Short Term Interest Rates example essay topic

There are numerous reasons for introducing a common currency. For most EU countries today, the majority of international trade is with other EU members. The euro-zone will become an area of monetary stability in Europe. The new currency removes exchange rate risks from the internal market, cuts the costs of transactions and encourages firms to trade across national borders.

It also forces EU states to adopt responsible economic policies that contain inflation and increase real living standards. Currency unions have collapsed in the past. There is no guarantee that EMU will be a success. Indeed the Euro may be a recipe for economic stagnation and higher structural unemployment if the European Central Bank pursues a deflationary monetary policy for Europe at odds with the needs of the domestic UK economy. It is quite possible that the monetary union will not be sustainable; countries that discover themselves to be in difficulty may cancel their membership and re-establish an independent currency and an inflationary monetary policy. The example of Ireland's departure from the sterling currency area suggests that leaving a currency union is beneficial, rather than joining one.

In theory, a currency union can offer economic benefits - but only under fortunate circumstances. The lack of exchange rates removes a very effective mechanism for adjusting imbalances between countries that can arise from differential shocks to their economies. History demonstrates that well-chosen devaluations can help an economy out of difficulties - the UK should retain this option. In a recession, a country can no longer stimulate its economy by devaluing its currency and increasing exports. The EMU is a step in a process that will cut Europe off from the rest of the world. It is bureaucratically motivated - a further advancement for European policy makers.

Entry would mean a permanent transfer of domestic monetary autonomy to the European Central Bank implying giving up flexibility on exchange rates and short-term interest rates. Domestic monetary policy would no longer be able to respond flexibly to external economic shocks such as a rise in commodity price inflation. The UK is thought to be more sensitive to interest rate changes than other EU countries - in part because of the high scale of owner-occupation on variable-rate mortgages in the UK housing market. Joining a currency union with no monetary flexibility requires the UK to have more flexibility in labour markets and in the housing market. The UK rented sector is too small to be a flexible substitute for owner-occupation. The UK has instituted within the Bank of England a very effective apparatus for managing interest rates.

The EMU will remove this policy lever, along with removing the opportunity for exchange rate policy. Substantial fiscal transfers will be needed for poorer countries within the EU along with a more activist European Regional Policy to reduce structural economic inequalities. The UK might not feel able to afford such large-scale intra-European transfers. The lack of any coordination between European monetary policy, emerging from a committee of central banks, and European fiscal policy, emerging from a committee of finance ministers, will further lessen the possibility for alleviating local economic difficulties.

This can be shown with the South-North migrations of millions of American and Italian citizens in the early years of their currency unions. The Euro will not be an optimal currency area - the European economies have not converged fully in a real structural sense and at some stage in the future, there is a fear that excessively high interest rates will be set because of an inflationary fear in one part of the zone which is unsuited to another area. There are economic costs and risks arising from losing the option to devalue the domestic currency in order to restore international competitiveness. This might lead to growing social dislocation and rising economic inequality within the European Union.

There are fears about which countries might dominate the workings of the Central Bank and the effects on monetary policy within Europe if there are different inflation psychologies between member nations. There are obvious structural differences within the countries of Europe so, even if EMU begins in a state of convergence, economic shocks, such as crisis of supply of primary products, will lead to imbalances and there will be no mechanism to restore the balance. Since there will only be a Europe-wide interest rate, individual countries that increase their debt will raise interest rates in all other countries. EU countries may have to increase their intra-EU transfer payments to help regions in need.

It may prove more difficult to sustain a currency union than to begin one. The EC tax revenue is only 1.5% of the gross domestic product, which is an insufficient basis for an effective system of re-distributive taxation. In the event of differential prosperity within Europe there can be no confidence that the more fortunate countries will permit a greater degree of re-distribution. For so long as the UK market structures remain susceptible to bouts of inflation, the move to a low European interest rate regime could prove to be very damaging. There is no reason why the UK should not continue to attract foreign capital inflows even if initially outside the new currency arrangement. Adjusting to a new European currency will involve substantial costs for businesses and banks.

Adjustment to economic divergence by migration of labour or capital will be costly; there is no clear EC commitment to relieving these costs. Consequences. The erosion of national economic sovereignty is the overriding argument against the euro. Once we join, we will no longer set our interest rates, in line with the needs of the national economy, and sterling will no longer be a key adjustment mechanism. The consequences could be very damaging: instability, lower growth, higher unemployment and economic decline... Euroland is not an 'optimal currency area'.

For a monetary union to be successful, the following key conditions must be satisfied: wage flexibility, labour mobility, and a sufficiently large central budget to compensate countries and regions that are disadvantaged. Unless these conditions are broadly met, the costs and drawbacks of a single currency could greatly exceed the benefits. When one examine these conditions, it is clear that Euroland is not an 'optimal currency area'. The labour markets are fairly rigid, labour mobility is limited, and the central EU budget is less than 1.3% of GDP... If the UK joins the euro, failure to adjust may have adverse consequences.

If, once inside the euro, the UK experiences a shock, or under performs the others in term of productivity or unit labour costs, the economy may suffer reduced growth and higher unemployment... Joining the euro will be costly for many businesses. If we join, the physical conversion from sterling to euros will involve sizable costs, particularly for banks and retailers. The Government is unlikely to cover most of these costs. In many cases the businesses affected will be SMEs, which will not derive direct benefits from the adoption of the euro... A one-size-fits-all monetary policy is harmful.

Given the lack of real convergence in Euroland, it is highly likely that cyclical trends and pressures will often vary considerably as between different members. Therefore, a common interest rate that may be appropriate for Euroland as a whole will be the wrong rate for some individual members. This fact partly accounts for Euroland's poor growth performance since 1999, particularly that of Germany... Short-term interest rates, home ownership, and mortgage lending are relatively more important in the UK than in Euroland. Although more UK lending is now longer term and at fixed rates, a large proportion of lending (both to individuals and businesses) is still based on short-term, floating, interest rates.

Consequently, changes in monetary policy could have a more unsettling and de stabilising effect on the UK; and, because UK home ownership is relatively large, interest rate rises could generate adverse political reactions... Inside the euro, structural rigidities are more likely to spread to the UK. The euro will undoubtedly encourage greater tax coordination and more centralisation in various policy areas. However, the main reason why the UK has accepted measures such as the social chapter or the working time directive has been our membership of the EU, rather than of the euro. If we remain more flexible and competitive than our trading partners, the euro may benefit us and the UK could be a successful member... If we join, the UK may be affected by Euroland's huge pension liabilities.

Though UK pension liabilities are fairly modest, Euroland's huge liabilities may have adverse long-term effects on the UK. While the UK cannot be forced to finance German or Italian pensions, we may suffer through higher interest rates... Inside the euro, the 'growth and stability pact' will hamper the UK. This pact, which constrains the euro's members' fiscal freedom, will be particularly harmful for the UK. The Government's fiscal plans, to finance much of its ambitious increases in public investment through borrowing, will conflict with the pact; but these plans are justified, given the UK's low public debt... Joining will create serious risks for sterling.

One major risk is that we may lock ourselves into the euro with a grossly over-valued exchange rate, thus exposing the British economy to a competitive disadvantage. Alternatively, in order to avoid this risk, the authorities may try to weaken sterling deliberately and, in doing so, cause inflation and economic instability... The Bank of England's MPC is better structured, more effective and more transparent than Euroland's ECB. The record of the ECB has been poor. It has shown a deflationary bias and, in the face of a major global downturn, it has eased policy too little and too late.

If we join the euro, the UK will have to accept an inferior monetary framework. Conclusions: The issues involved are clearly very complex. Joining the euro entails massive risks. Equally, staying outside the euro permanently also involves serious dangers. The immediate risks, resulting from losing the ability to set our interest rates in line with our own needs and locking sterling permanently, must be weighed against the more long-term benefits produced by greater exchange rate stability and increased competition and dynamism unleashed by the euro.

However, the Government's insistence that the decision will be determined only by economic considerations lacks credibility. For some people, the most powerful argument against joining is the fear that it may lead to political union. For those supporting entry, many of the economic risks of staying out (e.g. discriminatory rules and adverse effects on foreign investment) are equally driven by politics. Ultimately, only wider political considerations, including a 'vision' of our long-term role in Europe and an assessment of the implications of staying outside permanently, may eventually persuade the British people to join. Employment Any major change like this will affect employment.

In the short term some roles will disappear before others begin to arrive. In the longer term a more stable currency can mean more stable employment... in the 1980's jobs were lost in the U.K. due partly to the low value of the pound. Raw materials became expensive and many manufacturers had problems or closed down completely... in the 1990's jobs were lost in the U.K. due partly to the high value of the pound. Finished products were hard to sell overseas and many manufacturers had problems or closed down completely Houses, Mortgages, Interest Rates Its a simple fact that at the launch of the euro the basic interest rate for those in the euro is less than half that of the U.K... Companies and home owners in the U.K. have been paying two or three times as much interest as other europeans. If you pay a mortgage or loan just think how much that is per month...

