Snatching defeat from the jaws of victory: Britain and the euro

By George Irvin

George Irvin

The euro debate has become emblematic of Britain’s increasingly uneasy relationship with the EU, a relationship strained by years of indecision about economic and political integration, damaged by Britain’s alliance with the US during the Iraq war and, most recently, poisoned by the tabloid press campaign against the draft Constitution. In 1997, the newly elected Labour Government appeared to be the very antithesis of the Euro-phobic wing of the Tory party. But Labour, while still ostensibly pro-European, has shifted steadily rightward; today, its European pronouncements recall the ill-disguised chauvinism of the Thatcher-Major years. Indeed, a significant segment of the British left is euro-sceptic. The spectrum includes unreconstructed Bennites, a new generation of militant trade unionists and disillusioned Blairites whose allegiance is now shifting to Gordon Brown. The implications of a semi-detached position in Europe are worrying. While the current piece is about the economics of euro-membership, the underlying question remains one about the geo-politics of the EU. Britain cannot stand still; it must either move forward within Europe or drift further into the mid-Atlantic, ultimately into the neo-liberal grasp of the Unites States. Starkly put, the choice for Britain is between European social democracy and US-style neo-liberal capitalism. (1)

Below, I try to put the economic debate over the euro in a manner accessible to the non-specialist. I first consider Gordon Brown’s ‘five tests’, currently under examination by the Cabinet and to which the probable verdict on 9 June will be “no, not yet … though perhaps in the not too distant future”. In the following section, I put what I consider to be the main arguments in favour of joining. In the penultimate section, I review what has rightly been described as the ‘sixth test’, notably, the opportunity cost of not joining the Euro at the earliest opportunity.

The ‘Five Tests’

As everyone knows by now, the ‘five tests’ were hastily concocted by Gordon Brown at the Treasury in October 1977 shortly after Labour came to power and which EMU (Economic and Monetary Union) at that time was deemed to fail. Few non-specialists, though, are clear what the tests were and are today. Briefly resumed, they are as follows.

Convergence: it must be shown that Britain’s interest rates are sufficiently close to those of the eurozone, and its exchange rate sufficiently competitive such that entry will not harm the UK economy. More generally, Britain’s business cycle cannot be too far out of line with that of the main eurozone countries if eurozone interest and exchange rates are to remain appropriate.

Flexibility: this means ‘labour market flexibility’. Joining the euro means that Britain can no longer devalue and that the weight of adjusting to any loss of competitiveness vis-à-vis the eurozone would fall exclusively on wages. Unless productivity rises, UK wages must be flexible enough to bear the burden.

Investment: will Britain’s membership of the euro help or hinder investment, in particular so-called ‘inward investment’, ie, the flow of DFI (direct foreign investment) into the UK from the rest of the world?

Financial services: will joining the euro help or hinder the growth of the financial services sector (ie, the City)?

Growth and jobs: it must be shown that joining the euro would enhance – or at least not stifle – economic growth and job creation. Given the current stagnation of the main eurozone economies, this test seen by some as the most contentious. Their argument is that a one-size fits-all interest rate and the SGP (Stability and Growth Pact) would harm Britain.

In 1997, the Treasury’s view was that British entry would pass only one test clearly, that of helping the financial services sector (2) to grow. On all other matters the verdict was either negative or the jury remained out. Broadly speaking, on convergence, conventional wisdom suggested that the UK business cycle was more closely aligned with that of the US than of Germany and France. The pound was still too high relative to the (then) DM – indeed it had appreciated since 1992 – and the spectrum of British interest rates was still several per centage points higher than their continental counterparts. The current Treasury view is that there is closer symmetry of the UK and eurozone economies today, that the pound is competitively aligned with the euro and that interest rates are converging. Nevertheless, on convergence, the Treasury is still undecided.

