Committee Reports::Report - Economic and Monetary Union::16 December, 1998::Appendix

Appendix 1

Summary and Conclusions of ESRI

Chapter 12


Terry Baker, John Fitz Gerald and Patrick Honohan

12.1 Introduction

This study has examined the impact of EMU on the Irish economy, especially on employment. It has explored the manner in which the Irish economy would respond to external developments and what pressure points would be experienced by particular sectors. In addressing these issues we draw on a wide body of economic literature including studies of aggregate price and wage determination in the Irish economy and of the role of policy credibility in influencing interest rates. In keeping with our terms of reference, the conclusions which we present are descriptive in character rather than prescriptive, as we have not been asked for direct policy recommendations.

We assess the impact of EMU both in the case where Ireland is a full member and where it is not. The future membership composition of the EMU is not yet certain. For the purpose of analysis, we have assumed that Germany, France and a number of other member states form the EMU from the outset. Whether or not the UK is a member is obviously a matter of great importance. so in considering the impact of membership on Ireland we have separately considered the cases where the UK is in and where it is out. We also briefly considered a number of other membership variants, and from these exercises we have isolated the key factors which will determine the overall impact of EMU. On the basis of this analysis we have provided an assessment of where the likely balance of advantage for the Irish economy lies.

We have examined the issues from the sectoral as well as the macroeconomic perspective. There are some sectors which will encounter particular adjustment difficulties, and others for which the single currency will bring enhanced opportunities.

The actual course of the Irish economy over the next five or ten years will be affected by a large number of factors, many of which are quite unrelated to EMU and as such are outside the ambit of this study. Accordingly no attempt is made to present here a forecast of the actual level of economic activity and employment in the years following EMU. At the same time it is recognised that EMU under any configuration of membership (or indeed its failure to materialise at all) will constitute a major change in the economic regime under which decisions are made by governments, firms, unions and private individuals in the international economy and within Ireland. Thus an indefinite continuation of the status quo is not possible and projections based on the assumption that the present regime could continue cannot be used as a standard of comparison.

Therefore attention is focused throughout the study on the differences in economic outcome related solely to Ireland’s EMU status under varying sets of assumptions concerning other countries’ membership and the economic policies they adopt. Purely for ease of exposition, the case adopted as a baseline or benchmark is one where both Ireland and the UK are outside EMU but following economic policies which result in a relatively “tranquil” exchange rate climate. From this benchmark the effects of alternative assumptions concerning EMU membership, economic management, and exchange rate behaviour are examined at both a macroeconomic and a sectoral level. Our main interest is in evaluating the differences between the benchmark and the alternative membership scenarios rather than in the benchmark projection itself.

A New Macroeconomic Regime for Europe

Chapter 2 briefly surveys the changed environment within which the Irish economy will be functioning when EMU gets under way. It is macroeconomic issues that have predominated in discussion of the single currency in Ireland, and indeed have been at the centre of the Europe-wide debate that led up to the adoption of the Maastricht Treaty including its timetable for the adoption of a single currency. But, despite the considerable efforts that have been made and are still under way to bring EMU into effect, it has to be acknowledged that there is little concrete evidence for very large income effects, positive or negative, arising from the adoption of a single currency. Looking first at the European economy in general, the move to a single currency - initially among a sub-group of the member states - will be a further step in reducing barriers to trade and to obtaining the efficiency gains of the single market. However, the likely gains on this microeconomic front are significant, though most observers agree that the impact will be less than in the single market programme which was launched by the Single European Act. Nevertheless, to the extent that the single currency reduces the risk of costly disruption to the single market arising from exchange rate movements not warranted by economic fundamentals and protectionist reaction to them, it would confer a substantial benefit on the EU. Moreover this benefit could be of considerable importance to Ireland, because of our high dependence on trade. More substantial gains are claimed in two other dimensions, namely improvements in macroeconomic policy and at the interaction between economics and politics.

Improvements in macroeconomic policy: to the extent that past deficiencies in monetary and fiscal policy in Europe can be attributed to political short-termism, the centralisation of monetary policy in an independent EU-wide central bank is expected to improve overall monetary policy performance. (As a result of the Maastricht Treaty EU Central Banks are being granted statutory independence.) Of course, with inflation now much lower than it was in the 1970s and early 1980s, many may have been lulled into a false sense of security on the inflation front, and accordingly they may tend to undervalue the bulwark against inflation which is offered by the institutional arrangements of EMU.

It must be recognised that these institutional arrangements operate through some reduction in political control of the monetary sphere, though there are some safeguards in the form of procedures for accountability to the democratically elected European Parliament.

If shocks occur, the inability of individual countries to adjust their exchange rate to suit local conditions as needed could also result in more pronounced recessions, but our judgement is that the gains to the Union as a whole outweigh the losses in this regard.

A much less measurable gain lies in the interaction between economics and politics. Success for the single currency process may promote a favourable atmosphere for economic policy co-operation in Europe, hence leading to a further momentum in deepening the single market, and perhaps eventually to certain desirable improvements in fiscal policy co-operation on a quasi-federal level. This study takes no strong position on the validity of such arguments, for the evaluation of which the authors are unaware of any scientific methodology.

Adaptability of the Irish Economy

By adopting the single currency, Ireland loses a potential adjustment mechanism to shocks. Before assessing how valuable this adjustment mechanism is, and how its loss should be weighed against the benefits envisaged from EMU, it is appropriate to explore the degree to which Irish firms could insulate themselves from these shocks. Chapter 3 examines the scope and limitations of risk management and risk hedging, with an eye to the circumstances of Irish firms vulnerable to exchange rate movements. There are unexploited possibilities here, though the possibilities will vary from firm to firm. Hedging is not a panacea for ensuring firms’ long-term competitiveness. Successful firms will supplement financial hedging with market diversification and other cost control and productivity enhancing measures.

12.2 Macroeconomic Assessment

Part II of the study deals with the overall macroeconomic aspects. The approach is quantitative and model-based. In order to assess the impact of EMU on the Irish economy, we have considered separately the steady effects of the system in tranquil conditions, and the impact of turbulent conditions, including sharp exchange rate movements of sterling. We then put these two “building blocks” together to arrive at a considered assessment of the impact of EMU.

Impact on Ireland - Tranquil Scenario

For a quantification of the steady-state effects of EMU we used the ESRI’s large macroeconomic model (Chapter 4). The main quantifiable channels through which EMU will impact on the economy are: the reduction in foreign exchange transaction costs; the impact on interest rates; and the possible effects on competitiveness.

The net effect of the reduction in transaction costs, consequential on the elimination of foreign exchange transactions on much of Irish trade, would be quite small in the short to medium term. The level of GNP each year would be higher than it would otherwise have been by around 0.1% (Table 12.1). Entry into EMU would impose significant once-off conversion costs but these would have few net employment effects. Once in the EMU, the elimination of many currency exchange transactions would reduce costs for traders and travellers, but would result in a corresponding loss of business and employment in the financial sector. Longer term, when the displaced financial employment has been re-absorbed, there would be a clear but minor benefit from reduced transactions costs.

It is from lower interest rates that we project the largest favourable benefit to Ireland. The reason for expecting lower interest rates is not simply lower inflation - a sustained lowering of inflation has already been achieved without the single currency. Instead it is through the complete removal of any kind of devaluation risk that Irish wholesale interest rates will permanently lose the premium above German rates which has been a fairly constant feature of financial markets in the last couple of decades. Even after taking account of higher inflation and actual exchange rate movements the premium was particularly large (at more than 2.5 percentage points on average, after exchange rate changes) during the narrow-band EMS period 1979-93, but has still remained significant in recent years.

Our judgement is that membership of the single currency can be taken to result in Irish wholesale interest rates in the medium term being lower by about 1 percentage point on average than they would otherwise be. The reduction would probably be greater than this in the initial period of EMU as economic policy conditions in the immediate aftermath of a decision that Ireland would not be a member could be extremely difficult. In that eventuality financial markets’ doubts about future policy and even about the strength of the Irish economy would tend to place upward pressure on interest rates. In Table 12.1 we show the effects where it is assumed that outside of EMU interest rates would fall back to a 1 per cent margin over euro rates over four years. Under these circumstances, whether or not the UK joins, the benefit to be obtained from EMU membership because of lower interest rates would average roughly 1.7 percentage points of GNP over the first five years of membership.