So what would happen if we joined? Based upon Ireland (a similar situation) those already owning property will be able to get more when they sell, and those already paying mortgages will be paying less And for those about to take out a mortgage? As house prices rise so will the (reduced) mortgages until a new state of balance is achieved. Even then it is unlikely that the amount paid per month for a given property will be much, if any, more than that paid today A single interest rate across the whole euro-zone cannot be appropriate for the diverse economies involved. Even in the UK, the Bank of England has been criticised for ignoring the needs of some regions in setting its interest rates.

Savings Savers may have to look for alternative ways of making their money work for them. Instead of taking part of the high interest rates charged to borrowers they may be led to invest some of their money in local enterprises. This, along with more affordable borrowing, could help generate employment and better prospects. So perhaps it's not so bad after all Euro Won't Help Trade Recent research by Christopher Taylor, former Chief Adviser in the European Division of the Bank of England, suggests that the UK would "suffer a marked increase in volatility on trade with the rest of the world" as a result of joining the euro. Monetary integration in Europe has led to "polarisation" of the euro exchange rate against the dollar. Membership of an enlarged euro area which included the UK would be likely to result in the UK experiencing twice as much volatility against the dollar as it does at present.

How the euro's polarisation against the dollar would affect the UK if it joined the euro depends crucially on what weight is given to different trading partners. Joining the euro would only reduce Britain's exposure to currency volatility by a third. Increasing intra-firm trade. The proportion of trade done between different national units of the same company is increasing with the growth of large multinational firms.

This increases the opportunity for so called "natural hedging" where exchange rate risks on a trade are offset by equal and opposite risks on trade in the reverse direction. All of the supposed benefits of the euro for exporters have to be offset against the cost to exporters themselves in terms of increased domestic instability. The UK would be likely to experience greater volatility of output, inflation and unemployment in the Eurozone. This increased domestic instability would harm exporters along with the rest of the economy. Failure to join and inward investment: fears that failure to join the euro will hurt jobs by curtailing inward investment need to be assessed with care. There are already signs that inward investment to the UK has been falling since the birth of the euro and looks set to fall further the longer the UK remains outside the eurozone.

However, the impact of this will ultimately show up in lower productivity and living standards than would otherwise be enjoyed, rather than jobs. The labour market will over time adjust to any loss of jobs resulting from lower inward investment, with alternative jobs being created. But the economy overall will suffer because inward investment generally introduces state-of-the art plant and machinery, up-to-date management techniques, and higher skilled, higher wage jobs. Single market The single market came into force in January 1993, establishing the free movement of goods, people, services and capital.

The Treaty of Rome which established the EEC in 1957 had set its sights on creating a common market. That came into being in 1968 with the creation of a customs union. But it took much longer to take the leap towards a single market. The Single European Act, signed in 1986, finally set a deadline of 1992 for the single market to be up and running.

It also streamlined the decision-making process to take account of successive enlargements and to speed up legislation to implement the single market. In the end, the single market was launched on 1 January 1993, though some of the legislation was still not in place. The single market set up four freedoms: . Goods: companies can sell their products anywhere in the member states and consumers can buy where they want with no penalty...

People: citizens of the member states can live and work in any other country and their professional qualifications should be recognised... Capital: currencies and capital can flow freely between the member states and European citizens can use financial services in any member state... Services: professional services such as banking, insurance, architecture and advertising can be offered in any member state. 5 criteria for joining the euro? 1.

Sustainable convergence between Britain and the economies of a single currency; including: o monetary transmission mechanisms o the housing market o national business cycles o sustainable real exchange rate 2. Whether there is sufficient flexibility to cope with economic change; including: o labour markets o adjustment mechanisms o fiscal policy as an economic stabiliser 3. The effect on investment; including: o the cost of capital o the impact of joining on different economic sectors 4. The impact on our financial services industry; including: o why financial services companies are located in cities like London and Edinburgh 5. Whether it is good for employment; including: o the euro's impact on external trade o lessons from American monetary union o the stability and growth pact o price differentials in the euro zone The Treasury and the Bank of England have about 30 officials undertaking an assessment of the five tests. They are due to reach their conclusions by June 2003.

This is probably well before any potential problems due to the single currency could surface. A really adequate assessment would need to cover the working of the euro over the whole economic cycle. It is reported that the House of Commons Treasury Select Committee will undertake an investigation of the five tests in Summer 2002..