Predictably, now the Pound has weakened significantly against the Euro, approaching parity, the Europhiles have come out of hiding and have started to bang the drum once again for British membership of the Euro.
The Europhiles have dusted off their old discredited arguments and are deploying them again. Now we hear that Britain is too small and weak to go it alone and we need the protection of the Eurozone. Gordon Brown may have buggered up our economy but come on, we’re not as small and helpless as Iceland!
Perhaps the only worthwhile thing Brown has done in office is oppose joining the Euro and holding Tony Blair’s Euro ambitions at bay with his five economic tests which were purely political in purpose. With the current speculation about joining the Euro, Brown has let it be known that Euro membership is not even on the agenda, never mind being discussed.
But it is worth reminding everyone why Euro membership is not a good idea.
The key economic argument against Britain joining the Euro is its ‘one-size-fits-all’ monetary policy – it is EMU’s biggest flaw. The former Governor of the Bank of England, Eddie George, said he saw “the one-size-fits-all monetary policy as a disadvantage and a special risk. The same monetary policy is not optimal for every country at the same time.” Britain has had problems having a single interest rate which does not always suit different regions of the United Kingdom. Some have criticised the Bank of England for setting rates to suit a booming South East of England rather than the more depressed North. Eddie George made this very point when he said that “the Bank’s job is to maintain macro stability for the whole country, and discrepancies between regions and industries were regrettable but inevitable.” This very problem would be far more pronounced for Britain with monetary policy set at the European level by ECB rather than the Bank of England’s Monetary Policy Committee (MPC).
Across the Eurozone, the effects of the one-size-fits-all interest rate have and will continue to be larger because the variation of performance is greater. They will also be more significant because the political fall-out will be much bigger. If Britain joined EMU it would have interest and exchange rates set for the whole of the Eurozone rather than being tailor-made specifically for British needs. Basically the ECB currently chooses a ‘compromise’ rate for the whole of the Eurozone and therefore this would never be as consistently responsive to Britain’s needs as a monetary policy set by our very own MPC. Look what happened to Ireland when the ECB cut interest rates that led to an unsustainable boom.
This “one-size-fits-all monetary policy” would matter less if the Eurozone was an Optimal Currency Area (OCA). OCA theory was developed by the Nobel Prize winning economist, Robert Mundell. It states in the event of negative economic shocks, such as a world recession or oil price increase, a currency area will have the best chance of minimising the damage if the economies that are members are broadly homogenous and synchronised. This is because shocks will then be symmetrical; that is, they will affect all economies similarly and hence only a single economic response is required to stabilise all of the economies of the currency area. However, if there is no OCA then the shocks are likely to be asymmetrical which will mean that economies will need specific policies applied to them. This is exactly the problem that EMU faces. Although the EU6 (Germany, France, Benelux and Austria) comprise an OCA, the Eurozone as a whole does not. The IMF has stated previously that the United Kingdom and Nordic countries are situated outside a cluster of core economies centred on Germany and some of the Southern European economies have even less in common with the ‘core’ European economies but have joined the Eurozone nonetheless.
Britain’s economic cycle is somewhere between that of the US and the EU6. before the Euro should be considered, with all its political ramifications about sovereignty and democratic accountability, Britain’s economic cycle would have to be in sync with the Eurozone’s core which is not the case today. In fact there is no reason to suppose that the economic cycles of countries will ever be sufficiently synchronised so that all countries require the same interest rate at the same time to influence the level of output or the rate of inflation. For real convergence, some countries need to grow faster than others do, which means encouraging investment at the expense of consumption. This, in turn, requires lower interest rates in some countries than others.
If we joined the EMU it would not only be signing up to a currency area which lacked convergence, we would obviously be surrendering our monetary policy instrument and thus would be reduced to having to rely on Gordon Brown economics to help our economy. No longer able to respond to asymmetric shocks with supply side economics we’d be forced to result to fiscal policy to get us out of a sticky situation – the failed and discredited policy of trying to spend our way out of recession. If we joined the Euro there would be no leaving unlike the ERM on Black (or was it White?) Wednesday. We would be forced to adopt the economics of Gordon Brown forever.