The effect of exchange rate movements on competitiveness would depend partly on whether Ireland were in EMU, but also, and more importantly, on the actual behaviour of sterling if the UK remained out. In tranquil times, EMU will certainly be a tougher regime than the ERM was, but (with the achievement of low wage and price inflation in Ireland now for a decade) we see no reason to assume a large trend loss of competitiveness. Our modelling of the “tranquil” scenario envisages sterling depreciating smoothly but modestly in line with differential inflation trends, implying (under tranquil conditions) a relatively small competitive difference between Ireland being in or out of EMU. In the absence of shocks, the competitiveness cost of Ireland joining EMU without the UK is an average of around 0.4 per cent of GNP as the economy adjusts to the new regime. (This cost would disappear if the UK also joined EMU.)

Taking account of the various elements and their impact on investment, consumption, and employment as computed by the model, the study concludes that, if the UK were to remain out of EMU, to the extent that tranquil times prevail in the first half-decade of the system, the average gain to GNP from Ireland’s membership of EMU would be of the order of 1.4 per cent. (This is the average increase in the level of GNP; once GNP attains this new higher level through slightly higher growth in the early years, the growth rate should return to its normal or benchmark rate.) Employment under this scenario is estimated to average about 24,000 higher than if Ireland remained outside.

In the absence of shocks, if the UK were also to join, the average gain in GNP (compared to the UK out scenario) would be about 0.4 per cent of GNP and the gain in employment would average around 4,000. This improved performance would arise from the albeit small beneficial impact on competitiveness of a fixed exchange rate with the UK.

Turbulent Scenario and the Role of Sterling

In order to assess the likely performance of Ireland in the face of disturbances we have focused on a number of examples of shocks (Chapter 5). One example where the loss of an independent currency could prove costly is the case of a sudden sharp decline in the value of sterling. Other examples of shocks which we consider are some repetition of the economic experience which resulted from German unification, a sudden major rise in oil prices or a shock specific to the Irish economy. The results of this analysis highlight the advantage to Ireland of UK membership of EMU as it greatly reduces the potential for destabilisation due to shocks to the UK economy leading to sudden changes in the valuation of sterling.

The choice of exchange rate regime only has a major effect on the short-to medium-term impact of shocks. This effect continues until prices and wages adjust fully to the new environment after three or four years. Where there is a real shock which necessitates structural change in the economy the choice of exchange rate regime can affect the speed and, therefore, the cost of adjustment, but it cannot avoid the need for adjustment altogether. However, the analysis in Chapter 5 also shows that whatever the nature of the exchange rate regime chosen, it can provide only limited insulation against shocks.

To quantify the cost of slow adjustment of the economy to an exchange rate shock we simulated a depreciation of sterling. For the purpose of analysis we chose an exceptionally large shock, 20 per cent, not because it seems at all likely but because it provided a useful test of the models’ properties. Our estimates lead to the conclusion that if Ireland were a member of EMU, and starting from a position where sterling was correctly valued, a 20 per cent fall in sterling against the euro would lead to a maximum reduction in GNP in the second year of around 1.6 per cent and a maximum reduction in employment of around 28,000 jobs. (The job loss would still be 16,000 and the loss of GNP would be 0.9 per cent even if Ireland had retained its own currency and was pursuing a sound medium-term economic policy targeting an average external value of its currency).

The analysis of the effects of an oil price increase highlights the fact that a sharp strengthening of sterling (outside EMU) would also have a disruptive impact on Ireland.

The results of this analysis are likely to be valid for most other kinds of shock which result in a sudden change in competitiveness or which render a sudden change in competitiveness necessary. Under such circumstances the choice of exchange rate regime affects the crucial determinant of the avoidable cost to the economy - the speed of adjustment.

