Monday, 8 December 2008

No euro, not here.

This is going to be a tad controversial: there are indeed benefits of joining the euro. For there are benefits about doing just about anything. There are also costs to joining the euro, just as there are costs to doing just about anything.

One thing economists like to point out is that there are in fact no solutions. There are only tradeoffs. And what you want to do is work out the value of all of those tradeoffs so that you can make the correct decsion, do this or don't do this?

One of the claimed benefits of joining the euro has been that it will boost trade. Yes, it almost certainly would as the costs (and uncertainties) of using different currencies fall. But what we actually want to know is by how much, so that we can set it off against the undoubted costs of losing our currency and interest rate freedoms.

One of the most important pieces of research used by euro proponents was a paper from Andrew Rose showing that countries which joined currency unions tended to see their trade increase by up to 200pc. However, a paper published by Harvard's Jeffrey Frankel has shown that, in fact, trade within the eurozone increased by just 10-20pc during the first four years of the currency. Moreover, the volume of trade did not rise any further thereafter.

In the paper, published by the National Bureau for Economic Research, Prof Frankel says: "The most surprising finding of this study was the absence of any evidence that the effects of the euro on bilateral trade have continued to rise during the second half of the eight-year history of the euro."

Worth noting that Jeff Frankels is one of those economists we should be listening to. And the benefits are a great deal smaller, one tenth only, of those previously assumed. Further, they come as a one off boost (a "step change" I like to call it) rather than an ever accelerating benefit. This is important because the exchange rate and interest rate flexibility will be something that, retaining the pound, continues to give us extra benefits each year into the future.

So, another nail in the coffin of the idea that the euro is good for us....or anyone else come to that.

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