The Euro is the European Single Currency which involves a common monetary policy, and permanentely fixed exchange rate between other member countries.
However, joining the Euro may incur various costs.
- Cost of replacing currency and adjusting machines, however, this is a one-off cost
- Loss of autonomy over economic policy. With the ECB setting a common interest rate for the whole area, countries have lost an important part of their Monetary policy. This is a major problem if a countries economy is at a different stage in the business cycle. For instance, in 2005, Ireland and Spain were growing quite fast and need higher interest rates to control inflation than other countries who need lower interest rates. Therefore with low-interest rate, Ireland might experience inflation On the other hand, in 2009, Ireland and Spain were experiencing a deeper recession than the rest of the Eurozone area. They needed lower interest rates and depreciation, but, other countries didn’t.
In 1992 the UK benefited from leaving the ERM in order to have lower interest rates and come out of recession. This showed that countries economies may not have converged and a single policy could be harmful.
- Lose ability of Central Bank to print money. This means countries more likely to experience liquidity crisis.
In the bond crisis of 2011-12, bond yields in Eurozone rose rapidly. Greece bond yields reached nearly 30%.
- Loss of Devaluation as economic management policy. As well as losing an independent Monetary policy countries cannot use their exchange rate. Business would argue Sterling is overvalued at the moment if we joined the Euro at this rate our exports would be uncompetitive
- Also, governments couldn’t devalue the Exchange Rate to overcome balance of payments problems.
- Countries will lose some independence over Fiscal Policy. This is because of the growth and stability pact.( e.g. no country is allowed to borrow more than 3% of its GDP. This means that they will have to try and maintain the economy at a similar stage to other countries. E.G. Ireland had high growth and was criticised for increasing spending, (which increases AD).
- Asymmetric Shocks. If one country experienced an external shock it might need a different response. But this is not possible with a common currency. E.g. German reunification required higher interest rates in order to help reduce inflation but this was not good for many other countries.
- An oil shock would affect net importers like France more than Norway and the UK who export a lot.
Monetary Policy will have different effects in different countries. For example, the UK is sensitive to changes in the interest rate because many people have mortgages.
- The Euro has been quite unstable against the dollar, whilst Sterling has been quite stable. Joining the EURO could, therefore, increase E.R. instability against over currencies
- The ECB is less transparent in their decision making, for example, they do not produce monthly minutes, this makes interest rate changes less predictable
- Deflationary bias since Euro introduced