Providing for “Blustery Conditions”

The separation of the effects of EMU into those which arise under a “tranquil” scenario and those which arise under a “turbulent” scenario is a useful approach to simplifying the economic analysis of EMU. However, economic developments are rarely stable for any significant period of time and the real world of EMU will involve periods of tranquillity interspersed by periods when shocks result in economic turbulence. To gain a proper understanding of the effect of EMU we have to integrate the results from both scenarios. This is done in Chapter 6, which places overall exchange rate policy in the context of the recent historical evolution, and which also addresses a number of transitional issues relating to the start-up of EMU and the relationship between those currencies that are in and those that are out.

If tranquil times convey benefits, but turbulence is costly, what is the net effect in the likely event that the outturn resembles some mixture of the tranquillity and turbulence? Indeed, it seems almost certain that over the years conditions could more often be characterised as blustery, than as either tranquil or turbulent. In order to analyse this middle ground, we need to combine the results for the two extreme conditions.

The approach we adopted involved firstly deriving an estimate of the potential cost of shocks. We used the example of the sterling shock from Chapter 5 to estimate the cost of such a shock under varying exchange rate regimes - Ireland in and out of EMU.

Table 12.1: Medium-Term Effects of Irish Membership of EMU

Average change in level compared to benchmark


UK Out


Effects of:

Change in GNP. %

Transactions costs



Interest Rates



Competitiveness - steady state



Cumulative Effect - Tranquil Scenario



Risk of Shocks - Competitiveness etc.



Net Effect




Change in Employment, (000)

Net Effect



Having arrived at an estimate of the cost of shocks the second task is to derive a weight to attach to the calculated cost. This weight should reflect the expected frequency and intensity of future shocks. We used past experience of the sterling - DM exchange rate as an indicator of the frequency and intensity of future shocks. If either changes in UK policy or the creation of the EMU itself were to reduce the volatility of the future euro-sterling rate this could reduce the cost of shocks below what we have estimated. (The simulations with NiGEM suggested that the volatility of the exchange rate as a result of country specific shocks would be reduced due to the formation of the EMU.) We also recognise that there may be other types of shocks not passing through the exchange rate channel which can adversely affect the economy. Finally, we must take account of the fact that a reasonable exchange rate policy outside EMU would not eliminate all of the shocks. (Indeed, the exchange rate policy which we assume in the simulations would eliminate less than a half of these shocks.) When all these factors are taken into account we feel that the weight we have derived is a generous assessment of the potential for blustery weather in the future.

We use this information in an appropriate model to arrive at an overall assessment of the allowance which should be made for the possible cost of future shocks under different exchange rate regimes. While crude, this measure seems the most satisfactory way to capture in one number our assessment of both the likely pattern of future shocks and of the cost of these shocks. It can be seen as the insurance premium which it would be worth paying to buy protection against future shocks.

The result of applying this methodology suggests that the allowance for the avoidable cost of shocks need be no higher than the annual equivalent of 1 per cent of GNP. This is insufficient to offset the estimated steady gains of around 1.4 per cent of GNP (Table 12.1). Having made provision for the cost of possible shocks the net benefit in terms of employment could be of the order of 10,000.

These quantified macroeconomic benefits of lower interest rates and risks of adverse currency movements are both rather smaller than might have been expected.

We also identified a number of other potential but unquantifiable effects of joining EMU, some of which could be substantial. They include the impact of commitment to Europe and increased currency stability on business confidence and investment plans among Irish and overseas investors. They also include wider political factors which are inherently unquantifiable. These unquantified effects seem likely to enhance the probability that EMU membership will prove beneficial even in blustery conditions.

On balance, the quantified effects indicate that EMU membership is likely to provide a modest benefit in terms of output, employment, and trade. When the unquantified effects are included the benefits from membership are likely to prove more significant. If the UK were to join the EMU then the gain from membership for Ireland would be further enhanced. However, even then the probable net benefits would still be on a smaller scale than the net gains from the completion of the Single European Market (SEM) in 1992 or from the inflow of European Structural Funds over the past decade.

