emu_article_for_new_economy_final - EMU A Simple Guide to...

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EMU: A Simple Guide to the Pros and Cons Simon Wren-Lewis 1 University of Exeter 1 I would like to thank John Maloney for his help, but the views expressed here are entirely my own.
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Economists are notorious for disagreeing with each other, and on the face of it UK entry into EMU is no exception. The Economist magazine even went so far as to poll academic economists, and although the majority supported entry, around a third did not. However the situation is not as confused as it seems. Economists generally agree on what the key issues are – the disagreement comes in trying to quantify the issues and balance them against each other. The first point that most economists would agree on is that there is no economic inevitability about UK entry into EMU. It is perfectly feasible to remain an active member of the European Community, and not be part of EMU. In particular the Single European Market does not require a common currency. The clearest example that demonstrates this is Canada. This is part of NAFTA, but there has not been any strong pressure to abandon the Canadian dollar. The UK therefore has a real choice. I will look at the key factors involved in this choice, and why economists disagree about their importance. I hope two points will emerge. The first is that the government’s five tests, while far from irrelevant, do not provide a complete framework for examining these issues. The second is that EMU is not a static choice. EMU contains within it one particular tension, or ‘contradiction’, which will lead to pressure for further change, and potentially further economic integration. The Governments Five Tests 1. Whether there can be sustainable convergence between Britain and the countries of the single currency 2. Whether there is sufficient flexibility to cope with economic change 3. The effect on investment 4. The impact on the financial services industry 5. Whether it is good for employment Unquestioned advantages Abolishing national currencies within Euroland, although involving temporary transition costs, will lead to a significant, permanent saving in transaction costs for trade between EMU members. This is a cost we all experience when we travel abroad, but the more significant saving will be for firms that import from and export to other EMU countries. Estimates suggest that this effect could make, on average, every person in the UK around £50-100 better off each year. To this benefit we need to add the advantages in the reduction in uncertainty that replacing sterling by the Euro will bring. There are two main areas here: trade between countries and investment. The non-economist’s intuition that reducing uncertainty must be a good thing is roughly right: although there are circumstances, for example, where increased uncertainty can encourage investment, most empirical studies find that uncertainty is a cost. The key issue which remains unresolved is just how large a cost is generated by exchange rate uncertainty. Take trade between countries first. When exchange rates fluctuate, this
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This note was uploaded on 10/21/2010 for the course ECON 1530 taught by Professor Blumberg during the Spring '10 term at Harvard.

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emu_article_for_new_economy_final - EMU A Simple Guide to...

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