The flexibility test is a curious one. While Britain claims to have Europe’s most flexible labour markets, the relatively low productivity growth and the overvaluation of the pound since the late 1990s until quite recently has been such that UK manufacturing has declined more sharply than at any time since the Thatcher years. (3) Since the pound has recently fallen and labour productivity has improved slightly, the current Treasury argument has changed. Instead of asking whether Britain is flexible enough, the Treasury asks whether the rest of Europe – notably Germany – -is flexible enough? Clearly Gordon Brown and his experts think not, and much is now made of the need for the EU to reform its labour market along UK lines; i.e., employers’ indirect labour costs should be lower, they should be able to shed labour more easily and the jobless should be encouraged, in Norman Tebbit’s immortal phrase, to ‘get on their bikes and find work’. The implicit assumption is that, were Britain to join, it might catch the German disease either because of increased trade union power or of the ‘deflationary’ bias of EU spending caps (see below).

On the investment question, Treasury reactions are mixed. On the one hand, it is accepted that long-term inward investment will suffer if Britain remains out of the euro permanently. On the other, while most analysts concede that inward investment has fallen somewhat in the recent past, some euro-sceptics argue that it is still too early to tell whether Britain is losing strategically important investment; equally, these economists argue that the UK should look for strategic partnerships elsewhere; e.g. in the US or in the high-growth Asian economies. As to the financial sector test, this was passed in 1997 and the assessment will doubtless be positive again. What has changed, though, is that the City has continued to prosper despite Britain’s retention of the pound. Economists are divided between those who think the euro is now largely irrelevant to Britain’s financial sector, and those who argue that just as New York could not act as America’s financial centre were it not part of the dollar-zone, so London cannot be Europe’s financial centre wile remaining outside the eurozone.

The final ‘test’ is about growth and jobs. As with labour market flexibility, since 1997 this test has been reversed. The Treasury’s conventional view is now that Britain does far better than the eurozone on growth and jobs, to join the euro would put Britain’s performance at risk – at least until such time as the eurozone undertakes the necessary reforms. A minority argues that although Britain has in recent years outperformed the eurozone on average, the smaller eurozone countries currently outperform Britain on growth (Eire, Greece) as do several on job creation. In particular, critics of the Treasury view point out that UK growth has been lead by high levels of consumer spending associated with the house-price boom, that the UK trade deficit has worsened and that UK industrial growth is negative and close to bottom of the EU-15 league table. (4)

The main issues

Most economists – including many Euro-sceptics – would agree that the ‘five tests’ are arbitrary and incomplete; this is one reason why the tests have been supplemented by the many volumes of material distributed to cabinet ministers. Equally, there has been much debate about what constitutes ‘sufficient’ evidence for a test to be passed or failed. Looking at the wider debate, there are at least two main questions which, strictly speaking, are either not addressed or addressed only indirectly by the tests. First, does abandoning the pound matter and, in particular, does the Maastricht Treaty impart a deflationary bias to the eurozone economy? Second, what are the benefits foregone of staying out; i.e. does remaining in mid-Atlantic carry a significant opportunity cost?

Does the pound matter and is the euro deflationary?

To readers of the Sun or the Daily Mail, having the sovereign’s head on our banknotes clearly does matter; indeed, for some euro-sceptics, no possible evidence can be adduced which would tilt the balance in favour of the euro. Debate at this level is clearly senseless. The concerned and undecided reader will presumably be concerned with the balance of costs and benefits; e.g. whether the loss of control over our exchange and interest rates in favour of ‘one size fits all’ is not a genuine cost, whether the costs of conversion to the euro will be outweighed by transaction costs saved, whether the economy will be less prone to exchange-rate shocks and so on.

If Britain abandons the pound, it loses control over its exchange rate and, by logical extension, over its interest rate. (5) Much has been made of this point by the anti-euro camp; by contrast, many pro-euro economists argue that interest rate and exchange rate autonomy in the UK has, over the long term, been a bad thing. Looking at the 30-year period 1966-96, the pound fell from DEM 11 to DEM 2.3 – a relative fall of 5 per cent per annum – while in terms of labour productivity and GDP growth, Britain remained well behind Germany. (6) To appreciate this argument one must look at Britain’s vulnerability to exchange rate movements and the relative weakness of interest-rate policy.

