Sunday, November 17, 2002

Pros and Cons of Euro Entry

In this timely piece, Morgan Stanley's Fatih Yilmaz and Stephen Jen do some options call accounting on the pluses and minuses for EMU participation on the part of the UK and Sweden. They rightly conclude that, seeing what we are seeing, the value attached to waiting just went up, dramatically. As they point out both the UK and Sweden are already members of the EU, and, in that capacity, enjoy all the trade benefits that are afforded to all EU members. In addition the benefits of joining the EMU should be distinguished from those of being EU members. On the plus side, the key benefits of joining the EMU seem to be: firstly, a reduction in the transaction costs of trading with and investing in the other EMU member countries fall, the cost of raising capital should also decline towards that of the rest of Euroland, secondly, in theory, "monomoney" in Euroland should enhance price (and wage) transparency, which in turn should lead to greater competition in the product market and the labour market (it's important to note the 'in theory part here, since at present it might seem that this transparency, absent labour market flexibility, is leading to a naive inflationary coupling effect in the Southern zone of Europe). Thirdly, any potential adverse effects of exchange rate uncertainty on trade and investment would disappear. These benefits appear extremely thin when we start to look at the associated costs:

Joining the EMU comes with its costs. First, there is the issue of abandoning monetary independence. The use of domestic monetary policy and exchange rate adjustments for the purpose of national demand management will be lost. The size of the cost of forsaking monetary independence depends on two factors: As the effectiveness of monetary policy for adjusting the macroeconomic imbalances increases, and as the asymmetry of the responses of the member countries to economic shocks intensifies, the associated costs will be larger. Second, the Maastricht treaty imposes tight fiscal policy restrictions to fulfil several convergence criteria. With negligible large-scale regional transfers, the loss of fiscal autonomy can also have adverse impacts on demand management and economic stabilisation. Third, factor mobility and price (wage) flexibility, the vital mechanisms for adjustments in a monetary union when monetary and fiscal constraints are binding, are severely restricted in Europe. Fourth, attempts to achieve one-size-fits type Europe-wide policies can themselves generate political conflicts within Europe.
Source: Morgan Stanley Global Economic Forum

Let me just run this again. You get to save some currency uncertainty costs, and possibly to borrow money a bit cheaper (mid-term this remains to be seen). In exchange you lose all control over fiscal and monetary policy, have to operate permanently in sub-optimal conditions (this follows from the fiscal/monetary point, look for eg at Germany right now) and face a lot of political in-fighting to boot. Seems like no-contest to me. Of course one mistake (there have been many I'm afraid) always was to create the category of EU member, non-EMU participant. But now it's too late I guess.

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