Time to start practising for single currency membership

Both the CBI and the Chancellor of the Exchequer have come out with an "Augustinian" policy on the euro: "Oh God, let us join, but not yet." The Chancellor has not ruled out the UK joining in the first wave on 1 January 1999, but the mix of fiscal and monetary policy measures taken by himself and the Bank of England make it highly unlikely.

My argument is that the new policy regime and the policy mix are wrong, both from the point of view of optimal UK economic management, and from the point of view of preparing ourselves for single currency membership.

The independence of a finance ministry and a central bank from each other is like independent taxation of husband and wife in a household. If independence means that each side acts without being privy to the other's plans, the financial results are less good than if the two collude to derive maximum benefit from independent status. The Maastricht Treaty, but not the new British regime, goes some way towards this by giving the presidents of the European Central Bank and the European Council of Ministers observer status at each other's meetings.

The use of interest rates as the main instrument to cool an overheated economy has shown not only the failings of the new regime but the disadvantages of not having monetary union here and now. The rises in short-term UK interest rates have led to an upwards overshooting of the pound, a fall in exports, and stagnation of manufacturing output.

To Eurosceptics, it has been proved that the UK needs a different interest rate and exchange rate from the rest of Europe, rather than a single monetary policy and an end to exchange rate changes. My argument to the contrary is that as long as the UK stays out of EMU, our independent national economic policy will ensure that we never converge sufficiently to join.

Were we in a monetary union today, short-term euro interest rates might now be rising from present low German levels, but British rates would be lower, not higher, than now. The exchange rate against the German mark would no longer exist, but if we had entered the euro at DM2.50, British manufacturing exports would be competitive and profitable.

Before EMU entry, the UK should try to achieve the Maastricht exchange rate stability criterion. The Treasury maintains that this need not involve rejoining the ERM, but it must then mean stability by some other definition. The pound has been highly unstable over the past year. The UK has to get it down to around DM2.50 to satisfy the CBI, and keep it close to that level to satisfy our EU partners.

Talking the pound down, or selling it down, or even announcing that the UK will join the euro, will have only a limited effect if monetary policy is facing in the opposite direction. The UK has to learn to live, not with disconcertingly large interest rate changes of the kind once implied by ERM membership, but with almost imperceptible touches on the tiller. The European Central Bank will have to set Europe-wide interest rates suitable for up to 15 countries in different stages of the economic cycle.

The end of monetary policy activism means the revival of fiscal policy activism. The fashion among economists is to applaud the flexibility and effectiveness of monetary policy, and to denounce a more active fiscal policy as cumbersome in execution and uncertain in effect. In fact both kinds of policy have drawbacks linked with uncertainty over the size of their effects and the timescale over which they operate. That is no reason for not honing the instruments and trying to use them more effectively.

Fiscal policy is in fact the main area in which governments will retain economic independence under EMU, as long as they observe the 3 per cent deficit limit and the Stability Pact. These are widely accepted as desirable in their own right for sound national reasons.

In present UK circumstances, an independent Bank of England trying to mimic a European monetary policy would have urged the Treasury to adopt a tighter fiscal stance in the June Budget. The Treasury would have taken the view that the peak of a consumer boom was the right moment to move to the balance or small surplus objective of the Stability Pact, so as to leave some leeway within the 3 per cent limit. National economic policy would thus have coincided with the needs of the EMU framework.

In 1997-98, the general government financial deficit on the Maastricht definition is set at 1.4 per cent of GDP by the Budget. Budget balance on the UK definition would have meant a further fiscal tightening of pounds 13bn over and above the pounds 6bn from the Budget tax increases, mainly on privatised utilities and pension funds. A realistic strategy would have been at least to close the pounds 5.5bn current government deficit, leaving only the pounds 7.5bn net capital spending to be financed by a deficit of just under 1 per cent of GDP thus observing Gordon Brown's famous "golden rule".