Until the price of gold was freed in 1971 and fixed exchange rates collapsed in 1973, exchange rates were not set by the market and nor was monetary policy the main instrument of macroeconomic policy. The Thatcher-Reagan years – combined with the internationalisation of capital markets – changed all that. Today’s conventional wisdom says that the exchange rate is set by the international market and government uses the interest rate (7) to steer the economy through the business cycle and offset the effect of unanticipated external shocks (eg, a sudden rise in oil prices). The problem with this sort of textbook economics is that in a world of speculative capital flows, exchange rates are unstable and tend to over- or undershoot their equilibrium level. (8) Nor can Central Banks always intervene successfully to keep exchange rates at the desired level, as 16 September 1992 (‘Black Wednesday’) showed when an overvalued pound (9) was forced out of the ERM (Exchange Rate Mechanism). In the intervening years, massive capital flows have produced further financial crises in Latin America and Southeast Asia. Most recently, after years of defying gravity, the overvalued dollar has fallen 30 per cent against the euro over only 6 months and threatens to go lower. (10) Because just over 50 per cent of Britain’s visible trade is with the EU (versus 17 per cent with the USA), large exchange rate fluctuations between sterling and the euro are undesirable. As long as the UK holds on to sterling, UK investment in the eurozone will carry exchange rate risk and a higher rate of return on such investment will be sought. Since sterling’s value has fallen relative to the euro (GBP 1 = EUR 1.39 at the time of writing), the objection that Britain might join the euro at ‘an uncompetitive exchange rate’ is no longer sustainable. (11) But no one can predict what sterling’s rate will be in five years’ time. Exchange rate fluctuations against the currency of our major trading partners carry a real cost in terms of risk. If sterling’s value is left to the mercy of an increasingly volatile capital market, the magnitude of exchange rate fluctuations will almost certainly rise in future.

The ‘one-size-fits-all’ objection to adhering a eurozone interest rate is equally problematic. Opponents of the euro often conflate two arguments. The first concerns how far the interest rate matters. First-year economics students learn about what Keynes called the ‘liquidity trap’; namely, the fact that when an economy is in recession, lowering the interest rate to near zero does not help much. The example of Japan, which has experienced nearly a decade of zero growth despite having the lowest interest rate of the industrialised countries, is instructive. The same misleading belief in the power of interest rates informs the argument of those who believe that Germany’s poor performance is due to the excessively monetary stringency of the Bundesbank after reunification in 1990 and, more recently, the ‘conservative’ monetary stance of the ECB (European Central Bank) and its lack of transparency. (12) While Germany has a supply side problem of a high reservation wage and an over-regulated service sector, Germany’s main problem is too low a level of aggregate demand. (13)

On a minor note, it has become fashionable of late to argue that by entering the euro and adopting lower short-term interest rates, the house-price boom would get out of control. This is because, unlike the rest of the EU, Britain mortgage rates are tied to short term rates which fluctuate far more than long-rates; this is sometimes called the ‘variable rate mortgage’ problem. The argument ignores several crucial facts. First, the house price boom has already peaked in most parts of Britain. Secondly, the house price boom and consumer credit can be reined in by other means; e.g. a temporary increase in duties on conveyancing is one example. Most important, moving to a continental-style or Pfandbrief system would be a good thing since current UK mortgage finance forces households to accept large risks: when short-term interest rates to squeeze an inflationary boom, households face higher debt at precisely the time house prices are falling. This in turn makes Government reluctant to tighten monetary policy, weakening the usefulness of monetary policy. (14) Thus, while accepting slightly lower ECB interest rates would lead Britain towards introducing non-variable mortgage rates, it would ease the burden of risk on house-owners. We can be quite sure that it would not lead to an inflationary boom.

The second argument is that the ECB suffers from an in-built ‘deflationary bias’. This is because the ECB’s brief set out in the 1992 Maastricht Treaty is to keep inflation in the range 0-2 per cent. In this it differs both from the US Federal Reserve which is charged with finding a trade off between the goals of combating inflation and maintaining employment as well as from the BoE (Bank of England). The latter, although unconstrained by any full-employment goal, has a so-called ‘symmetrical’ target of 2.5 per cent inflation; ie, should inflation falls below 2 ½ per cent, the BoE must loosen monetary policy. Furthermore, the UK can in principle use more active fiscal policy to offset any weakness on the monetary side whereas the SGP (Stability and Growth Pact) signed in 1997 imposes fines on those countries running a fiscal deficit grater than 3 per cent of cyclically-adjusted GDP.

