Euro Membership as a U.K. Monetary Policy Option

Riccardo DiCecio and Edward Nelson

in Europe and the Euro

Published by University of Chicago Press

Published in print April 2010 | ISBN: 9780226012834
Published online February 2013 | e-ISBN: 9780226012858 | DOI:
Euro Membership as a U.K. Monetary Policy Option

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This chapter shows that euro membership would eliminate shocks to the uncovered interest rate parity condition, which is identified as a major source of exchange rate variation. It considers euro area membership as a U.K. monetary policy option by studying the effect of monetary union under various parameterizations of the Erceg, Gust, and López-Salido model. One issue in determining whether monetary union contributes to an improvement in U.K. macroeconomic stabilization is the status of the uncovered interest rate parity (UIP), or foreign exchange risk premium, shock. The results suggest that monetary union may increase inflation variability if UIP shocks do not disappear at the inception of monetary union. This effect is detectable even though UIP shocks are actually only a modest inherent source of exchange rate variation. This chapter also affirms that if the differences in the degree of nominal wage rigidity across the U.K. and the euro area are sufficiently large, U.K. inflation variability under monetary union is higher than that achievable under monetary policy autonomy. The improvement in U.K. economic stability under monetary union also diminishes if imports from the euro area are modeled as primarily intermediates instead of finished goods.

Keywords: euro membership; monetary policy; macroeconomic stabilization; exchange rate; inflation variability

Chapter.  14360 words.  Illustrated.

Subjects: International Economics

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