THE LIMITATIONS of Euroland's one-size-fits-all interest rate policy are being tested early. When the single currency was on the drawing board, few people foresaw that it would be Germany, the Continent's powerhouse, that would be flagging while the peripheral countries enjoyed robust growth.
The recent half-point interest rate cut by the European Central Bank was essentially a response to weak growth at the core at a time when economic indicators for the smaller countries in the euro-11 pointed to no change in policy. Wim Duisenberg, president of the ECB, indicated again yesterday that he was worried about the inflationary impact of the weak euro, and would not be in a hurry to reduce interest rates again.
Little wonder then that the Spanish government has decided to tackle head-on its higher-than-average inflation rate (at 2.2 per cent compared to the 0.8 per cent average). It has announced a package of measures to reduce charges by the gas, electricity and telephone companies, and cut motorway tolls and prescription charges. The measures are intended to slice 0.2-0.3 points directly off consumer prices this year.
Reductions in directly administered prices have helped trim the UK inflation rate over the years too, and are not to be sneezed at, even though the long-term consequences of putting more money into consumers' pockets are themselves sometimes inflationary. Spain is also, sensibly, boosting competition in the utilities markets.
All the same, the constraints imposed on policy by a single currency and single interest rate could scarcely be clearer. This is certainly the conclusion John Townend, the Bank of England director responsible for euro matters, drew yesterday when he said Britain needed rates at roughly twice European levels. It was right for the UK not to have joined in the first wave, he said, given the divergence between the British and Continental economies.
If this argument is taken too far, however, Britain never will join, and most of the existing members should not have either. The lesson of the Spanish measures is that governments can still use taxes and other policies to tackle inflationary pressures. If the British economy is as flexible as we like to think, it is hard to see a move to lower Euro-style interest rates as such a terrible threat.