I accept the ‘deflationary bias’ argument, as indeed do most supporters of the euro (15) – most famously the current President of the Commission, Romano Prodi and his Trade Commissioner, Pascal Lamy. (16) The 2 per cent inflation limit, the 3 per cent budget-deficit cap and the fiscal borrowing constraint (debt cannot exceed 60 per cent of GDP) were dreamt up in the late 1980s when the Community was still struggling with an inflationary legacy. (17) The danger today is not inflation but rather its opposite, deflation. The Council of Ministers has, in effect, ignored attempts by the Commission to impose SGP rules on Germany and France. Even the ex-President of the Bundesbank, Karl-Otto Pohl said at a conference in late 2002 that in the EU “The main problems are stagnation or even a recession”. (18) As German growth turns negative, US interest rates fall to Japanese levels and the Bush ‘stimulus package’ attempts to redistribute income in the wrong direction, a veritable chorus of academic and business economists are urging both the US and the EU to abandon pre-Keynesian orthodoxy and adopt actively expansionary fiscal policy. (19)

Because of the manner in which Britain calculates inflation, the 2½ per cent inflation target used by the BoE is tighter than the 2 per cent used by the ECB. (20) This is not to deny that the ECB needs to loosen the rules: symmetrical inflation targeting would be useful, but there is nothing sacrosanct about 2 per cent. Doubling the ECB inflation target would not lead to hyperinflation in the current world deflationary climate. It would allow the ECB to lower interest rates and well as to act more proactively. Neither the Maastricht budget deficit cap of 3 per cent nor the 60 per cent borrowing rule need be carved in stone. (21) The ‘3/60 rule’ was devised in the run up to EMU before 1999 when separate EU currencies were still vulnerable to speculation and financial markets needed to believe the euro would work. A relatively conservative reform would be to make the 3 per cent GDP cap refer to the core, not the headline budget; ie, to the budget deficit stripped of its cyclical component. And as in the UK, the deficit should exclude capital spending. (22) There is no reason why a higher deficit cap should not be allowed as long as inflation does not rise unduly. The US total budget deficit is currently forecast to be 4 per cent in 2003 and rising (23) (3 per cent if only the federal deficit is counted) while, in contrast to the EU where domestic private saving is high, the US internal deficit is mirrored by a growing external trade deficit.

Gordon Brown’s mounting the moral pulpit to extol the virtues of Anglo-Saxon pragmatism in creating jobs and overcoming ‘structural rigidities’ which plague our EU neighbours while continuing to veto British euro-entry is, when viewed from the perspective of those inside the eurozone wanting to change the rules, wholly counterproductive. (24) It is likely that the debate over the SGP and ECB rules will be settled before the complement of 10 new members is fully achieved. Britain has a short window of opportunity in which to put its position. By staying out, Britain cannot hope to influence that debate, just as happened with the Common Agricultural Policy in the 1960s.

Equally important is the issue is fiscal reform. Consider both EU level and national level. At EU level, although the ‘federal’ budget is a tiny 1.1 per cent of combined EU GDP (25) (versus about 25 per cent in the USA), nearly half is spent on the CAP (Common Agricultural Policy). Leaving aside arguments about the negative impact of the CAP on Third-World farmers, the CAP itself is extremely inefficient since it subsidises crop prices, not the income of poorer farmers. With enlargement imminent, though, CAP spending will slowly fall in real terms after 2006, (26) thus freeing EU ‘federal’ funds for other uses. The most pressing need of the EU is for greater regional equity; such equity can be achieved in part through the regional policies of member states, though ultimately much will depend upon enlarging the Structural Fund and putting money into improved EU-wide economic and social infrastructure. (27) Some years ago, the MacDougall Committee reported to the Commission that if there were to be constant redistribution from rich to poor regions rather than merely compensation for shocks, the EU budget would need to rise to somewhere between 2-7 per cent of GDP. As European anti-federalists have gained the upper hand in recent years, (28) this proposal has been consigned to oblivion. Fiscally induced reflation must thus rely on the relatively weak mechanism of inter-Government fiscal co-ordination.