12.3 Sectoral Effects

The macroeconomic analysis makes it clear that the distribution of potential benefits and risks among the various sectors of the Irish economy will be far from uniform. For example, the building and construction industry is likely to be among the principal beneficiaries of lower interest rates, while parts of the financial sector are likely to suffer adverse effects from the curtailment of currency transactions. The detailed sectoral analysis in Part III of the study examines such issues.


The most obvious sector to gain from EMU is the building industry. A permanent reduction in interest rates of 1 percentage point below the level they would otherwise attain would result in a higher level of investment, especially in building and construction. In the initial years of EMU this could mean up to 8,000 more people being employed in that sector.

Much of the focus in public debate has been on manufacturing industry as perhaps the key sector in respect to the balance of benefits and risks. Chapter 7 presents an analysis of the exposure of the various industrial sectors to the changes implied by EMU. As in the wider economy, there are big differences between industrial sectors and company types in the extent to which they should gain from lower interest rates and the degree to which they are exposed to possible currency risk.

The principal beneficiaries in manufacturing industry of lower interest rates will be those sectors selling income-elastic products related to the building industry. Also likely to benefit from lower interest rates are those companies which are heavily indebted to the Irish financial system either because of their capital structure or because they have a big requirement for working capital. The firms most likely to be in this situation are small-to-medium sized Irish companies which also sell most of their output domestically.

The sectors which are most exposed to potential currency risk are those with a considerable proportion of their output sold in the UK market and with a domestic market which is open to UK competition. The most exposed sectors are clothing, food processing and textiles, although individual firms in several other sectors could also be exposed.

The fast-growing export-oriented sectors, dominated by multinational firms who - for well-known reasons - enjoy high margins, would appear to be relatively insensitive to the level of Irish interest rates and little concerned by sterling exposure. However, these are the sectors where the unquantifiable confidence effects on investment are likely to be greatest.

The balance of advantage within manufacturing clearly depends to a large extent on the evolution of the sterling/euro exchange rate. If the UK also enters EMU the exchange risk disappears, although (depending on the precise rates at which sterling and the Irish pound enter EMU) some initial adjustment might be necessary. If the UK remains outside the EMU and sterling depreciates post-EMU only slightly and in line with inflation trends, then the risks to the sterling-exposed sectors will remain latent, and the interest-rate benefits to the domestically oriented sectors, mentioned above, will tend to dominate.

A large sterling depreciation would be damaging whether Ireland were in or out of EMU, but the immediate impact of such a shock would undoubtedly be greater if Ireland had adopted the euro. The additional loss of competitiveness, compared with following a responsible currency policy outside EMU, would outweigh any beneficial interest rate effects for the sector and the net loss of employment concentrated in, but by no means confined to, the most exposed sectors, could be substantial. However, in the longer term the more rapid adjustment and the lower interest rates associated with being in EMU, should lead to an earlier and stronger industrial recovery than if Ireland were continuing to operate as an independent currency.

The Financial Sector

The financial services sector is considered in Chapter 8. This sector is in the front line of the changes arising from the introduction of a single currency. The once-off costs of introducing the euro, including the cost of staff training and the modification of information technology systems, will fall mainly on the banks and, to a lesser extent, on the other financial institutions. The net costs of change-over will be substantial, though industry estimates of these lack detailed substantiation and will probably prove to have been on the high side.

In the longer term, entry to EMU would result in a substantial fall in the banks’ foreign exchange business, impacting on employment and profits in the sector (though it does reflect a welfare gain to the rest of the economy). For the financial sector, the effect of sterling entry would actually be unfavourable, as it would about double the loss of business. At the same time, lower nominal interest rates as an EMU member would tend to lower the spread over deposit rates that banks can charge, at least to their larger customers; the impact on bank profitability from this fall in net interest margins is likely, however, to be compensated for by growth in other business.

