Five economic tests

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The five economic tests are the criteria defined by the United Kingdom Government that are to be used to assess the UK's readiness to join the Eurozone and adopt the euro as its currency. In principle, these tests will be distinct from any political decision to join.

The five tests are as follows (EMU stands for Economic and Monetary Union):^[1]

Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?
If problems emerge is there sufficient flexibility to deal with them?
Would joining EMU create better conditions for firms making long-term decisions to invest in Britain?
What impact would entry into EMU have on the competitive position of the UK's financial services industry, particularly the City's wholesale markets?
In summary, will joining EMU promote higher growth, stability and a lasting increase in jobs?

In addition to these self-imposed criteria, the UK would also have to meet the EU's economic convergence criteria ("Maastricht criteria") before being allowed to adopt the euro. One criterion is two years' membership of ERM II, of which the UK is currently not a member. Under the Maastricht Treaty, the UK is not obliged to adopt the euro.

1 History of the tests
2 External links
3 See also
4 References

[edit] History of the tests

The five tests were designed in 1997 by former British Labour Party Chancellor Gordon Brown and his then assistant Ed Balls, allegedly in the back of a taxi while Brown was in the United States. Despite this uncertain pedigree, the IMF deemed them to be "broadly consistent with the economic considerations that are relevant for assessing entry into a monetary union"^[2].

The UK Treasury is responsible for assessing the tests. It first did so in October 1997, when it was decided that the UK economy was neither sufficiently converged with that of the rest of the EU, nor sufficiently flexible, to justify a recommendation of membership at that time. The government pledged to reassess the tests early in the next Parliament (which began in June 2001), and published a revised assessment of the five tests in June 2003. This assessment was much weightier (at least literally) than its predecessor, running to around 250 pages and backed up by eighteen supporting studies, on subjects such as housing, labour market flexibility, and the euro area's monetary and fiscal frameworks.

The conclusions, though, were broadly the same; the Treasury argued that

There had been significant progress on convergence since 1997, but there remained some significant structural differences, such as in the housing market.
While UK flexibility had improved, they could not be confident that it is sufficient.
Euro membership would increase investment, but only if convergence and flexibility were sufficient.
The City of London, Britain's financial centre, would benefit from Eurozone membership.
Growth, stability and employment would increase as a result of euro membership, but, again, only if convergence and flexibility were sufficient.

On the basis of this assessment, the government effectively ruled out UK membership of the euro for the duration of the 2001 Parliament. Since Labour has been re-elected in 2005, it may reassess the tests once more, though the debate on the European Constitution and subsequent Treaty of Lisbon has upstaged that on the euro so far. Gordon Brown, now British Prime Minister, has ruled out membership for the foreseeable future, saying that the decision not to join had been right for Britain and for Europe[1].

One of the main underlying issues that stand in the way of monetary union is the large structural difference between the UK housing market and those of continental Europe. Historically, because of the British tradition of home ownership, as opposed to home rental, and the scarcity of fixed-rate mortgages to finance home purchases (itself a legacy of past monetary instability), the average Briton carries a substantial volume of variable-rate debt. This makes British consumer spending far more sensitive to prevailing interest rates than is the case in the rest of Europe, thus making the British economy extremely vulnerable to sub-optimal interest rates. Critics have argued that until this structural difference is resolved, joining the Euro would be disastrous for the UK.