At national level, fiscal reform is required if the ‘social market economy’ is to have any meaning. While much current discussion is devoted to cutting ‘unaffordable’ expenditure on pensions, (29) unemployment benefit, medical services and so on, few political parties (even on the left) have called for the higher tax levels required to finance an ‘affordable’ level of public spending compatible with maintaining a social market economy under conditions of increasing demographic strain. The tax burden differs greatly between the different member states: from about 50 per cent on France to 33 per cent in Eire (slightly lower than the UK), and this is precisely what lies at the heart of the ‘tax harmonisation’ debate. If the inclusive nature of social benefits is not to be eroded, ‘tax competition’ must be minimised and the tax-burden question must be debated as an EU issue, not merely as an issue of national competence. (30)

The costs of not joining?

Although the UK has not joined the euro, at present it is considered a ‘pre-in’ country to use the jargon. As Begg et al (2003) point out, saying ‘no’ to entry in June can mean two things. Either it means ‘not yet but the tests will be re-examined soon’ in which case Britain’s ‘pre-in’ status may be retained for a time; or it means ‘no and probably not any time soon’ in which case the UK would become a ‘probable out’. What is certain is that the longer Britain waits to hold a referendum, the less likely are other trading partners to believe Britain will join. The questions we examine immediately below are how this is likely to effect British trade with Europe, its share of inward investment and, ultimately, its growth.

One of the oldest pro-euro points is that by joining, Britain avoids the transaction costs of exchange rate conversion. As the story goes, back in the 1990s if one started out from London with £100 and changed the entire amount into local currency each time one crossed the border into another EU country, one would return to London with only £50. The argument is correct, but of course relatively trivial. Far more important is that membership of a large single currency area like the eurozone gives companies the chance to trade in a single market and enjoy the scale and technological economies so long available to industry in the US. Moreover, there is quite compelling evidence that given the option of trading within the currency area (intra-trade) and outside it, intra-trade will generally win. Several studies have examined the case of Canadian provinces trading with each other compared to trading with US states across the border; the results suggest that a Canadian province is twenty times more likely to do business with another province than with an equidistant US state. (31) Begg et al (2003:10) conclude that “there is now robust evidence that monetary unions do foster trade between their member states” and that the principal cost for Britain of staying out would be its failure to share in the growth of intra-trade together with its failure to benefit from rising competitiveness.

The evidence on intra-EU trade is that Britain has already lost out. If one considers British, German and French trade with other EU countries in 1998 and 2001 (i.e. before and after the launch of the euro), Germany and France both raised their share of trade in GDP – from 27 to 32 per cent and 28 to 32 per cent respectively – while Britain’s trade share fell from 23 to 22 per cent; Over the same period. Britain’s share of FDI (foreign direct investment) into the EU has also fallen: from an average of 39 per cent over the period 1990-98 to 24 per cent for 1999-2001. If one considers labour productivity – output per hour worked – Britain has lost out even more sharply; its productivity level in 2002 was 15 per cent lower than the average of Germany and France. (32)

A further benefit of EMU (economic and monetary union) is that it creates greater market integration within member states. The argument in Britain about convergence has tended to ask: is Britain’s economy sufficiently like the rest of the EU to make entry advisable? Here, the empirical evidence has been mixed: Britain’s cycle has not fully converged with the core countries, but it is certainly more similar than some of the peripheral countries (eg, Spain, Ireland). However, it would appear that membership of a monetary union accelerates convergence; i.e. if Britain were to join, it could expect its business cycle to move more closely with the core countries. Per contra, if Britain remains outside the eurozone, eurozone economies will converge more with each other than with Britain.

