More going for EMU than against

The benefits of a single currency in Europe are likely to outweigh the disadvantages, argues Richard Freeman

The single European currency has probably taken up more serious media space and time over the last six months than any other issue. The debate has been both lively and emotional but not very informative or objective as politics have taken front stage. Yet behind the political toing and froing, there has been a growing economic analysis of the euro that has been largely ignored by the media.

An important speech in July by Howard Davies on the economic implications of the single currency went almost unreported in the press, for example. Economics is, after all, much less interesting than politics even though a little more edifying!

While there are aspects of European Monetary Union that are hotly disputed by economists both in the UK and in the rest of Europe, there is a growing consensus about some of the most important costs and benefits. There is still some way to go, however, on getting a consensus on where the balance lies.

Starting with the benefits of the single currency, there is little dispute among the experts that the elimination of transactions costs within Europe will be of considerable benefit for business. Tourists will also gain. It is easy to quibble about the size of the benefit, but it will undoubtedly be of considerable advantage to insiders. A gain of only 1 per cent of turnover is not to be sneezed at, and it is likely to be larger than that.

The second benefit is that the single currency will make prices more transparent across borders. That should promote competition and further economic integration in Europe. As a result, economic efficiency is likely to be improved.

Thirdly, the single currency, by getting rid of nominal exchange-rate variability, will reduce uncertainty. Businessmen dislike exchange-rate variability. Without it, trade should receive a boost providing an incentive particularly for small and medium-sized companies, which are currently discouraged from exporting by currency risks and high hedging costs.

The removal of exchange-rate variability is linked to the fourth potential benefit, an increased incentive to invest. Many surveys among businessmen have shown that uncertainty about exchange rates makes planning and investment decisions difficult. A single currency would remove that uncertainty.

It is argued that many firms include exchange-rate risk premiums in their hurdle rates of return for investment projects. With the removal of exchange risks, there would be an inducement to higher investment. There should also be lower nominal interest rates in the euro area than outside with the elimination exchange-rate premiums.

There is also a possibility that real interest rates in Europe will fall over time to provide a boost to investment. This potential fifth benefit comes from the greater price stability that is widely expected as a result of the conduct of economic policy.

Monetary policy in the euro area will undoubtedly be conducted Bundesbank- style, aimed at ensuring sustained low inflation. Over time, this should result in greater price stability than in the past in some European countries from the start. While outsiders can and do pursue similar monetary policies, the policies in the euro area are likely to have greater market credibility for some time ahead.

The management of fiscal deficits should also be beneficial to stability. Already a number of countries are attempting to put their fiscal houses in order. When they have done so, the Stability Pact, when agreed, should ensure that public-sector deficits do not get out of hand and endanger price stability.

The final potential benefit of the euro is that it could be widely used as a reserve currency. This would act to reduce further exchange-rate risks for countries in the currency's area and there would be income to the central bank from its holdings of euro.

What then of the potential economic costs of the single currency? On these, there is also considerable agreement among experts, but not on their size.

The most important economic cost is the loss of the exchange rate as a means of adjustment to the economy. There will almost certainly be disruptions in future that have different impacts in different countries. To offset the effects on employment and output, countries in the euro area will need to rely more on fiscal policies than in the past, which may be difficult. Greater flexibility in fiscal policies than now envisaged could be essential.

The other costs are mainly transitional. Of these, the costs associated with the Maastricht criteria, particularly the public deficit and debt criteria, are important. In terms of slow growth and unemployment, the costs have been sizeable.

The other transitional costs relate to the technical aspects for governments and companies in switching to the euro. While significant in the short- term, they are not a serious argument against the single currency.

Where does the balance lie between economic costs and benefits? lt is impossible to quantify, but my view is that the balance is in favour of the benefits.

Richard Freeman is corporate chief economist at ICI

Alan Bennett has criticised the “repellent” reality shows which dominate our screens
tvBut he does like Stewart Lee
Life and Style
The Google Doodle celebrating the start of the first day of autumn, 2014.
Arts and Entertainment
Sheridan Smith as Cilla Black and Ed Stoppard as her manager Brian Epstein
tvCilla Episode 2 review: Grit under the glamour in part two of biopic series starring Sheridan Smith
David Moyes and Louis van Gaal
Life and Style
Vote with your wallet: the app can help shoppers feel more informed about items on sale
lifeNew app reveals political leanings of food companies
Former Governor of Alaska Sarah Palin, left, with her daughter, Bristol
newsShe's 'proud' of eldest daughter, who 'punched host in the face'
New Zealand fly-half Aaron Cruden pictured in The Zookeeper's Son on a late-night drinking session
Arts and Entertainment
Salmond told a Scottish television chat show in 2001that he would also sit in front of a mirror and say things like,
tvCelebrity Trekkies from Alex Salmond to Barack Obama
Life and Style
Carol O'Brien, whose son Rob suffered many years of depression
healthOne mother's story of how London charity Maytree helped her son with his depression
ebooksAn unforgettable anthology of contemporary reportage
Arts and Entertainment
The cover of Dark Side of the Moon
musicCan 'The Endless River' carry on the tradition? See for yourself
Life and Style
food + drink
Rob Merrick's Lobby Journalists were playing Ed Balls' Labour Party MPs. The match is an annual event which takes place ahead of the opening of the party conference
newsRob Merrick insistes 'Ed will be hurting much more than me'
A cabin crew member photographed the devastation after one flight
A new app has been launched that enables people to have a cuddle from a stranger
voicesMaybe the new app will make it more normal to reach out to strangers
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee / Experienced Recruitment Consultants

£20000 - £25000 per annum + OTE £40,000: SThree: SThree are a global FTSE 250 ...

Trainee Recruitment Consultant - Soho

£20000 - £25000 per annum + OTE £40000: SThree: As a Recruitment Consultant, y...

Trainee Recruitment Consultants - Banking & Finance

£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

Quantitative Risk Manager

Up to £80000: Saxton Leigh: My client, a large commodities broker, is looking ...

Day In a Page

Secret politics of the weekly shop

The politics of the weekly shop

New app reveals political leanings of food companies
Beam me up, Scottie!

Beam me up, Scottie!

Celebrity Trekkies from Alex Salmond to Barack Obama
Beware Wet Paint: The ICA's latest ambitious exhibition

Beware Wet Paint

The ICA's latest ambitious exhibition
Pink Floyd have produced some of rock's greatest ever album covers

Pink Floyd have produced some of rock's greatest ever album covers

Can 'The Endless River' carry on the tradition?
Sanctuary for the suicidal

Sanctuary for the suicidal

One mother's story of how London charity Maytree helped her son with his depression
A roller-coaster tale from the 'voice of a generation'

Not That Kind of Girl:

A roller-coaster tale from 'voice of a generation' Lena Dunham
London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

London is not bedlam or a cradle of vice

In fact it, as much as anywhere, deserves independence
Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

Vivienne Westwood 'didn’t want' relationship with McLaren

Designer 'felt pressured' into going out with Sex Pistols manager
Jourdan Dunn: Model mother

Model mother

Jordan Dunn became one of the best-paid models in the world
Apple still coolest brand – despite U2 PR disaster

Apple still the coolest brand

Despite PR disaster of free U2 album
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits