European unemployment crisis

Unemployment in many European countries has risen sharply due to the credit crunch and global recession. The worst hit countries include Spain (ES) and Greece (EL), who both have unemployment rates of over 25%.
  • Unemployment rate in the Eurozone area: 11.8% (March 2014)
  • EU-28 Unemployment is slightly lower at 10.5% (March 2014)
  • Total unemployment in the EU-28 is 25.699 million (March 2014)
  • The Eurozone  (EA-18) jobless total is now 18.913 million. (link) The highest since records began.
  • Youth unemployment rates in the EU 27 is 22.8% (March 2014)
  • The lowest unemployment rates are in Austria (4.9 %), Germany (5.1 %) and Luxembourg (6.1 %). The highest rates are in Greece (26.7 % in January 2014) and Spain (25.3 %).
  • By comparison, unemployment in Japan is 3.6%, and in US 6.8%
  • Eurostat unemployment figures

EU unemployment

Source: ECB

 Causes of European unemployment crisis

After falling to 7.5% in 2008, the prolonged recession of 2008-13, has caused a sharp rise in unemployment.  The continent seems to be stuck in a deflationary spiral and is facing a prolonged double dip recession. Hardest hit debtor countries, such as Spain, Greece, Portugal and Italy are facing stringent budget cuts – which are depressing demand.

Will Eurozone break up?

But, in the Eurozone, there is little relief available to boost demand. Countries are unable to devalue. Monetary policy set by the ECB has been unflinching in targeting low inflation and offering little monetary easing – despite the prolonged recession. Also, depressed demand throughout the region is making it difficult to grow through increasing exports. Even northern Europe, which has had large current account surpluses are engaging in modest austerity. The result is that demand has remained depressed across Europe.

Despite its potentially damaging social and economic impact, throughout the 2008-13 European crisis, unemployment has had a relatively low profile -  European policy makers have always given the impression they are more concerned about appeasing bond markets and low inflation than tackling the more pressing problem of unemployment. There has  been a reluctance to tackle the fundamental deficiency of aggregate demand which is leading to lower growth and falling employment. Efforts to reduce unemployment have centred on talk of more flexible labour markets. This may be part of the solution for structural unemployment, but increasing labour market flexibility alone cannot deal with the cyclical unemployment.

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Policies to reduce pollution

What policies can a government use to reduce pollution?

Pollution is an example of a negative externality – when producing or consuming a good causes a negative impact on a third party. For example, using a petrol car causes CO2, and other pollutants to be released into the atmosphere. Similarly producing power from a power station creates pollutants, such as sulphur dioxide and CO2. The external cost of pollution is acid rain, global warming and health issues relating from air pollution.

Government policies to reduce pollution

  1. Tax. e.g. Carbon tax, which makes people pay social cost of pollution.
  2. Subsidy. e.g. subsidy of alternative energy sources.
  3. Pollution permits,. e.g. carbon trading schemes where firms are given the right to pollute a certain amount; these permits can be traded with other firms.
  4. Regulation. Limits on the amount of pollutants that can be discarded into the atmosphere.



The idea of tax is to make consumers and producers pay the full social cost of producing pollution. For example, petrol tax or a carbon tax.

tax-on-negative-externalityIn this case, the social marginal cost (SMC) of producing the good is greater than the private marginal cost (PMC) The difference is the external cost of the pollution. The tax shifts the supply curve to S2 and therefore, consumers are forced to pay the full social marginal cost. This reduces the quantity consumed to Q2, which is the socially efficient outcome (because the SMC=SMB)


  • The advantage of this scheme is that the government raises substantial revenue, which could be used to finance other pollution reduction schemes (e.g. subsidising alternative)
  • It provides a market incentive for firms to offer more efficient engines, which cause less pollution. Increased petrol tax has created an incentive for firms and consumers to switch to less fuel intensive engines.
  • One drawbacks of carbon tax is that demand may be quite inelastic and that an increase in petrol tax may do little to reduce demand and only marginally reduce the amount of pollution. Though in the long term, demand may become more elastic as people switch to other forms of transport over time.
  • Another potential problem is that it can be difficult to implement green taxes due to administration costs or it is difficult to know how much to tax.
  • In practical terms (non-economic issue), the difficulty is often political resistance – people never like paying new taxes, even if there is a long term goal of reducing pollution.
  • More detail on pros and cons of carbon tax

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Impact of rising population in the UK

The UK population is rising and is forecast to rise to over 71 million by 2031. This is a look at the economic and social impact of a rise in the population.

