Summary:
Martin Wolf giving some reasons why Britain is better off outside the euro. Whether the UK meets arbitrary economic tests at a particular moment is irrelevant. What is right today may be wrong tomorrow. Britain needs the ability to increase short term interest rates in order to restrain the growth of credit. Exchange rate flexibility has not led to price instability. There is no evidence that being outside the eurozone has imposed a performance penalty upon the UK economy. Argument against joining mainly economical, but also part political. (Published: 29/05/08)
Notes:
- Lex column last week: UK close to meeting the economic tests for joining; only obstacle to entry is political
- Martin Wolf disagrees:
- Whether UK meets arbitrary tests at a particular moment is irrelevant
- What is right today may be wrong tomorrow.
- If country is to join eurozone, its people must be willing to cope with the consequences forever, however unpleasant they may sometimes be.
- At present exchange rates, entry looks more plausible than for the past 12 years
- implied rate of old D-Mark against the pound was 2.46 on May 23
- well below the rate at which sterling was put in the old exchange rate mechanism in 1990
- Proponents of joining claim UK is paying price for staying outside euro zone
- real central bank intervention rate has averaged 3.2 per cent in the UK since 1999, against just 1.4 per cent in Germany or even negative levels in Ireland and Spain
- these relatively high short-term rates have also pushed longer-term rates above levels in the eurozone
- Arguments not compelling
- not long ago some argued that the fact that sterling had been so stable against the euro from early 2003 to late 2007 was a reason for joining
- now people argue that sterling should join the eurozone because it is weak
- all this shows is that the equilibrium exchange rate varies
- the rate that made sense when the world was willing to finance the UK's property-related borrowing spree no longer does so today
- high short-term real interest rates were needed to contain the growth of credit
- if UK had been a member of the eurozone, with lower interest rates, both credit growth and the economy would have been stronger, domestic inflation higher and real short-term interest rates possibly even negative
- would be no offsetting stimulus from the fall in the exchange rate as there is at the moment
- sterling has fallen by about 14 per cent against the euro since last August
- to achieve the same gain, Spain, now struggling with the end of a far bigger property-related boom, would need an annual rate of increase in unit labour costs a percentage point lower than in its eurozone competitors, for a good 15 years
- advantages of exchange-rate flexibility need not go with worse price stability
- between 1998 and 2008, consumer prices will have risen by just 18 per cent in the UK, the same amount as in Germany and below the 20 per cent rise in France and 26 per cent in Italy
- because sterling has fallen against the euro, the domestic price level will rise in the UK relative to the eurozone
- provided the Bank of England is determined to prevent pass-through to domestically determined prices, this should not endanger low inflation to any significant extent
- no evidence that being outside the eurozone has imposed a performance penalty upon the UK economy
- between the first quarter of 1999 and the first quarter of 2008, UK economy expanded by 28 per cent, against 21 per cent in the eurozone as a whole and 16 per cent in Germany
- no evidence that Emu has improved the economic dynamism of its members
- if anything, membership seems to have reduced the pressures for reform.
- The proposition then is fundamentally an economic one:
- remaining outside the euro preserves the safety valve of currency flexibility, while losing nothing in aggregate economic performance.
- Being outside has not even hurt London's position as a financial centre.
- Big proviso is that the Bank of England continues to fulfil its mandate
- might now require a period of much slower growth, or even a recession.
- but long-lasting slowdowns in particular economies are just as likely (probably even more likely) inside the eurozone
- Proposition is also political:
- inside a currency union, years of slow growth will occasionally be needed if relative costs are to come back into line
- there are countries in which it is possible for politicians to sell this proposition.
- Spain and Italy may be among them.
- Not UK.
