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Answer to question 1 Continued.
The European Union countries whose currencies did not join the Euro project in 1999 were Britain, Sweden, Denmark, and Greece. Greece applied to join, was rejected as unready in 1999 because it did not satisfy the economic conditions of 'convergence' set out in the Maastricht Treaty which determines the way the Euro will work; but it was finally admitted in 2001. The other three countries refused to join in 1999, exercising an 'opt-out'.

A single currency means that interest rates are the same in all countries where it is the only money: the reason is that if for example interest rates in Frankfurt on euros were higher than those in Bradford, then depositors would switch from Bradford to Frankfurt entirely, forcing Bradford rates up because of a shortage of money to lend or else Frankfurt rates down because of excess amounts to lend. By the same argument borrowers in one place would switch to wherever was cheapest forcing all borrowing rates to be equal for the same borrower. This is to be compared with each country having a separate currency, where its interest rate may differ from the interest rates in other countries; this is possible because the currencies are able to move in value against each other (to 'float' as in 'floating exchange rates') so that people will tolerate different interest rates because the change in the value of the currency could compensate them for the interest rate difference. For example suppose, as was the case in May 1999, interest rates on sterling deposits are 5% but on German or euro deposits they are 2.5%, depositors are disinclined to switch to sterling because the pound may fall against the euro from its currently rather high level. Similarly borrowers are unwilling to switch to borrowing in euros because the euro may rise in value and so their loan could cost them more when they pay it back.

Obviously by definition in a single currency the participating countries' currencies cannot change in value (float) against each other. So we see that the two key characteristics of a single currency that distinguish it from the case of separate (floating) currencies are that interest rates and exchange rates are the same. The European Central Bank must set interest rates that suit the average of all twelve countries ('one size fits all' monetary policy, as the Governor of the Bank of England, Mr. Eddie George, has dubbed it); similarly the exchange rates of all twelve countries will move around in lockstep, as affected by the average of conditions across the euro-zone. This means that the two main ways in which a country's government or central bank controls the behaviour of its own economy- that is, by varying interest rates and the value of its currency - are removed; it has to put up with whatever is set for the average of all the countries of the euro-zone, not necessarily appropriate for it at all. This loss of controllability causes problems of economic management which have to be dealt with somehow by other means. The main way planned within the euro area is the coordination of other economic policies- notably taxes and public spending. However, this coordination means that governments also lose the power to control their own taxes, public spending and other things that are coordinated. Hence the ramifications of Britain joining the Euro extend broadly across our economic policies and our politics, raising many questions dealt with in what follows.

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(question 2)
© Patrick Minford 2002