The Euro, Income Divergence and Monetary Union

This paper looks at the impact of the UK joining the Euro on compatibility between the UK and the Euro zone. We construct a theoretical model to capture such effects, and then estimate the model using data from the period 1980-1999 (the period covering the existence of the ECU and the Euro). Particular attention is paid to the actual dynamics of the system and the important roles of monetary and fiscal policy. We find that the dynamic path of the UK and Euro members is stable and that UK monetary policy is in line with that of its Euro zone neighbours in a way that would be close to that expected if the UK were already a member of the Euro zone.