UK Population Households
The UK is bucking the trend of many Western economies, such as Italy, France and Japan – who are seeing low birth rates, an ageing population and declining populations.


UK population projections at BBC

The growth of the UK population raises many issues, some positive and some negative. From an economic perspective, the population growth is generally good news. The growing population will increase the productive capacity of the economy, and help the UK avoid a demographic time bomb through improving tax revenues. However, a growing population will exacerbate existing problems, such as the long standing housing crisis and shortage of supply. To deal with the rising population and congestion, we are likely to see increased building on greenbelt land and a change in the UK’s landscape.

On the one hand, population growth will help the UK economy become one of the largest in the EU, but as a consequence we will have to deal with increased congestion and increased demand on local infrastructure.


The UK is already struggling to meet existing demand for housing. A rising population will put even more pressure on housing; also, the rise in number of households is greater than the rise in the population due to growth of single occupancy households.

As mentioned in housing crisis, the UK already has a persistent shortage of housing. Demand is rising faster than our willingness to build. This shortfall is causing an increase in long-term house prices, reducing affordability. If the UK population continues to grow to 71 million plus it will, ceteris paribus, put upward pressure on house prices. It will require a dramatic change in housing policy and could require large scale new towns to catch up with the shortage.

If supply of housing fails to meet the growth in the number of households, it will increase the cost of living. House prices will rise and the cost of renting will also continue to rise. This is likely to exacerbate the growth in wealth inequality we have seen in the past few years.

Arguably we could deal with the housing shortage, if the political will is there. In the 1950s, we built 400,000 new homes a year. But, given the current resistance to even moderate new home building programmes, 300-400,000 new homes a year will be very difficult.

Limiting the impact of an ageing population

Many countries with declining populations are seeing a rise in the percentage of people over retirement age. This puts pressure on government spending (health and pensions) and leads to lower tax revenues (See: impact of ageing population). The UK population is rising due to net migration and higher birth rates. This means the UK has a higher % of people of working age, who are net contributors to the exchequer (paying income tax, not receiving pensions)

Therefore the growth in the population improves the long-term UK budgetary position, reducing the need for spending cuts and / or tax increases.

The growth in the working age population also increases the size of the UK labour force, enabling higher productive capacity. This will help increase UK real GDP compared to other countries. (note, GDP per capita – GDP per head may not be affected by a growing population.)

Increased efficiency of greater population density

Increased population density is more efficient from both an environmental and economic perspective. The highest carbon per capita consumption comes from rural / low population density areas. There are economies of scale in providing transport and infrastructure which helps reduce the per capita impact on both government spending and the environment.  (Report: increased efficiency of higher urban density) (Study: efficiency of public services from higher density)

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Policies to ease pressure on the housing market

Readers Question: What policies could be used to ease pressure on housing market?

Firstly, the main pressure in the UK housing market is the persistent and continued above inflation price increases. Back in 2004, Kate Barker’s report into housing market trends found that the UK would need to build 250,000 houses to reduce the house price inflation rate to 1.1%. But, since 2004, the UK housing market has fallen short of this target. In the middle of the recession, the number of home starts fell to just over 100,000. (Housing supply)

The  Home Builders Federation claim to catch up, we would need to increase home building to 320,000  a year – something not seen in the UK since the 1950s.

Policies to ease pressure on housing market

1. New Garden cities The building of new cities, in the mode of Milton Keynes, can enable a significant increase in homes. Currently there are plans for a new city in Ebbsfleet, Kent on the high speed railway line to London.

However, from planning to completion this will take a long time. It also means building on greenbelt land, which is likely to raise objections.

2. Government subsidy / council homes. Additional government spending to subsidise the building of ‘social’ housing could help increase supply. In the past decades, council housing has fallen out of vogue as the government have sought to sell off council housing and cut back on the building of council housing. But, it was council houses which provided a significant boost to the UK’s housing stock in the post war period.


Clement Attlee’s post-war Labour government built more than a million homes, 80% of which were council houses. In recent years, local authority building of new houses has virtually ceased. It is notable that since local authorities ceased to build homes, the UK housing shortage has become more acute. Housing associations have never been able to replace the large numbers built by local authorities.

It would require a change in political commitment and the willingness to spend extra money. Also, since the Thatcher era, the notion of council housing has gained a form of social stigma. However, it could make a big difference to the number of homes built.

3. Greater flexibility in planning. Planning restrictions are quite strict in the UK. Loosening the number of restrictions and making it easier for builders will make supply more elastic. This could involve reducing the amount of protected greenbelt land. It could also involve streamlining the regulations home-builders have to meet.

However, this could lead to significant local objections as people protest about the increased building, congestion and loss of green fields. One other solution would be to provide grants for turning derelict brown field sites into new homes.

4. Incentives for local authorities

Home building is a local issue. Local authorities have to deal with opposition to home building, so there is often local political pressure to stop house building. However greater financial incentives, such as allowing the council to keep council tax receipts from new housing developments, could give them a greater motivation to allow home building.

5. Introduction of a Planning-gain Supplement scheme

At the moment, building new houses tends to give the greatest benefit to landowners. Local residents feel they just lose out – depressed house prices, loss of unique village e.t.c. One solution is to make sure local residents near new housing schemes gain some compensation in return for accepting more houses. For example, a new housing development could be accompanied with a bypass or better public transport links. This is interesting from an economic perspective as it is seeking to provide a pareto improvement (one where everyone benefits).

The difficulty is that in the real world, it can be difficult to ensure people are compensated. Some local residents may feel there is nothing to compensate for the loss of a beautiful view. People may also exaggerate how much they lose from a new housing scheme.

6. Government’s Help to to buy

The government’s help to buy scheme is controversial because it is seeking to ease the problem through helping homeowners borrow more money. Critics argue this merely fuels demand and keeps prices artificially high.

However, to some extent, the Help to Buy scheme has provided some incentive for private builders to increase supply. In particular the first part of the scheme which offers buyers an interest-free loan worth up to 20% of the value of a new-build home. This increased demand for new build homes, encourages house builders because they are more confident there will be demand for the new homes. Continue Reading →


Are UK house price rises sustainable or are we heading for a crash?

Readers comment on – House prices stats Excuse me for pointing out the obvious, but why are those ratios (House price to incomes) unsustainable if interest rates stay low? It’s the ratio of house-price-multiplied-by-interest-rate to earnings that determines affordability, not ratio of house price to earnings.

If rates fall as prices rise, then the first ratio remains affordable. If earnings rise, the ratio remains affordable.

Interest rates have been on a downward trend for 25 years and inflation has been tamed, there’s no reason for that trend to change..

UK base interest rates

UK base rates have stayed at 0.5% since early 2009. But, how long will they stay at 0.5%

It is true that housing affordability is determined b:

  • Disposable income
  • The cost of mortgage payments; (this depends on both the cost of buying a house and interest rates).

The ratio of house price to earnings is not a reliable guide to the actual cost of housing because there are other factors we need to consider.

We can see this by comparing two graphs which show house price to earnings.




These two graphs show that we can have an improvement in affordability (fall in the cost of mortgage payments) even as house prices rise.

I agree that in the long term the sustainable ratio of house price to earnings can increase. There is no law that the ratio of house price to earnings has to stay at (say 3). For example if we see a decade of lower interest rates and / or rising real incomes. Then house price to income ratios could increase.

However, that doesn’t mean we should ignore a rapid increase in house price to earning ratios.

  1. Affordability has been increased by the significant fall in interest rates to 0.5% – Interest rates certainly can’t fall any further and are likely to increase.
  2. House prices are rising much faster than average earnings.
  3. Many first time buyers, struggle to raise the increased deposits required to buy a house.


    ONS house price index Nov, 2013 – Deposits are rising as % of income

  4. There is evidence that house prices are being pushed higher by investors rather than young buyers. The ratio of people renting is increasing.

