The ERM story naturally hogged the headlines yesterday, the more so since Britain's relationship with the single currency has been somewhat to the forefront of people's minds. The fact that there was a mini-row about the entry point for the lira gave a further spice to it. But in big economic terms it is not really that important an issue.
The ERM ain't what it used to be, for if you allow 15 per cent movement on either side of a central rate you have built in quite a lot of leeway.
Indeed, arguing whether that central point should be 1000 lire to the mark, or as it eventually was, L990, really makes no sense at all.
Nor does this have great implications for the membership of the Euro club. True, prior entry to the ERM was on paper one of the essential conditions of membership. But so is a fiscal deficit of less than 3 per cent and total debt of less than 60 per cent of GDP. If these conditions are fudged, which they will have to be if France and Germany are to become members, then membership of the ERM can be fudged too. If the French and Germans want the Italians in, and Italy decides to come in, then the lira will be included. If not, then it won't.
No, the really interesting this is what has been happening in Italy itself. Most of the comment in the last few months has been about the gradual return to fiscal probity. The borrowing splurge of the 1980s has left the country with a debt-to-GDP ratio of more than 120 per cent, the highest of any large developed country in the world.
The running deficit has been cut so that Italy is not running a primary surplus - i.e. taxation more than covers current spending, so were it not for debt interest the budget would be in the black. In theory, by dint of introducing as special "Europe tax", a great way to make EMU popular, the overall budget deficit should be under 3 per cent by 1997. But nobody believes that, hence the general scepticism about Italy's finances. Most commentators rank Italy as "better, but still pretty dreadful".
That is true enough if you focus on the fiscal side. But if you look instead at the monetary data an altogether more impressive picture emerges. The graph on the left shows how the country has recovered its position of monetary virtue that it had in the early 1980s, and which it progressively abandoned until the lira's ejection from the ERM.
Most recently Italy has further underpinned this return by extending a much greater degree of independence to the Banca d'Italia, which has resisted pressure to cut interest rates too quickly despite weak growth.
The output gap - the difference between actual output and the theoretical full capacity of the economy - has therefore been widening, further reducing inflationary pressure. Result: inflation running at 2.6 per cent over the last year, a touch below the UK or for that matter the US.
Some forecasts for inflation next year put it at 2 per cent. It would be wrong to paint the country as a secure, low-inflation zone, for earnings growth is still running at close to 6 per cent a year, suggesting an underlying increase of at least 3 per cent in industrial costs. (UK earnings growth is running just below 4 per cent and we are right to be concerned about that.) Nevertheless it is a considerable achievement.
But it is not just an achievement for Italy. It is also a sign of a change that has taken place in the world, for the developed world as a whole has now conquered inflation.
Say that and you risk looking very silly indeed. After the searing experience of the 1970s and 1980s the markets will not be prepared to drop their guard on inflation for perhaps another generation, and rightly so. There will undoubtedly be a cyclical upturn in inflation during the next two to three years, but if the G7 country with the worst inflation record can get down to 2 per cent then that is progress indeed.
It is even possible that this 2 per cent figure is too high - in the US they reckon that quality improvements not counted in the consumer price index account for between 1 and 2 per cent of inflation: i.e. any inflation figure of below 2 per cent may mean there is no inflation at all.
This has the profoundest implications for currencies. Not so much for the new European currency union, if it indeed takes place, but rather for world currencies.
A world in which inflation is about 2 per cent, give or take a bit, is completely different from one in which inflation is in high single figures, let alone double digits. Suddenly a much greater degree of currency stability becomes possible. Indeed we are almost back to the conditions where a fixed exchange rate system becomes practicable: inflation is back to the level of the 1950s and while the Bretton Woods model could not be re-established, it should certainly become possible to inject greater "viscosity" into exchange rates.
At the moment nobody is talking about this. Nobody is thinking about the Louvre Accord of a decade ago, which set unpublished monitoring ranges for the important currencies. Nobody in Europe is thinking beyond EMU. Nobody in Japan is thinking beyond the new-found and, they hope, more stable trading range for the yen. Nobody in the US is thinking much about the external value of the dollar at all.
I suspect this will change, whether or not the euro happens. If it does, then it would be useful to establish some kind of relationship - an understanding of nothing more - with the other main currencies, in particular the dollar. The "ins" will in any case have to establish a relationship with the "outs" like sterling (and maybe despite the above, the lira); how much more important it will be to establish a relationship, if it were possible, with the "out, outs", the dollar and the yen.
Suppose on the other hand the euro does not happen, currently an unfashionable view, but who knows? Then it will be enormously important to monitor not just European exchange rates, but also world ones so that there is no unnecessary damage to the world trading system.
To say all this is not to call for a new Bretton Woods, for that would be Utopian. In any case we don't need it, witness the way in which world trade has continued to grow as rapidly under floating rates as it did under fixed ones. Rather it is to point out that a world in which inflation has disappeared is a world where wild currency fluctuations need no longer exist - just little ones to keep people on their toes.Reuse content