United Kingdom’s Challenges in the European Monetary and Economic Union (EMU)

Scientific Essay, 2008

10 Pages, Grade: A+


This monograph faces the question why the United Kingdom ‘opted out’ of the European Monetary and Economic Union (EMU). Then, an analysis will be drawn in accordance to the advantages and the disadvantages of the EMU for UK’s economic and business environment.

From Bordo’s and Jonung’s book (2000), it was stated that since the European Monetary System (EMS) was introduced in 1979, which aims to minimize the risk of changes of exchange rates that hampered trade between the European countries. In this mechanism as ascribed in the research of Cohen and Wyplosz (1989), the currencies in Europe were tied together in narrow fluctuation bands of ± 2.25 % towards each other. Since 1993 this bands have been "temporary expanded" to ±15 %. This system existed 1999 as the European Economic and Monetary Union (EMU) succeeded the EMS with its task to introduce the Euro as single currency.

The UK left the EMS after two years membership in 1992 on the so-called ′Black Wednesday′ on September 16th. Due to a "loss of trust in the EMS, where several EMS currencies got under devaluation pressure," after there have been heavy differences between high interest rates in Germany and low interest rates in the USA, what made "finance flow towards the EMS and out of US dollars and sterling." The British government "took drastic measures to attempt to maintain a rigid position but neither was sufficient to prevent sales of sterling from reducing its rate against its currency well below the EMS ′floor′ DM 2.78. This was withdrawn from the EMS system and allowed to ′float′."

Another big topic circulated in Bordo’s and Jonung’s working paper (1999) is the public opinion in the UK. A big number of people do not want to give up the Pound for the Euro, which is regarded as inferior. The government still emphasizes the economic side of effects of joining the EMU, but it does not take much influence on the public opinion. The opposition uses the fear of the citizens to gain votes and tried to win the elections on 7 June 2001 on that topic.

While Buiter (1999) assumed that the UK membership of EMU is also about a constitutional issue. How will monetary policy have to change? UK interest rates would be lower, set in relation to a European aggregate, and more stable than in the past. The inflation target will be set by the economic board and not by politicians and the economic board should be genuinely independent. Another thing is the new fiscal regime, but the question here is for whom regime is? There is pressure to move to the golden rule within EMU and allow more government borrowing to invest. Otherwise UK fiscal policy would have to tighten, which would help bring down interest and exchange rates.

Arestis and Sawyer (2002) speculate that the Government's central economic objective is to achieve high and stable levels of growth and employment. Britain's economic interests in the single currency need to be judged against this central objective. These were the important issues to worry about:

- were output gaps different in the UK and Europe
- were business cycles coincident in Europe and the UK
- were interest rates in Europe acceptable for the UK
- were inflation rates diverging and different
- were exchange rates stable and properly aligned

They also emphasized the entry to EMU at an inappropriate exchange rate could trigger a full-blown business cycle in the UK. Once inside EMU, the UK’s response to a number of different economic shocks would change, partly because of the fixed exchange rate, and partly because of the common monetary policy. In particular, when an asymmetric shock occurs, one that hits the UK harder than other Eurozone economies, the UK response is generally likely to be more pronounced inside EMU than outside.

Allsopp (2003) introduced what the UK Government has announced that any move to the third stage of EMU will depend on five economic tests being met:

- Convergence of business cycles. Business cycles in the euro zone and the United Kingdom must be compatible. The assessment will focus on economic indicators such as inflation, interest rates, the output gap and the real effective exchange rate with a view to long-term convergence.
- Flexibility. The UK economy must be flexible enough to ensure that any asymmetrical shocks can be absorbed by, for example, labor-market flexibility and mobility and by fiscal policy.
- Investment. UK participation in the single currency must promote investment (foreign or domestic) in the long term.
- Financial services. EMU must improve the competitive position of the UK's financial services industry, particularly in London.
- Growth, stability and jobs. EMU must have positive effects on employment and growth, measured by the impact on UK foreign trade, price differentials and macroeconomic stability.


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United Kingdom’s Challenges in the European Monetary and Economic Union (EMU)
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Nassef Adiong (Author), 2008, United Kingdom’s Challenges in the European Monetary and Economic Union (EMU), Munich, GRIN Verlag, https://www.grin.com/document/160435


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