Britain and EMU: Assessing the costs in macroeconomic variability

Stochastic simulations are used on the Liverpool Model of the UK to assess the effect of macroeconomic stability of the UK adopting the euro. Instability increases substantially, particularly for inflation and real interest rates. A key factor is the extent of the euro’s instability against the dollar; by adopting a regional currency the UK imports this source of shocks, as well as losing its control of interest rates. The results are not highly sensitive to changes in assumptions about the degree of labour market flexibility, the use of fiscal policy, and increased convergence of monetary transmission