1. Benefits versus costs of adopting the Euro for the UK An Optimum Currency Area Theory approach

2. Introduction Optimal Currency Area framework Three economic criteria: 1. Labor Mobility 2. Production Diversification 3. Openness Three political criteria: 1. Fiscal Transfers 2. Homogenous preferences 3. Commonality of destiny The Economist survey: 67% of macroeconomists – favor joining EMU, 75 % of monetary economists – are against

3. Labor Mobility Importance of asymmetric shocks Movement of labor from recessionary to expansionary countries Irrelevance of exchange rates assuming perfect labor mobility

4. Labor Mobility Low movement of people in Europe as compared to US ( language, culture, legal barriers ) UK vs. Continental Europe - Different market regulation philosophies ( e.g. difficult lay offs in France ) Labor mobility across European countries is lower than the one within countries Conclusion: Labor Mobility criterion- unfulfilled

5. Production Diversification Kenen : Exports and Production diversified and of similar structure Response to asymmetric shocks Decreases in demand or supply of one product are leveled off by increases in the demand and supply of another product

6. Production Diversification UK’s market – “sectoral liberalization” in housing and retail – more diversified than Continental Europe Major structural differences: UK -mortgage debt 57% of GDP > EU’s 33% in 1997 -short term debt & equity issuance UK – exporter of OIL ( e.g. high demand in Italy and Germany) not sure for how long Conclusion: Kenen criterion- unfulfilled

7. Openness McKinnon:countries trade heavily with each other, then - monetary policy insignificant -prices adjust rapidly Is UK heavily engaged in trade with the rest of the EU member states? Core-periphery dichotomy

8. Openness UK’s ratio of exports and imports to GDP towards the rest of the Euro zone UK periphery Benefit of joining: low exchange rate uncertainty Insurance from exchange rate fluctuations Conclusion: McKinon criterion- unfulfilled

9. Fiscal Transfers Money is transferred to countries affected from the asymmetric shocks theory of economic needs – money allocated based on wealth not the impact of adverse shocks – UK would suffer No fiscal transfer mechanism Conclusion: Fiscal Transfers criterion- unfulfilled

10. Homogeneity of preferences criterion countries must agree on the policies the Central Bank will use Germany – inflation averse, UK more tolerant Gordon Brown – UK prefers flexibility Conclusion: Homogeneity of preferences criterion criterion- unfulfilled

11. Commonality of destiny vs. nationalism criterion willingness to sacrifice for fellow members EU – a union of nations – political quarrels Jacque Chirac : “EU is not a United States of Europe but rather a Europe of United States” Conclusion: Commonality of destiny vs. nationalism criterion- unfulfilled

12. CONCLUSION UK’s current optimal choice is to continue to opt out However the costs of opting out should be re-evaluated on time to time basis