An increasingly small % of the population is able to get a mortgage. The median income of mortgage borrowers has nearly tripled since 1990.

income mortgage borrowers

Long Interest rate prediction


House price affordability has increased because interest rates are at record lows. In the long term I cannot see a return to double digit interest rates that we saw in the 1980s and early 1990s. However, I do expect interest rates to increase above 0.5%. When the economy recovery becomes stronger, I would expect interest rates of 4%. Historically, we see real interest rates of 2%. If inflation stays on target of 2%, then the most likely long-term interest rate is around 4%.

It is possible that the UK and Eurozone economies could replicate Japan ‘lost decade’ of deflationary pressures. In this case interest rates could stay at 0.5% for a decade. But, I would hope, this is still a reasonable chance we can escape this threat of prolonged deflation. Recent growth edging towards 2% a year is promising. The balance of probability suggests interest rates will rise by the end of 2014, or definitely in 2015.

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House prices and interest rates

There is concern that UK house prices are rising at an unsustainable rate. In the past 40 years, UK house prices have consistently grown faster than average earnings. (Why are UK house prices so expensive)


Even as the economy just begins to emerge from recession, the housing market is already showing signs of overheating. In some areas, house prices are rising 10%  a year – much higher than CPI inflation of 1.6%.

Expensive house prices threaten the economy in various ways:

  • Make many areas unaffordable for young people causing shortages of skilled labour.
  • Increased wealth inequality between home owners and renters.
  • An unsustainable boom in house prices could lead to an eventual fall in prices, with corresponding bank losses and negative wealth effect.
  • See also: Problems of expensive house prices

How do interest rates affect house prices?


Interest rates were cut in 2008/09 – causing a a decline in the cost of mortgage payments

  • Currently, in the UK interest rates are very low. Base rates, set by the Bank of England, are currently 0.5%. This has reduced the cost of mortgage payments, making buying a house relatively attractive.
  • It means that despite the rise in house prices, mortgage payments are not too expensive. With interest rates so low, it make sense to try and buy. This increase in demand for housing is one significant factor in pushing up prices.

The effect of rising interest rates on the housing market

  • If interest rates rise it will have a significant effect on increasing the cost of mortgages. This will deter prospective home-buyers, but it may also force some existing home-buyers to sell. The danger is that many homeowners are being protected by ultra low interest rates. If rates rise, this will make mortgage payments too expensive and they may be forced to sell.
    • This increase in sellers and decline in buyers will cause house prices to fall.

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What happens when you destroy money?

Readers question: What happens to the underlying money (supply) if someone destroys currency rather than saving it or spending it?

The money supply is the total stock of notes, coins and bank deposits in the economy.

If money is destroyed (taken out of circulation) and not put back in by the Central Bank, then the overall money supply in the economy will fall. There will be less money circulating.


If the money supply is reduced how does that affect the economy?

If the money supply falls, it is likely to cause deflation (falling prices) or at least reduce the inflation rate.

It is the opposite of printing more money. If you print more money, it doesn’t change the output of an economy, it just creates more money and so puts upward pressure on prices. See: The problem of printing money

If the money supply falls, that doesn’t directly affect output. The amount of goods and services in the economy is not directly affected by people destroying or creating money But, with less money circulating, there is a downward pressure on the price of the same number of goods.

Suppose in an economy, you have a 10,000 goods and a money supply of £10 million. Then the average price of those goods will be £1,000.

  • If the money supply falls to £8 million, the average price of those 10,000 goods will be now £800. You still enjoy the same number of goods, it’s just that the goods will be cheaper.
  • After the fall in prices, the nominal GDP is lower. But, because prices are cheaper, people are still able to enjoy the same number of goods and services as before.
  • It is the opposite to inflation. With inflation, we see a rise in nominal GDP. But, because prices go up, the amount of goods and services you enjoy remains the same.

Effect of deflation in the real world

In theory, reducing the money supply shouldn’t have any affect on real incomes or real output. However, in a situation where the money supply is falling, it could cause a fall in aggregate demand and lower economic growth.

If consumers notice a fall in the money supply (e.g. through lower nominal wages) they may lose confidence and because they fear lower incomes or unemployment start saving a higher percentage of their income.

Even falling prices can have the effect of reducing spending:

  • If prices are falling, consumers are more likely to delay purchasing them – until they are cheaper. This causes lower aggregate demand.
  • If prices and wages are falling, the real value of debt increases. It becomes harder to pay old debts back with falling wages, therefore this also causes lower economic growth.
  • see more at: Problems of deflation

In recent years, deflation or very low inflation has created significant economic problems in both Japan and the Eurozone.



