1) The potential benefits and costs of adopting the euro for United Kingdom:

Benefits for UK if adopting euro:

(1) No transaction costs. This is the most obvious advantage. UK people will no longer need to incur transaction costs in exchanging currency when they go for a holiday in Euro-land. For businesses the advantage is considered bigger, as they no longer need to incur higher transaction costs which include the costs of hedging against huge currency swings

(2) Price transparency. Since everything will be quoted in euro, UK consumers will find it easier when comparing prices of goods & services. Also this ensures that local firms will always price their goods competitively. This results in increase in consumers’ welfare. For firms, they can also take this opportunity to source their raw materials from the cheapest suppliers thus minimising their production costs

(3) Eliminate exchange rate volatility. Manufacturers in UK will have greater incentive to invest e.g. expanding operation into Euro-land, import capital goods from German etc when exchange rate is certain. Also they can plan their production of output systematically, as the trend of demand for UK goods will be more apparent. This is very important considering UK has more than 50% of trading share with Euro-zone. Ability to explore the wider market also means greater EOS (economies of scale)

(4) Attract investors from outside. It is said that UK could have attracted more investors if it adopts euro earlier. According to critics, no doubt UK has its own advantage such as pool of productive workforce, flexibility in labour market, independence of the monetary committee etc which largely explains for the influx of foreign investment all this while. However with single currency, the attraction is larger as it helps investors to further minimise their costs of production as accrued to the first 3 reasons as above

(5) Improvement in inflation performance. Compared to UK’s Bank of England, the ECB (European Central Bank) is said to have ‘zero-tolerance’ policy against rising inflationary pressure. In UK, CPI is allowed to increase up to 3% but in Euro, its targeted inflation is close, but not more than 2%. Countries that have high inflation could benefit from these

(6) Rising importance of Euro. Euro currency is increasingly becoming more influential in international trade. Some economists argued that it may replace dollar one day as the most sought after currency in period of globalisation. This is because, the size of Euro’s economy is much larger than US alone & this is not considering other potential members which may be joining at later date. The market is large & it is politically stable too. On the other hand, instability of dollar & rising national debt in US has sort of spark fears that the dollar will collapse one day. China is also accused of slowly diverting its dollar holding to euro holding

Costs of adopting euro:

(1) Sensitivity of changes in interest rates. This is the MAIN reasons as to why UK chose to stay out of Euro. House ownership in UK is the highest in any parts of Euro-land & also traditionally Britons store their wealth in property market. As such any changes in interest rates even by 25 basis points or 0.25%, will have a severe effect on UK economy.

For instance, Euro’s interest rates are lower than in UK (much earlier before the mortgage crisis). Upon joining, UK interest rates will be lowered in accordance with ECB rate. This will surefire raise the inflationary pressure in UK as everybody will be taking up loans to buy property. Another classic case, Ireland. Before joining it had 6% of interest rates. After adopting euro, its interest rate was 3%. This largely explains why inflation rate in Ireland is reasonably higher than others

(2) Constraint in government spending. Stability pact signed by member countries makes things worse. It states that members’ annual budget deficit (how much spending exceed tax revenue) cannot exceed 3% of GDP. This will be the biggest stumbling block when it comes to recession. In downturn the figure is easily in excess of 3%. Look at it mathematically. When economy slows down, it makes sense for government to continuously increase public spending. So budget deficit widens (numerator). At same time, GDP is falling (denominator). Of course this will lead to a huge number!

(3) Surrendering of monetary decisions to ECB. Since gaining independence from Labour government in May 1997, UK’s MPC (Monetary Policy Committee) has gained credibility & international recognition. Due to this, it sounds more like an embarrassment if MPC loses control in the monetary decisions by bowing to the ECB

(4) Inflexibility in labour market. Labour market in UK is much more flexible than most of those in Euro. UK has finally reaped all the benefits under the reforms during the era of Margaret Thatcher (1979-1990) after some effect lags. Trade union has been under control thus wage-push inflation is of limited influence. Meanwhile, UK firms are given more autonomy when it comes to employment. As a result, more part time works have been created & this result in lower unemployment

(5) Costs of adjusting currency. Machines & other tools will have to be adjusted. In between firms will be in darkness regarding the proper exchange rate to use. Nevertheless all these are once-off costs.

2) economic and political constraints facing the country

The instability of the system.

Throughout most of the 1980s the UK refused to join the ERM (Exchange rate mechanism). It argued that it would be impossible to maintain exchange rate stability within the ERM, especially in the early 1980s when the pound was a petro-currency and when the UK inflation rate was consistently above that of Germany. When the UK joined the ERM in 1990 there had been three years of relative currency stability in Europe and it looked as though the system had become relatively robust. The events of Sept. 1992, when the UK and Italy were forced to leave the system, showed that the system was much less robust than had been thought.

Over estimation of Trade benefits.

Some economists argue that the trade and cost advantages of EMU have been grossly overestimated. There is little to be gained from moving from the present system which has some stability built into it, to the rigidities which EMU would bring.

Loss of Sovereignty.

On the political side, it is argued that an independent central bank is undemocratic. Governments must be able to control the actions of the central banks because Governments have been democratically elected by the people, whereas an independent central bank would be controlled by a non elected body. Moreover, there would be a considerable loss of sovereignty. Power would be transferred from London to Brussels. This would be highly undesirabel because national governments would lose the ability to control policy. It would be one more step down the road towards a Europe where Brussels was akin to Westminster and Westminster akin to a local authority.

Deflationary tendencies.

Perhaps the most important economic argument relates to the deflationary tendencies within the system. In the 1980s and 90's France succeeded in reducing her inflation rates to German levels, but at the cost of higher unemployent, For the UK, it can be aruged, that membership of the ERM between 1990 and 1992 prolonged unnecessarily the recessional period. This is because the adjustment mechanism acts rather like that of the gold standard. Higher inflation in one ERM country means that it is likely to generate current account deficits and put downward pressure on its currency. To reduce the deficit and reduce inflation, the country has to deflate its economy. In the UK, it could be argued that the battle to bring down inflation had been won by the time the UK joined the ERM in 1990.

3)The potential impact on British for adopting the euro in the international financial system

The impact:

Transaction costs will be eliminated. For instance, UK firms currently spend about £1.5 billion a year buying and selling foreign currencies to do business in the EU.With the EMU this is eliminated, so increasing profitability of EU firms. Advice to young people: You can go on holiday and not have to worry about getting your money changed, therefore avoiding high conversion charges. Price transparency.Eu firms and households often find it difficult to accurately compare the prices of goods, services and resources across the EU because of the distorting effects of exchange rate differences. This discourages trade. According to economic theory, prices should act as a mechanism to allocate resources in an optimal way, so as to improve economic efficiency. There is a far greater chance of this happening across an area where E.M.U exists. Advice to young people: We can buy things without wrecking our brains trying to calculate what price it is in our currency. Uncertainty caused by Exchange rate fluctuations eliminated. Many firms become wary when investing in other countries because of the uncertainty caused by the fluctuating currencies in the EU. Investment would rise in the EMU area as the currency is universal within the area, therefore the anxiety that was previously apparent is there no more. Single currency in single market makes sense. Trade and everything else should operate more effectively and efficiently with the Euro. Single currency in a single market seems to be the way forward. Increased Trade and reduced costs to firms. Proponents of the move argue that it brings considerable economic trade through the wiping out of exchange rate fluctuations, but as well as this it helps to lower costs to industry because companies will not have to buy foreign exchange for use within the EU. For them, EU represents the completion of the Single European Market. It is vital if Europe is to compete with the other large trading blocs of the Far East and North America.