Bank of England chief explains UK euro delay
Speech by the Rt Hon Eddie George , 11 April
ONE CURRENCY, FIFTEEN COUNTRIES?"
Sir Edward George, the governor of the Bank of England, has placed the loss of control over interest rates as a major reason behind the UK's reluctance to adopt the euro.
Britons were also sceptical over the level of regulation in other parts of the European Union, Sir Edward told a seminar in Spain.
Sir Edward, explaining why the UK was still outside the euro, said Britons had yet to be convinced that the benefits of adopting the currency were sufficient to warrant abandoning control over interest rates.
Let me make clear, from the outset, that monetary union is fundamentally a political rather than an economic issue. It necessarily involves the deliberate pooling of national sovereignty over important aspects of public policy, in the interest not just of collective economic advantage, but of a perceived wider political harmony within Europe.
As a central banker, I have nothing to say about the politics of monetary union - that's for elected politicians. But it is also an economic issue and that is my concern.
So what are the economic pros and cons?
The potential economic advantages and disadvantages are now reasonably well defined - though different opinions inevitably attach different weights to the respective arguments.
On the plus side, the crucial and unique economic advantage of monetary union is nominal exchange rate certainty within the Eurozone - which takes over half UK exports. I'm not talking just about reasonable exchange rate stability - which might result over time from each country pursuing disciplined macro-economic policies in parallel. I'm talking about nominal exchange rate certainty for the indefinite future.
That very real economic advantage is well understood in the UK - especially by businesses that trade with, or compete with, businesses in the Eurozone. And on that ground alone many of them, who have suffered from excessive sterling strength against the euro, would see our joining as an advantage provided of course the exchange rate were initially fixed at an appropriate - and significantly lower - level than at present. At the broader macro-economic level the potential benefit of joining - as a result of greater transparency of costs and prices and lower transaction costs - leading to greater competition and more efficient economic resource allocation is well understood.
Exchange rate certainty within Europe - even though it is nominal certainty rather than real exchange rate certainty - would potentially enhance the benefits to be derived from the European Single Market.
The euro's second very powerful advantage is the possibility it opens up for much broader and more liquid financial markets. It will mean a progressive narrowing of spreads between borrowers and lenders - and that will be good news too for financial intermediaries as a group, because it will lead to higher volumes of financial activity - though not every individual intermediary will benefit, of course, in the more competitive environment. The City of London is already making an important contribution to this process of financial euro-market integration.
So there are potentially powerful advantages. What then are the risks - the possible arguments against our joining the euro?
Essentially the potential downside can be summed up as the risk that the single - one-size-fits-all - short term interest rate within the Eurozone - which is the inevitable consequence of a single currency - will not in the event prove to be appropriate to the domestic monetary policy needs of all the participating countries.
Countries may have divergent cyclical positions. They may face divergent fiscal positions which would affect their appropriate fiscal/monetary policy mix in different directions - though this should be contained by the Growth and Stability pact. Or their domestic policy needs may diverge as a result of economic shocks of some sort - a classic but unique example being German unification, but the recent global economic disturbance is perhaps another example.
So the risks of divergent monetary policy needs within the monetary union are real. They are essentially similar to the risks of sectoral and regional divergences within a national currency area. And if there were to be material divergence within the Eurozone the tensions could be more severe than in a national currency area because alternative mechanisms - labour migration or fiscal redistribution through a central budget - which help alleviate regional disparities in the national context - are less well developed at the Eurozone level.
Some commentators point to the present inflationary pressures in Ireland as an example of the problems that could arise on the upside as it were - through I'm not sure how far one can generalise from the Irish case.
The fact that the UK did not join in the first wave of EMU was a disappointment to some people, including to some of our European partners - but it was also a considerable relief to them - we could have been the elephant in the rowing boat! It was I must confess also a relief to me. If we had joined EMU from the start - and had Eurozone interest rates over the past year or so it is very difficult to envisage how we would have avoided an inflationary boom in this country. It is true that, to the extent that the present imbalance within the economy reflects sterling's appreciation against the euro, we would have been protected against that. But, with accelerating inflation in the economy as a whole, the price of such protection of the suffering sectors would have been tantamount to real exchange rate appreciation, which would in any event have damaged their competitive position. And, it would not in that case be possible to reverse that effect through exchange rate adjustment. Joining EMU from the start would in fact, as things have turned out, have been a strong form of relaxing our objective for consistently low inflation in the economy as a whole to ease the pressures on the internationally-exposed sectors which I argued against a few moments ago. There are no easy answers so long as our economies continue to diverge.
Coping with such tensions as may emerge within the Eurozone - with or without the UK - is likely to be easier in a context of structural, supply-side, flexibility and adaptability - which also, as I say, essentially determines the underlying rate at which the economy can expand in the medium and longer-term. The Eurozone started with chronically high unemployment. Some countries still have very high ratios of public debt to GDP. And most face the prospect of an increasing burden on their public finances with ageing populations.
Some people in the Eurozone acknowledge these concerns, but they are inclined to argue that if a country participating in the monetary union were to find itself in an unsustainable situation and given that it would have no macro-economic way out - through exchange rate adjustment, or independent monetary policy action, or fiscal stimulus beyond the limits of the Growth and Stability pact - and given limited labour migration or fiscal redistribution at the pan-European level - then it would have an overwhelming incentive to undertake the supply-side reforms which have proved so difficult to introduce up until now. One of my ECB colleagues in fact once put it to me that - "when we have closed off every other policy option, we will finally be forced to do the things we know that we should have done all along!"
I hope that this proves to be right and that it does help ease the tensions. Supply-side flexibility within Europe is crucial in my view not just to the success of the euro, but to the success of the European economy in a much broader sense - to the resolution of Europe's chronic unemployment problem and to the contribution which a strong European economy can make to the whole of the world economy.
In all of this - in our pursuit of both macro-economic stability on the one hand and structural reform on the other - we share much the same basic philosophy as our partners in the European Union, though it may be true to say that, at least as a matter of degree, while we were later than some of them in coming to macro-economic stability, we may have gone further in the direction of improving the supply-side flexibility of our economy through structural reform.
The best thing that we can do for the time being - on both sides - is to pursue this common approach in parallel. That should help to bring about greater convergence between us, to reduce the risks of UK membership of the euro and to help meet the Government's five economic tests for joining. In the meantime, ahead of any decision, it seems sensible to prepare in order to keep open the option to join.