomic cons: the eurozone evidence
GDP growth rates have converged since 1999, but this can be largely attributed to the global slowdown
fears that a one size monetary policy would not fit all have not materialsed
convergence has been achieved by a big reduction in Ireland’s growth rate
Slight convergence of eurozone inflation rates
but, inflation has increased under the ECB and is above the 2% target
Less disparity in unemployment rates as unemployment has fallen
but eurozone unemployment remains high, esp in relation to UK and US
long term unemployment remains a big problem for some economies and may be indicative of a lack of labour market flexibility
Little change in productivity, with Portugal, Spain and Greece still well below the eurozone average
Wide disparity in unit labour cost growth
could cause some countries problems in terms of competitiveness
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15. Macroeconomic cons: the eurozone evidence
Stability and Growth Pact increasingly under strain
lacks the flexibility to cope with major world economic slowdowns
has been criticised by Gordon Brown for its lack of distinction between current and capital expenditure (the so-called ‘Golden Rule’)
Portugal and Germany are currently running deficits close to the limit and France and Italy are not far behind - fears that automatic stabilisers will not operate under such a strict fiscal regime
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16. The evidence: eurozone GDP growth
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17. The evidence: eurozone inflation
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18. The evidence: eurozone unemployment
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19. The evidence: eurozone long-term unemployment
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20. The evidence: eurozone GDP per hr worked (EU15 = 100)
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21. The evidence: eurozone ULC growth
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22. The evidence: eurozone budget balance as % of GDP
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23. The eurozone: useful links and articles
Go to the department’s website news section and click on “view all previous items”
Explaining Europe's low productivity - Saturday 25/05/2002
Inflation worries for the ECB - Thursday 16/05/2002
Stability and growth pact under strain - Thursday 16/05/2002
Economists defend ECB monetary policy - Saturday 27/04/2002
Other useful links on eurozone economies and the diverse economic performance of economies include:
Germany’s Stability and Growth Pact problems
Diverse performance of eurozone economies
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24. The UK and the euro: Government policy
Current UK policy is that “in principle, the government is in favour of UK membership of EMU; in practice the economic conditions must be right” (HM Treasury, 1997)
Membership is, therefore, subject to the UK passing the Treasury’s Five Economic Tests:
Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?
If problems emerge is there sufficient flexibility to deal with them?
Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?
What impact would entry into EMU have on the competitive position of the UK's financial services industry, particularly the City's wholesale markets?In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs?
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25. The UK and the euro: could the UK join?
Membership of the euro is also subject to the UK meeting the Maastricht convergence criteria which, adapted for the existence of the eurozone, would now be that applicants should have:
an inflation rate of no more than 1.5% above the eurozone rate;
long-term interest rates of no more than 2% above the eurozone rate;
a national budget deficit less than 3% of GDP;
a national debt less than 60% of GDP;
a stable exchange rate against the euro prior to entry which would be sustainable once the exchange rate is locked in by entry into the eurozone
With the possible exception of the question of the sustainability of the current £ / euro exchange rate, the UK meets the other criteria for membership and could, therefore, join
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26. The UK and the euro: convergence criteria in 2001
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27. The UK and the euro: evaluation of membership tests
Maastricht convergence criteria focus on measures of monetary convergence
they tend to biased towards the success of the euro project itself rather than the interests of each individual member
they do not guarantee that the benefits of membership will outweigh the costs and only provide a ‘snapshot’ at one point in time
monetary convergence can occur without real convergence
they do not employ the logic of optimal currency area theory
Five Economic Tests are better but are, themselves, criticised:
they focus on whether UK membership would be in the UK’s best interest
they imply an optimal currency area framework (ie real convergence, flexibility to deal with asymmetric shocks etc)
however, it is not clear that there are objective measures against which the tests can be judged (ie they are unquantified and subjective)
the tests, therefore, fulfil a political function as much as an economic one
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28. The UK and the euro: should the UK join?
Interest rates differentials have now converged to 0.5% points
the UK “could live comfortably with euro interest rates” but whether “permanently” depends on other measures of real convergence
the value of sterling against the euro is, as a result, likely to decline making membership more viable
There would appear to be a good degree of business cycle convergence over a sustained period
growth rates have been synchronised since 1998, although with a lag
even greater convergence since 1999 in terms of peak in growth
Inflation performance shows a very different picture
inflation rates diverged from mid 1999
BoE has been more successful in keeping inflation low than the ECB
part of the explanation lies in the depreciation of the euro and the consequent appreciation of sterling which is now abating
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29. The UK and the euro: should the UK join?
Unemployment figures show a divergence, even though eurozone unemployment has fallen
in 1996 eurozone unemployment was 1.4 times higher than that in the UK
at the beginning of 2002 it was 1.7 times higher
the UK has an increasingly ‘tight’ labour market which may require increases in interest rates
some eurozone economies have significant long term unemployment, however, which means that inflationary problems emerge at higher rates of unemployment
eurozone unemployment has a significant bearing on ECB monetary policy since inflationary pressures from the labour market can only be moderated by greater supply side / labour market reform
evidence on the relative sizes of eurozone and UK ‘output gaps’ would help to assess whether business cycles have converged on a permanent basis
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30. The UK and the euro: should the UK join?
The UK continues to have a competitiveness problem relative to the eurozone economies
its productivity is much lower than the average of the eurozone economies ie GDP per hour worked in the UK is about 11% lower than in the eurozone
the loss of the exchange rate as a policy instrument places greater emphasis on supply side reform to tackle relative uncompetitiveness
at least by being in the eurozone, this competitiveness problem cannot be exacerbated by an appreciation of sterling as has happened since 1999
the UK is beginning to close the productivity gap, so problems are not as sever as they would have been in 1999
lack of competitiveness is also reflected in the growth in UK unit labour costs relative to the eurozone, although there would appear to be some convergence here since 1999
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31. The UK and the euro: evidence on real convergence
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32. The UK and the euro: evidence on real convergence
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33. The UK and the euro: evidence on real convergence
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34. The UK and the euro: evidence on real convergence
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35. The UK and the euro: evidence on real convergence
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36. The UK and the euro: evidence on real convergence
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37. The UK and the eurozone: useful links and articles
Go to the department’s website news section and click on “view all previous items”
Euro entry could mean higher taxes - Tuesday 21/05/2002
UK productivity stuck at 2% - Thursday 09/05/2002
UK passes Five Economic Tests - Wednesday 08/05/2002
Brown stands his ground - Sunday 05/05/2002
Time to join the euro? - Friday 03/05/2002
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