Problems of Agriculture – Market Failure

Agriculture often appears to be one of the most difficult industries, frequently leading to some form of market failure. In the EU, agriculture is the most heavily subsidised industry, yet despite the cost of the subsidy it fails to address many issues relating to agriculture.

Types of market failure in agriculture

  1. Volatile Prices / volatile supply
  2. Low and volatile income for farmers
  3. Environmental costs of intensive farming (negative externalities)
  4. Agriculture key component of rural life (positive externalities)
  5. Monopsony power of food purchasers.

Volatile Prices in Agriculture

Prices in agricultural markets are often much more volatile than other industries. This is because:

  1. Supply is price inelastic in short term. (It takes a year to grow most crops)
  2. Demand is price inelastic. (Food is essential and people are not usually put off by higher prices)
  3. Supply can vary due to climatic conditions.


This diagram shows that a ‘good’ harvest leads to an increase in supply. This leads to a significant fall in price (P1 to P2). See also volatile food prices

The problem of volatile prices is that:

  1. A sharp drop in price leads to a fall in revenue for farmers. Farmers could easily go out of business if their is a glut in supply because prices can plummet below cost.
  2. Cobweb Theory. The cobweb theory suggests prices can become stuck in a cycle of ever-increasing volatility. E.g. if prices fall like in the above example. Many farmers will go out of business. Next year supply will fall. This causes price to increase. However, this higher price acts as incentive for greater supply. Therefore, next year supply increases and prices plummet again!.
  3. In some years, consumers can be faced with rapid increase in food prices which reduces their disposable income.

2. Low income for farmers

Often farmers don’t share the same benefits of economic growth. As the economy expands, firms don’t see a similar increase in income. Food has a low income elasticity of demand. As incomes rise, people don’t spend more on food. Also, technological advances can lead to falling prices rather than rising incomes. Many developed economies feel it is necessary to subsidise farmers to protect their incomes.

For a developing economy, their current comparative advantage may lie in producing primary products. However, these may have a low income elasticity of demand. With global growth the demand for agricultural products doesn’t increase as much as manufacturing. Therefore, relying on agriculture can lead to lower rates of economic growth.

3. Environmental costs of intensive farming

Modern technology has enabled increased crop yields. However, this often requires chemical fertilizers which cause pollution. As farming becomes more competitive there is a greater pressure to produce more leading to increased use of chemicals. However, artificial fertilizers have diminishing returns, so it becomes more expensive and greater environmental cost for little benefit. Many farming methods have led to deforestation and cutting down trees. This can upset the eco-balance making regions more susceptible to flooding.

4. Positive externalities of farming

You could argue farming communities play an integral role in rural life. If farmers go out of business it has adverse consequences for rural communities and the environment they live in. This is often a justification for subsidising farmers (e.g. the social benefit of subsidising sheep farmers in the Lake District)

5. Monopsony

Supermarkets can have monopsony buying power over local farmers. This means farmers may see their profit margins squeezed by the big supermarkets who have substantial buying power. If farmers don’t sell to the big supermarkets they can’t sell their products, this is why it puts them in a difficult position.


Government intervention in agriculture

  • Buffer stocks - to help stabilise prices though having minimum and maximum prices
  • Minimum prices – to guarantee farmers basic income by subsidising food prices. However, minimum prices may encourage oversupply and lead to wasted food production.
  • Subsidies for farmers who follow more environmentally friendly methods.
  • Tariffs on imports. This increases the domestic price of agricultural produce, but leads to lower trade.

Problems of government intervention in agriculture

  1.  Cost of subsidising agriculture in developed world It is estimated support to agricultural producers in advanced countries was $245 billion in 2000, five times total development assistance. In the members of OECD as a whole, a third of farm income came from government mandated support in 2000. (Martin Wolf, Financial Times, 21 November 2001) (problems of Agriculture)
  2. Subsidies have often been given to farmers with large amounts of land and with little incentive to follow more environmentally friendly procedures.
  3. Minimum prices have led to over-supply
  4. Tariffs on agriculture have led to lower income for food exporters in the developing world and have been a big stumbling block to trade.