The introduction of the euro could be expected to lead to a greater concentration of wholesale financial market activity in the major EU centres, as local knowledge of potential currency risks becomes less relevant. Thus, although the single currency does not present any particular threat to the IFSC, Dublin’s local bond and money markets could be adversely affected, with a consequent loss of income and employment among market intermediaries. The equity market seems less likely to be affected.

The Retail Sector

It seems likely that EMU will not have a major long-term effect on the sector but, depending on the membership scenario, it could act to hasten changes which are already under way. It seems likely that the interest rate benefits from EMU membership will be partially offset by the loss of interest income by major operators on their substantial cash flow. As such, Irish membership of EMU will affect the sector less through this channel than it will affect many others.

There are also unlikely to be major effects from savings on transactions costs under the different scenarios. Probably the most important way that Irish membership of EMU is likely to affect the sector will be through its effects on competitiveness, though even here the effects may be quite limited. If existing Irish retail operators react effectively to the changing environment through developing their relations with their suppliers they will limit the effects of albeit temporary shocks to the exchange rate where Ireland is a member of the EMU.

While the longer-term effects on the sector will be limited, the short-term impact of the transition to a new currency will be significant. Although the costs of transition will be of a non-recurring kind, because of the large volume of cash handled by the sector it will be at the forefront of the change-over process. The introduction of the new currency will require significant expenditure both on staff training and on developing the computer systems to handle the change-over. While some of these costs might arise in any event at a later date as computer systems evolve, the overall expenditure on the transition will none the less be significant. The burden of the change-over process may prove greatest for mid-sized firms in the retail business. For all operators in the industry there will be a desire to see the transition period for the introduction of the euro in 2002 kept to a minimum.


Chapter 10 discusses the agricultural sector and its relationship with the food processing industry. More than other sectors, agriculture will be subject to special factors over the next ten years or so which are likely to have much more radical effects than the introduction of EMU. Under the twin pressures of international trade rounds and the probable enlargement of the European Union. the Common Agricultural Policy is certain to undergo substantial change. Although the precise nature of CAP reform cannot yet be predicted in detail, the general thrust of change will include a continued move towards world price levels. In compensation, direct payments, mainly unrelated to output, are likely to increase. and to form a higher proportion of total farm income.

With the floor to agricultural prices currently provided by intervention purchases and export refunds thus further eroded, farm prices throughout the EU, including Ireland, are likely to be lower and more variable. Farm incomes are likely to be more or less maintained through direct payments. This new price scenario will clearly change the conditions under which food processors currently operate, although there is some uncertainty as to how agricultural output will respond. This greater flexibility of pricing would mean that the agricultural sector might in the future share more of the burdens of adjustment to exchange rate fluctuations currently carried by the processing sector.

Given this general background of change, the specific EMU effects on agriculture are relatively minor. As a sector with a high level of indebtedness to the Irish banking system, agriculture would tend to benefit from lower interest rates. Transaction costs are not directly relevant, but competitive effects are likely to feed back to agricultural prices to a greater extent than in the past. This would be avoided if both Ireland and the UK join EMU, and would remain latent under a tranquil evolution of exchange rates if Ireland were in and the UK out. The issue would only become active if there were a substantial sterling depreciation, which would improve UK agricultural competitiveness through the mechanisms of the Green Currency. In this case the effect on farm prices, and probably to some extent on farm incomes, would be greater if Ireland were in EMU than if it were outside.


The potential impact of EMU on tourism is considered in Chapter 11. The tourism sector is likely to benefit from the reduction in transaction costs associated with EMU entry more than most other sectors of the economy. Even here, however, the benefit will be relatively small in relation to total turnover. If the UK were also to join, the saving could amount to 1.5 per cent of turnover, while if the UK remained out, the saving would be 0.6 per cent. The greater convenience of a single currency could well have a stronger beneficial effect than the simple saving in transaction costs.

The cost savings from lower interest rates could be somewhat larger than those from reduced transaction costs, although probably of a similar order of magnitude. Taken together, interest and transactions savings could make a noticeable but not large, difference to the cost of Irish holidays, but broadly similar savings would be made by tourist operators in some other EMU destinations.

