Should UK enter the EMU?

Paper on
International Economics

Submitted on
28th November 2005

by Hartwin Maas

Table of Contents

1 INTRODUCTION 1
2 THE DEVELOPMENT OF THE EMU 2
3 THE BRITISH PUBLIC OPINION 4
4 THE FIVE ECONOMIC TESTS 6
5 THEORY OF OCA 8
5.1 THEORIES ABOUT THE BENEFITS JOINING AN OCA 9
5.2 THE COST-BENEFIT FRAMEWORK OF OCA 12
6 BUSINESS CYCLE 14
7 CONCLUSION 16
APPENDIX A 17
SUMMARY OF THE THREE-STAGE APPROACH 17
APPENDIX B 17
CONVERGENCE CRITERIA 17
APPENDIX C 18
COMPARISON OF THE BRETTON-WOODS-SYSTEMS AND THE EMS 18
APPENDIX D 18
SUMMARY OF THE RESULTS OF THE FIVE ECONOMIC TESTS 18
BIBLIOGRAPHY 20

1 Introduction

Since the beginning of the idea of the European Monetary Union (EMU), UK had a negative attitude towards a single monetary policy with a single currency. This antipathy was amplified on the one hand by the withdrawal of the European Exchange Rate Mechanism in 1992 caused by different economic policies, oil price rises and German unification and on the other hand by the launch of the EMU in 1999. In fact the UK government starts to work towards cooperation with the EMU by setting specific goals. But before taking further steps, the criteria of the Maastricht Treaty have to be fulfilled and the five economic tests assessed by the UK government have to be passed. Since 1997 the UK has made real progress towards meeting the five economic tests. Although there are arguments that in a long term the payback of joining EMU offset the costs, the benefits are too low and the costs too high at the moment.

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2 The development of the EMU

The idea of one currency in Europe has been around for many years. But according to Pitchford the true launching of the EMU process dates from the Werner Committee which was set up in 1970 and submitted its final report, called ′the Werner Report′1, in February 1971.2 The first major step for the implementation of the Werner plan was the European ′currency snake′ in 1972. Through this arrangement the fluctuations between participants′ exchange rates should be limited to ± 2.25%. However, this process was not effective because of the collapse of the Bretton-Woods regime which determined a fixed exchange rate in terms of gold.3 The UK joined the snake system just for one month.

A further step was the creation of the European Monetary System (EMS) in 1979. The main objective of this system was to create monetary stability in Europe. This should be realized by the fixed rates between the currencies of the participating countries which where settled on their value against the European Currency Unit (ECU4).5 The UK did not join in the EMS and was still remote at the time of Delors Report in 1989.6

In 1988 a Committee chaired by Jacques Delors, president of the Comission decided to generate an outline for the EMU. The Committee reported its proposals for a three-stage approach in April 1989 (see Appendix A). It was decided to start stage one in July 1990 and to arrange an Intergovernmental Conference (IGC) on EMU as soon as possible afterwards.7

The Conservative Party of UK′s government did not accept the conditions in the Delors Report. After one year of negotiations in the IGCs, the Treaty on EU was agreed by the European Council at Maastricht in December 1991. Though the Treaty incorporates much of the Delors outline, it included important new issues. Finally, it is mainly about the establishment of an economic and monetary union with an introduction of a single currency.8 In the Maastricht Treaty the target date for the EMU′s implementation was set on the 1999. Furthermore a list of

^{1 timetable for EMU devised by Pierre Werner (Prime Minister and Finance Minister of Luxembourg)
2 Pitchford, R.; et al.: EMU Explained, 1997, pp. 28-29.
3 Geld & Geldpolitik, 2001/2002, p. 128.
4 The ECU was an artificial currency which was introduced to ease transactions.
5 Mühlbacher, H; et al.: International Marketing, 1999, p. 20.
6 Takata, K.: Joining the Fold, 2002, p. 2.
7 Pitchford, R.; et al.: EMU Explained, 1997, pp. 30-31.
8 Eijffinger, S.; et al.: European monetary integration and the financial sector, 1993, p. 21.}

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convergence criteria was made to decide about the acceptation of member countries (see Appendix B). The UK reserved the right of non-attendance at the EMU by the ′opting out clauses′9.

Before the implementation of EMU in 1999 the EMS was quite successful until 1992, when a general downturn in economic activities in some of the member countries and the high capital demand of Germany occurred, caused by the enormous public investment in former East Germany (GMU-Shock10). The German central bank raised its interest rates in an attempt to control the inflation. This forced other countries to raise their interest rates as well. Because of its economic situation, UK could not follow. To avoid massive losses in foreign currency, UK had to withdraw the European Exchange Rate Mechanism on the 16th of September 1992, called the ′Black Wednesday′ and devalue the pound sterling.11 (See also Appendix C)

After this exchange rate crisis the rest of the EU managed to unite their business cycles around 1995. But the UK′s business cycle still did not synchronize with that of the rest (see chapter five).12 This fact explains one of the reasons the UK kept sceptical towards the implementation of EMU. Nevertheless the EMU is an economic issue it is accompanied by politics and society.

^{9 The opting out clauses is a special regulation in the Maastricht Treaty for a country that does not join the cooperation on an existing field within the EU.
10 German Economic and Monetary Unification was a real asymmetric shock.
11 Compare: Mühlbacher, H.; et al.: International Marketing, 1999, p. 20 and Kreinin, M.: International Economics, 2002, p. 265.
12 Takata, K.: Joining the Fold, 2002, p. 3.}

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