Photo: A field in the Cotswolds by Tejvan

The economic effects of cheaper solar power

In recent years the cost of producing solar energy has fallen dramatically. Discuss the economic effects of cheaper solar power on the energy industry and wider economic welfare.


Solar power is an alternative energy source to coal and natural gas.

Solar power also has a significant environmental advantage over traditional fossil fuels.

  • It is renewable. there is no danger of running out.
  • It does not cause pollution. There are no CO2 and other emissions created from solar power.
  • Solar power has significant positive externalities. Switching to solar energy would help reduce the environmental costs (pollution, global warming) associated with fossil fuels.

Coal / Gas industries

The fall in the price of solar energy means that demand for coal and gas (a substitute to solar energy) is likely to fall, either in the short term or long term. Currently, solar energy is still a little more expensive. This graphs suggests that solar power is $1, whereas gas / coal is in the band $0.30 to $0.90. However, the sharp downward trend appears for solar power to become cheaper as technology improves.

As industry and consumers switch to solar alternatives, the coal / gas  industry will face a fall in demand. This could lead to lower prices of coal due to excess supply.


This fall in demand for coal and gas could see firms leaving those industries (and a subsequent fall in supply). Alternatively, some coal firms may respond by cutting prices to try and undercut the price of solar power. This increased competition could lead to even lower energy prices for consumers. However, ultimately, you would expect the coal and gas industry to decline as people switch to solar.

However, it could take considerable time for this switch to occur. Many countries may be reluctant to invest in solar power plants, when it is still more expensive. Also, they may be unwilling to invest money in developing new power stations, and out of habit they may continue to use fossil fuels.

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Euro revision notes

The Euro is the single European countries adopted by 18 out of 28 EU countries. The UK has not joined.

The Euro involves:

  • Common currency
  • Common monetary policy – Eurozone interest rates set by the ECB in Brussels.
  • Some fiscal rules, e.g. The Fiscal Compact (2012) limiting the amount of government borrowing (a balanced budget of less than 3% of GDP)

The Euro is the second largest reserve currency in the world after the US Dollar.

Benefits of the Euro

  • Lower transaction costs for trade, tourism and consumers.
  • Greater price transparency (leading to more price competition and lower prices for consumers)
  • Eliminates exchange rate volatility, encouraging trade and inward investment.
  • In theory, lower inflation and lower interest rates.
  • See more: benefits of the Euro

Problems of the Euro

  • Common monetary policy not always suitable for all 18 members. e.g. southern Eurozone in recession, but ECB have kept monetary policy quite tight (relatively high interest rates). This means countries can be at risk of recession (if ECB keep interest rates too high) or boom if ECB don’t tackle inflationary pressure in that country.
  • Uncompetitiveness. Countries in the Euro cannot devalue their currency against European neighbours. If an economy becomes uncompetitive (e.g. relatively higher inflation / wages) then they will become uncompetitive and there will be: a fall in demand for exports and growth and a current account deficit.
  • Geographical immobilities. The Eurozone is quite diverse, it is difficult for unemployed Spanish workers to move to Germany to take advantage of jobs there. This lack of mobility makes a common monetary policy difficult.
  • Fiscal compact has created pressure for austerity, leading to lower growth. Countries in the Eurozone have few policies to increase aggregate demand (AD) in a recession.
  • Higher bond yields. Countries in Eurozone have faced rising bond yields because they have no Central Bank to act as lender of last resort.
  • Recession and low growth. Since 2008, the Eurozone has experienced low growth, high unemployment. Many fear the Eurozone has a deflationary bias.

More details – problems of the Euro

Should the UK join the Euro?


  1. Reduce exchange rate volatility
  2. Encourage trade and inward investment with main trading partners


  1. UK would suffer from losing independent monetary policy, e.g. no quantitative easing could have made recession worse.
  2. UK housing market very sensitive to interest rates.
  3. UK exports could end up becoming uncompetitive lack Southern Europe
  4. Growth likely to be lower.
  5. Past five years suggest membership of the Euro could contribute to very serious recession.

Should UK join the Euro?

Possible essay questions on the Euro

  • Discuss whether an Eastern Europe country like Latvia is likely to benefit from adopting the Euro?
  • Discuss how the UK economy would be affected if it adopted the Euro?


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