Currency Union in Europe: Prospects for the UK

Currency Union in Europe: Prospects for the UK
Name
Course
Instructor
Date
Introduction to Currency Union
A currency or monetary union refers the system where two or more countries use the same currency, and this typically occurs for states that are neighbors or share similar cultural bonds. A specified geographical boundary is one of the criteria for adoption of a single area currency for much member states. A monetary union may determine the exchange rate in the defined area, but in the absence of this, many countries adopt a common currency to form a currency union. Economic integration of states facilitates the adoption of a single currency for countries, which trade together, and this may extend to formation of a custom union.
Advantages
The advantages of a Currency Union are various, with a reduction in transaction costs being one of the major reasons for the adoption of a currency union. With the adoption of a single currency, the labor costs typically reduce for member states and rlower the cost of production. In essence, wages will adjust to reflect the market conditions where an increase supply of labor would lower the cost of labor and reduce transaction costs across the specified geographical area. In any case, currency conversion is an added cost for travelers and having different currencies increases the cost of doing business.
Fluctuation in different currencies presents challenges to markets and international traders as transactions have an added risk brought about by currency fluctuation. Even though, joining a currency union would not shield traders from currency fluctuations, there is better predictability. Consequently, pegging international trade on a single currency for countries in a currency union allows traders to make strategic decisions depending on the exchange rate and the market conditions. Furthermore, the means of exchange is unified across the countries in a custom union, making it easier for traders to transact without fear of transaction risk occasioned by exchange rate fluctuations.
A currency union also ensures better predictability through using the fixed exchange rate rather than floating exchange rate. Consequently, there is less currency instability for countries under the custom union. Furthermore, a single currency would be widely used over a larger geographical area resulting in increase investor confidence in using such a currency. Additionally, there would be fewer possibilities of speculation in comparison to using different currencies, and this reduces risk in transacting using the currency. Reducing the effect of instability is also advantageous to exporters who can position their products in accordance with market operations, better than when using different currencies from countries in the same economic zone.
Disadvantages of a Currency Union
Entering currency union results to centralization of monetary policies through a central or single monetary system. Consequently, countries in the economic zone lose power in creating some economic policies in their countries, because major monetary decisions would affect other countries. Equally, there is loss of sovereignty for governments in the states affected by single currency adoption. This is because governments have less power to control the actions of central banks and agencies staked with monetary policy formulation. This loss in sovereignty is also tied to the undemocratic nature of the centralized monetary authorities, where decisions are made from a non elected council.
Integrating economies with different structures may result in an unstable system where more economically endowed nations dominate the currency union. For instance, in Europe, the German economy is the largest, and the French economy also has a big stake in the Eurozone areas, but other countries face instability because of their inability to compete with the two economies. Additionally, the instability of the currency union may result to a drag in the economy of other countries, if economic shocks affect the value of the common currency. Greece is one of the countries to have suffered a government debt crisis resulting to reduced investor confidence, and this has necessitated bailouts to avoid a negative ripple effect to other Eurozone countries.
The Currency Union in Europe: Brief Background
The precursor development of the European Currency Union had gained much pace in 1990, when a European Council decided on the need to establish that a union that would eliminate restrictions on movement of capital among members. Furthermore, officials from the European Economic Community deliberated on the modalities to implement the best monetary policies for the member states. The Maastricht Treaty of 1991 led to the formal adoption of the Economic and Monetary Union, (Europa, 2013), and the signing of the Treaty of Rome allowed the establishment of a legal framework and structure to govern the Currency Union This was followed by the establishment of the European Monetary Institute (EMI) in 1994 tasked with ensuring that there coordinated efforts towards monetary policy formulations and setting the stage for adoption of a single currency. The European Council agreed to establish a single currency called the ‘euro’ in 1995. This was followed by issuance of new bank notes that were officially circulated in 2002, and the setting up of a fixed exchange rate regime.
Significance of the Study
The study is significant as it offers insights on the role of monetary unions and the pros and cons of economic integration. This study further illustrates the importance of monetary policy making and how this affects the economic conditions of countries. The impact of the global down turn has renewed interest on economic integration and how it affects member countries. For policy makers it is critical to predict the likely effect of membership or non membership to monetary unions as this may affect trade patterns.
The Currency Union in Europe and the UK
Reasons for the UK’s non-membership in the Currency Union
The UK opted out of the third stage of the EMU because the country feared about its sovereignty and independence at the time. However, the five economic tests provided an avenue through which to assess the viability of joining the Currency Union. Even though, there are potential benefits to joining the Currency Union, lack of converge of business cycles is a concern for the UK. This notion comes from the fear that asymmetric shocks may occur in the Eurozone making it harder to achieve cyclical convergence. Thus, the policies adopted by the European Central Bank (ECB) to deal with such shocks would be inappropriate for the UK economy. In addition, both the monetary policies of the Euro zone and those of the UK are divergent, with the UK supporting price stability, with the BoE focusing more on employment levels and economic growth (D’Addona & Musumeci, 2012).
The UK has overseas territories, which use the pound sterling as the main currency, and adoption of the euro would result to transfer of national sovereignty. Thus, the UK’s concern is that adopting the euro cedes sovereignty to the monetary authorities that make monetary policies. Proponents of this view assert that the need to join the Currency Union has also political implications that do not favor UK. In any case, the creation of central banks has traditionally occurred when there are governance structures already in place. The EU was originally an untested idea, and now there are no reasons to favor a monetary union that would seek to create UK’s monetary policies.
Even though, the UK is a major economy in Europe, there are marked differences with mainland Europe that does not make it plausible to enter into a Currency Union. To add credence to this observation is UK’s political history and geography, and hence there are fewer incentives towards European integration. Thus, the need for integration to a Currency Union does feature prominently for politicians and policy makers in the UK. Essentially, legislators across the political divide understand the unique history of UK, and there is agreement that there is low support for integration among the British people. The consensus in Britain is that the economic benefits of using the euro are not large enough to warrant the adoption of this currency. Furthermore, British governments would not want to antagonize the public by focusing on the role of a Currency Union, for fear of a political backlash.
UK’s non-membership ...