In a previous section, the problems of interest rate convergence and a suitable exchange rate have already been discussed. Suffice it to repeat here that while the exchange rate issue has been a problem in the past – i.e. the pound has been overvalued – today the exchange rate is not a problem. But what of the future? Just as pre-announcement of the convergence rates for the euro in 1997 ‘steered’ participating currencies in the right direction, it is likely that pre-announcement of an entry rate for Britain of (say) €1.37, the PPP rate, would have the desired effect.

In conclusion, it is worth quoting from Begg et al (2003) on the crucial question of the opportunity costs of remaining outside the eurozone.

The Sixth Test should be whether the further gains of waiting outweigh the further costs of waiting. Those who argue that the UK can afford to wait until the convergence tests are met ‘beyond reasonable doubt’ have ignored the first lesson of economics. Optimal behaviour equates the marginal costs and the marginal benefit. Driving the marginal benefit of waiting to zero means waiting too long. [Begg et al, p 13]


This paper has resumed the economic arguments. The costs of not joining the euro outweigh the ‘benefits’ of staying out. As David Begg, Richard Layard, Robin Marris, Will Hutton and many others have argued, if this is true today, then the longer Britain waits, the greater the opportunity costs incurred. Why have we not joined?

The answer is clearly political – more precisely, it is about political weakness. (33) When the Labour Government came to power in 1997, the tabloid press was against the euro and public opinion was divided. Gordon Brown at the Treasury was already sceptical, and Tony Blair was unconvinced that a referendum could be won. The ‘doctrine of unripe time’ was borne – we would only join when it could be shown to be was unambiguously in the country’s interests to do so. The pro-euro Britain In Europe (BiE) campaign was put on hold; debate could not begin until the Treasury had ruled, and unless Brown backed euro-entry, the debate could not be won. Blair – whether by design or by default – handed the Treasury and its allies at the BoE (Bank of England) a veto. Central Banks are generally reluctant to abolish themselves, and no Ministry of Finance wants its powers constrained by treaty obligations, particularly those of Maastricht. Both the Treasury and the BoE had bitter memories of Black Wednesday and suspected the Bundesbank of schadenfreude. Moreover, as Brown became stronger at the Treasury and more sceptical on the euro (34), Blair became less able to shift him to another Cabinet post (eg, the FO) where his views might have been influenced by other factors.

Even after the resounding Labour victory in 2001 – which saw the Independence Party lose its deposits – the Government was unable to decide on a referendum. In the post 11 September environment of the ‘war on terror’, Britain’s alliance with the US became ever more visible. By mid-2002, word was out that the Treasury assessment would be negative. The more Blair enthused about Britain’s key role in Europe, the less believable he became.

This is not the first time Britain has been late. It waited 13 years to sign the Treaty of Rome and delayed its decision on joining the EMS until 1990, choosing the worst possible moment. Tellingly, throughout the period Britain has remained locked into its ‘special relationship’ with the United States and, in that capacity, first acted as conduit for the ‘Third Way’ and ‘triangulation’ schemes of Clinton; more recently, it has teamed up with the radical right in Washington against the main EU countries.

Perhaps the time has past and Britain will not join the euro, preferring instead to form a free-trade area with America; this is the preferred solution of Murdoch, Black and such right-wing economists such as Patrick Minford (35). Perhaps as Robin Marris has argued ” … there will soon be only three significant currencies in the world-the dollar, the euro and an Asian currency based on the yen. … If sterling stayed out, our currency would become the repository of large amounts of short-term funds, unwanted at any particular time in the other three… our society and economy would be seriously damaged.” (36) Or perhaps even more pessimistically, as John Gray has argued “So long as it serves the Blairite agenda, Britain’s deeper integration into the EU spells the end of any European project worthy of the name … not only in foreign and defence matters but also in economic and social policy, Britain’s goal will be to “modernise” Europe on an Anglo-American model.” (37) Whatever position you the reader hold on this question, be assured (to paraphrase Robin Marris) that the ultimate choice Britain makes will affect our welfare of Britain long after Saddam Hussein and Osama bin Laden are forgotten.

(1) Some will argue that this states the argument too simply. However, it is an argument put eloquently by a range of political commentator; eg, see Hugo Young (1999), Britain and Europe from Churchill to Blair, London: Macmillan; Will Hutton (2002) The World we’re In, London: Little Brown; and George Monbiot ‘The bottom dollar’ The Guardian, April 22, 2003.