As with other sectors of the economy, a substantial depreciation of sterling could have a temporary but significant effect on the competitiveness of Irish tourism, which would be greater if Ireland were in EMU rather than out. Because of the structure of the industry, some sections might find it difficult to hedge against even temporary currency fluctuations.

On balance, the sector is likely to be a net beneficiary of a decision to join the EMU, whether or not the UK joins. The implications of any change in the overall competitiveness of the sector (either improvement or disimprovement) consequent on joining EMU will depend on the price sensitivity of the different markets. The limited evidence available suggests that certain important segments of the market are quite sensitive to relative prices.

A higher proportion of the US tourist trade is probably more price sensitive than for other tourist markets. However, this sector stands to gain less than the average on savings in transactions costs. As a result, it is probably most vulnerable to any shocks which affect competitiveness. Short-stay holidays from the UK are probably also vulnerable. For other EU markets the potential savings from EMU entry would be greater than for the US and the UK markets and the proportion of the business which is price sensitive is less than for the US. These markets would probably show the biggest gain from EMU membership. If Ireland were not a member of the EMU then there would probably be some loss in relative price competitiveness for tourism from continental Europe.

12.4 Conclusion

The examination of specific sectors has tended to confirm and flesh out the preliminary conclusions reached from the macroeconomic analysis. Compared with a benchmark scenario of both Ireland and the UK remaining outside. EMU, the principal conclusions concerning alternative configurations are as follows.

If both Ireland and the UK enter EMU, there would be benefits (relative to remaining outside) from lower interest rates and reduced transaction charges. Employment and profitability of the financial sector would be adversely affected; but virtually all other sectors of the economy would gain. The net improvement in total employment in the first five years of EMU is estimated at about 28,000. It would raise the level of real GNP on average by 1.8 per cent over the first five years. These estimates do not allow for any particular confidence effects on future investment.

If Ireland entered EMU but the UK remained out, and sterling retained the stability of the benchmark scenario, there would still be benefits from lower interest rates, but a smaller benefit from reduced transaction costs. Though there might be some trend loss of competitiveness in the UK market, it would be small. In the absence of shocks all sectors, except the financial, would be net beneficiaries of entry. The losses to the financial sector would be smaller than if the UK also entered, but so too would be the gains to other sectors from the reduction in transactions costs of trade. The net employment gain compared with the baseline is estimated at an average of 24,000 in the first five years and the impact on GNP would average 1.4 per cent.

Occasional turbulence in the sterling/euro exchange rate is more likely than stability. Such turbulence would adversely affect Ireland, whether in EMU or not. In the benchmark, where both the UK and Ireland are assumed to remain outside EMU, it would be likely to increase interest rates (thereby somewhat increasing the advantage of membership). It would also result in competitiveness shocks. For example, a substantial depreciation of sterling would have damaging short-to medium-term effects on the Irish economy which would be greater if Ireland had adopted the euro. Particularly vulnerable to a substantial exchange rate shock would be those industrial sectors, such as clothing, textiles and food processing, which are most exposed to UK competition.

To weigh the cost of such shocks against the steady benefits requires a composite measure which takes account of the frequency and intensity of actual shocks. Applying a model of repeated shocks suggests that the provision for the avoidable cost of shocks should be no higher than the annual equivalent of 1 per cent of GNP. When this is subtracted from the estimated benefits under the “tranquil” scenario of plus 1.4 per cent of GNP the net balance - albeit small - favours membership. This net balance could be expected to translate into an addition to employment of 10,000 jobs.

The gains from membership of EMU, even where the UK remains outside, are likely to be greatest in the early years. Where a country remains outside EMU we have assumed that pursuit of consistent and sensible economic policies can eventually reduce, but not eliminate, the interest cost arising from a lack of credibility. However, in the early years of EMU it appears likely that the enhanced credibility for domestic policy in Ireland due to membership will be quite significant. This makes postponement of membership relatively unattractive.

In summary, our quantification indicates that Ireland can expect to benefit modestly in terms of income and employment through membership of EMU. This conclusion is reinforced by the fact that the unquantified benefits are also likely to favour EMU entry.