I shudder at the thought.
The Europhiles have dusted off their old discredited arguments and are deploying them again. Now we hear that Britain is too small and weak to go it alone and we need the protection of the Eurozone. Gordon Brown may have buggered up our economy but come on, we’re not as small and helpless as Iceland!
Perhaps the only worthwhile thing Brown has done in office is oppose joining the Euro and holding Tony Blair’s Euro ambitions at bay with his five economic tests which were purely political in purpose. With the current speculation about joining the Euro, Brown has let it be known that Euro membership is not even on the agenda, never mind being discussed.
But it is worth reminding everyone why Euro membership is not a good idea.
The key economic argument against Britain joining the Euro is its ‘one-size-fits-all’ monetary policy – it is EMU’s biggest flaw. The former Governor of the Bank of England, Eddie George, said he saw “the one-size-fits-all monetary policy as a disadvantage and a special risk. The same monetary policy is not optimal for every country at the same time.” Britain has had problems having a single interest rate which does not always suit different regions of the United Kingdom. Some have criticised the Bank of England for setting rates to suit a booming South East of England rather than the more depressed North. Eddie George made this very point when he said that “the Bank’s job is to maintain macro stability for the whole country, and discrepancies between regions and industries were regrettable but inevitable.” This very problem would be far more pronounced for Britain with monetary policy set at the European level by ECB rather than the Bank of England’s Monetary Policy Committee (MPC).
Across the Eurozone, the effects of the one-size-fits-all interest rate have and will continue to be larger because the variation of performance is greater. They will also be more significant because the political fall-out will be much bigger. If Britain joined EMU it would have interest and exchange rates set for the whole of the Eurozone rather than being tailor-made specifically for British needs. Basically the ECB currently chooses a ‘compromise’ rate for the whole of the Eurozone and therefore this would never be as consistently responsive to Britain’s needs as a monetary policy set by our very own MPC. Look what happened to Ireland when the ECB cut interest rates that led to an unsustainable boom.
This “one-size-fits-all monetary policy” would matter less if the Eurozone was an Optimal Currency Area (OCA). OCA theory was developed by the Nobel Prize winning economist, Robert Mundell. It states in the event of negative economic shocks, such as a world recession or oil price increase, a currency area will have the best chance of minimising the damage if the economies that are members are broadly homogenous and synchronised. This is because shocks will then be symmetrical; that is, they will affect all economies similarly and hence only a single economic response is required to stabilise all of the economies of the currency area. However, if there is no OCA then the shocks are likely to be asymmetrical which will mean that economies will need specific policies applied to them. This is exactly the problem that EMU faces. Although the EU6 (Germany, France, Benelux and Austria) comprise an OCA, the Eurozone as a whole does not. The IMF has stated previously that the United Kingdom and Nordic countries are situated outside a cluster of core economies centred on Germany and some of the Southern European economies have even less in common with the ‘core’ European economies but have joined the Eurozone nonetheless.
Britain’s economic cycle is somewhere between that of the US and the EU6. before the Euro should be considered, with all its political ramifications about sovereignty and democratic accountability, Britain’s economic cycle would have to be in sync with the Eurozone’s core which is not the case today. In fact there is no reason to suppose that the economic cycles of countries will ever be sufficiently synchronised so that all countries require the same interest rate at the same time to influence the level of output or the rate of inflation. For real convergence, some countries need to grow faster than others do, which means encouraging investment at the expense of consumption. This, in turn, requires lower interest rates in some countries than others.
If we joined the EMU it would not only be signing up to a currency area which lacked convergence, we would obviously be surrendering our monetary policy instrument and thus would be reduced to having to rely on Gordon Brown economics to help our economy. No longer able to respond to asymmetric shocks with supply side economics we’d be forced to result to fiscal policy to get us out of a sticky situation – the failed and discredited policy of trying to spend our way out of recession. If we joined the Euro there would be no leaving unlike the ERM on Black (or was it White?) Wednesday. We would be forced to adopt the economics of Gordon Brown forever.
I shudder at the thought.
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