(2) In recent years the term FIREB (Financial services, Insurance and the Real Estate Business) has become a favoured acronym.

(3) In May 2000, the GBP peaked at DEM 3.46, nearly 20 per cent above the value at which it was forced to leave the ERM in1992. Huhne estimates that between 1998 and 2000 when the pound peaked, British manufacturing lost 350,000 jobs. See Huhne in Forder, J and C Huhne (2001), Both Sides of the Coin, London: Profile Books, p 14.

(4) For the 2002 figures by quarter from Eurostat , see; also Larry Elliot ‘Industry is dying a slow, lonely death’ The Guardian, March 12, 2003. Also see Ray Barrell and Martin Weale ‘Designing and Choosing Macroeconomic Frameworks: The Position of the UK after 4 years of the Euro’ NIESR Discussion Paper No.212, 19 April 2003.

(5) Note that Britain does not lose full control since, as a major EU economy, Britain’s economic performance influences that of the eurozone and Britain gains a voice

(6) See Currie quoted in Huhne’s section of Forder, J and C Huhne (2001), Both Sides of the Coin, London: Profile Books, p 71.

(7) By ‘interest rate’ is meant the short-term interest rate on monetary instruments, itself closely aligned with the rate at which the Central Bank will lend to the commercial banking sector.

(8) The ‘equilibrium level’ is best thought of as that exchange rate at which domestic prices would be closely aligned with world prices such that purchasing power parity (PPP) would be achieved; ie, a hamburger would cost the same in New York, London and Buenos Aires.

(9) After Nigel Lawson began shadowing the DEM in 1987, the new Chancellor, John Major, took the pound into the ERM in 1990 at DEM 2.95, a rate which most analysts considered too high. The 1991 recession convinced international markets that the rate was unsustainable and by late 1992, the position became untenable. Like Britain, Italy was forced to leave the ERM in 1992, but renegotiated its exchange rate and rejoined. The Bundesbank had suggested Britain might renegotiate before Black Wednesday but this warning went unheeded by the Treasury; after the event, such was the embarrassment that the Treasury remained firmly opposed to the ERM and its successor, the single currency.

(10) Interestingly, the Fed has shown no signs of wanting to halt dollar depreciation, leading a number of countries to conclude that the US is ‘exporting’ its unsustainable external account deficit, which could otherwise only be cut by reducing US domestic demand (absorption).

(11) See Robin Marris, ‘Falling pound opens the door for euro entry’ The Times, March 7, 2003.

(12) A very useful discussion of ECB transparency is contained in Willem Buiter, ‘Alice in Euroland’, speech at South Bank University, 15 December 1998.

(13) See James Forder in Huhne and Forder (2001) Both Sides of the Coin, London: Profile Books. Forder overlooks the fact that since unification, it is estimated that Germany has spent 4-5 per cent of its annual GDP in maintaining East German living standards.

(14) See David Begg, Olivier Blanchard et al (2003) ‘The Consequences of saying no’ London: Britain in Europe, May, p 51.

(15) See Will Hutton ‘Now can we join the euro’ The Observer, Sept. 22, 2002. There a various technical discussions of how to reform the ECB of which two are: Fitoussi, J-P and Jerome Creel (2002) ‘How to reform the European Central Bank’ London: The Centre for European Reform; and David Begg, Olivier Blanchard op cit.

(16) See Chris Huhne, ‘Commission concedes need to make stability and growth pact more flexible’ October 17, 2002

(17) For a powerful critique of the Maastricht criteria see Krugman, P. (1995) Peddling Prosperity, New York: Norton. “The Fed does not need to police the budgetary deficits of New York and California, because they cannot print money to cover their deficits. The same would be true of national governments after EMU.” (p. 191)

(18) See William Keegan ‘How many angels can dance on the head of a pin’ The Observer, November 24, 2002.

