European monetary union: the benefits, the problems and the traveller's tale : LETTER

Sir: After all the fuss in the last few weeks about the political aspects of Britain joining a European monetary union (EMU), your editorial discussing some of the economic issues was most welcome ("Why we say Yes to a single currency", 11 February). Unfortunately, you exaggerate the likely economic benefits from monetary union and underestimate the potential problems. The arguments you put forward in favour of EMU are that it would reduce the risk of higher inflation, reduce uncertainties for companies, cut transaction costs and strengthen Europe's position in the global economy.

The inflation risks in a monetary union depend largely on the willingness of the authorities responsible for setting monetary policy to accommodate inflation pressures. In a future EMU, the monetary authority may be less accommodating than British governments have been in the past, but that does not make EMU the only, or even the best, guarantee of low inflation. (West) Germany has had the best inflation record among industrialised countries for much of the post-war period, not because it was a member of a monetary union but because the Bundesbank always acted when necessary to counter inflation pressures. Making the Bank of England independent and charging it with keeping inflation within a low target range is more likely to result in low inflation than joining a monetary union.

European monetary union would reduce exchange rate uncertainty for those companies trading within the union, though only once a single currency is established. But such companies account for only a small proportion of the UK's total output. For all companies, other risks might be increased. For example, an inflation shock elsewhere within the union, from which UK companies did not benefit, could lead to them paying higher interest rates on their borrowings.

Transactions costs on foreign exchange deals are now so low that their elimination would be a small benefit to most companies. But UK financial institutions, which dominate European currency trading, would lose out from a reduction in foreign exchange business.

Lastly, you argue that a single currency would "strengthen Europe's position on the global economic stage". What does this mean? If it means that a single currency would improve Europe's hand in trade negotiations with the US and Japan, it is a dubious claim. A co-ordinated viewpoint on trade issues would help; a single currency would not.

The potential benefits of European monetry union are questionable, the potential costs could be very serious. A successful monetary union requires that the economies joining it are broadly the same, especially in regard to their response to external and internal inflation shocks. This is not the case in Europe. Take two examples: oil and housing.

The effect of a sustained, steep rise in the oil price will be very different in Germany, which is highly dependent on imported oil and gas; in France, where nuclear power is used to generate a high proportion of energy needs; and in the UK, where the North Sea sector of the economy would actually benefit. Imagine trying to set an appropriate, anti-inflationary interest rate policy for a monetary union including these three economies should the oil price double.

The housing sectors of European economies also differ, with the UK's high level of home ownership financed by variable rate mortgages not being found elsewhere. This makes the UK housing market more sensitive to interest rate changes than is the case on the Continent. It is easy to envisage a situation where the interest rate policy of a European monetary union was entirely inappropriate for the housing sector of the UK economy. And, since their home is most families' main asset, this would have negative repercussions for consumer spending and the overall growth of the economy.

These and other structural differences between European economies will not disappear over the next four years, nor at any time in the foreseeable future. Until they do, the economic argument against European monetary union is powerful, and far more clear cut than the political arguments for or against.

Yours faithfully,

Tony Dolphin

Chief Economist

AMP Asset Management

London, EC2

13 February

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