(19) See William Buiter (2003) ‘Deflation: causes, prevention and cure’ LSE Centre for Economic Performance, London, 19 May 2003; Paul Krugman (2000) The Return of Depression Economics London: Penguin; John Greave Smith (2002) There is a Better Way, London: Anthem Press; Wynne Godley, ‘The new interest-rate orthodoxy is as flawed as the old one’ The Guardian, November 11, 2002; Larry Elliot ‘Brown can relax the reins this year, The Guardian, April 7, 2003;

(20) The EU HICP (Harmonised Index of Consumer Prices) uses different weighting conventions from those used by Britain’s RPIX and in consequence shows inflation to be about 1 per cent lower than the RPIX. If Brown shifted to the HICP, UK inflation would be 2 per cent, not 3 per cent, and thus is line with the ECB target. See ‘Brown figures it out’ The Guardian, 3 June 2003.

(21) While the ‘3/60’ rule is set in the Maastricht Treaty, the SGP (requiring the rule to be enforced) was only added in 1997 and could be amended. Equally, section 3 of the draft EU Constitution sets ‘full employment’ as a primary goal; if approved, this would enable governments to use fiscal policy more actively.

(22) The UK Treasury’s ‘golden rule’ is more conservative: it says that over the cycle current revenue should cover current expenditure so restricting long-term public borrowing exclusively for capital expenditure.

(23) See BBC News ‘US budget deficit soars’ 29 January 2003,

(24) See Larry Elliot and Charlotte Denny ‘Brown goes the American way’ The Guardian, 10 April 2003.

(25) This figure is capped by the Maastricht treaty at 1.27 per cent.

(26) Under the 2002 ‘deal’ between Chirac and Schroeder, CAP spending is to rise by only 1 per cent nominally p.a. after 2006, a greater share going to new entrants until 2013 when subsidies will be ‘lower but equal’.

(27) Thus Jacques Delors, when President of the European Commission in the early 1990s, proposed a trans-European transport plan emphasising a network of high-speed rail links to take the strain off air and road traffic; the plan was rejected for reasons of budgetary orthodoxy.

(28) For a discussion of the MacDougall Committee see Huhne in Huhne and Forder (2001) Both Sides of the Coin, London: Profile Books, p 91. That EU anti-Federalists have gained the upper hand is clearly apparent from the 2003 Constitutional Convention.

(29) Although the Chancellor boasts that ‘Britain’s pension liability’ is one of the lowest in the EU, far better than that in Germany and France, see Will Hutton ‘The Great Pensions Lie’ The Observer, February 16, 2003. I do not deal with the argument that in joining the euro would entail Britain assuming responsibility for the ‘unfunded pension deficit’ of other countries; the argument is nonsensical.

(30) To suggest that evidence from different US states – e.g. high taxes in Vermont and none in Florida – shows otherwise is to miss the point that state taxes are minor compared to the federal taxes paid by all US residents.

(31) See McCallum, J (1995) ‘National borders matter: Canada-US regional trade patterns’ American Economic Review; Helliwell, J (1998) ‘How much do National Borders Matter?’ Washington DC: Brookings Institution.

(32) Both sets of figures are from R. Layard, ‘The case for joining the euro’ LSE Centre for Economic Performance Public Debate, 28 April 2003. Trade here means trade in goods (sum of imports and exports).

(33) See David Clark ‘The Weakest Link’ The Guardian, April 23, 2003.

(34) Having rules out the euro in 1997, Gordon Brown subsequently tried to gatecrash a meeting of the eurozone Finance Ministers and was turned away. According to one MEP who sits on the parliament’s Economic and Monetary Affairs Committee, these days Mr Brown regularly misses meetings of the Finance Ministers of the full EU-15.

(35) See Patrick Minford ‘Should Britain join the euro – the Chancellor’s five tests examined’ IEA Occasional Paper 126, September 2002.

(36) Robin Marris ‘Five steps to nowhere’ The Guardian, 1 February 2000.

(37) John Gray ‘For Europe’s sake, keep Britain out’ New Statesman, Monday 19 May 2003.

This article was contributed by George Irvin, Associate Professor of Economics, ISS, The Hague; he may be contacted at The opinions expressed at those of the author and not necessarily those of Federal Union.

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