It is no good taking monetary policy out of politics by making the Bank of England independent if fiscal policy is then to become a political plaything. Although New Labour's election pledges left plenty of loopholes by which personal taxation could have been increased without any changes in income tax rates, the Chancellor was under political pressure not to spoil the post-electoral honeymoon. The result was a net increase in personal taxation of 0.1 per cent of GDP, or pounds 800m. The unexpected increase in the building society share windfall to pounds 37bn, thanks to the rise in the financial stock market, would have been enough to justify a different kind of windfall tax from the one the Chancellor carried out.

An extra pounds 5.5bn in personal taxation by means of income tax allowances, higher upper earnings limits for National Insurance employee contributions, withdrawal of mortgage interest relief and higher VAT would have made it unnecessary for the Bank of England to raise interest rates further. It would also have tilted the balance of demand from consumption and imports to investment and exports - or is this now an outdated Old Labour policy propounded only by Ken Livingstone? It may be needed in Gordon Brown's next Budget.

The decision about whether to enter the single currency is a choice between the existing national policy regime and the new European policy regime. Which will give better outcomes in terms of stable non-inflationary economic growth? There is every sign that New Labour, like Old Tories, has condemned itself to the familiar stop-go cycle, with the difference that the stop may come uncomfortably close to the next election. If EMU makes Britain take better economic decisions than it would take left to its own devices, that should settle the matter. It need not be nearly as unpleasant as the IMF medicine which Old Labour swallowed in 1976.

Christopher Johnson was a specialist adviser to the Treasury Select Committee from 1981 to 1997.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Executive / Foreign Exchange Dealer - OTE £40,000+

£16000 - £40000 per annum: Recruitment Genius: A Foreign Exchange Dealer is re...

SThree: Experienced Recruitment Consultant

£20000 - £40000 per annum + OTE + Incentives + Benefits: SThree: Established f...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40/45k + INCENTIVES + BENEFITS: SThree: The su...

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

Day In a Page

The long walk west: they fled war in Syria, only to get held up in Hungary – now hundreds of refugees have set off on foot for Austria

They fled war in Syria...

...only to get stuck and sidetracked in Hungary
From The Prisoner to Mad Men, elaborate title sequences are one of the keys to a great TV series

Title sequences: From The Prisoner to Mad Men

Elaborate title sequences are one of the keys to a great TV series. But why does the art form have such a chequered history?
Giorgio Armani Beauty's fabric-inspired foundations: Get back to basics this autumn

Giorgio Armani Beauty's foundations

Sumptuous fabrics meet luscious cosmetics for this elegant look
From stowaways to Operation Stack: Life in a transcontinental lorry cab

Life from the inside of a trucker's cab

From stowaways to Operation Stack, it's a challenging time to be a trucker heading to and from the Continent
Kelis interview: The songwriter and sauce-maker on cooking for Pharrell and crying over potatoes

Kelis interview

The singer and sauce-maker on cooking for Pharrell
Refugee crisis: David Cameron lowered the flag for the dead king of Saudi Arabia - will he do the same honour for little Aylan Kurdi?

Cameron lowered the flag for the dead king of Saudi Arabia...

But will he do the same honour for little Aylan Kurdi, asks Robert Fisk
Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Humanity must be at the heart of politics, says Jeremy Corbyn
Joe Biden's 'tease tour': Could the US Vice-President be testing the water for a presidential run?

Joe Biden's 'tease tour'

Could the US Vice-President be testing the water for a presidential run?
Britain's 24-hour culture: With the 'leisured society' a distant dream we're working longer and less regular hours than ever

Britain's 24-hour culture

With the 'leisured society' a distant dream we're working longer and less regular hours than ever
Diplomacy board game: Treachery is the way to win - which makes it just like the real thing

The addictive nature of Diplomacy

Bullying, betrayal, aggression – it may be just a board game, but the family that plays Diplomacy may never look at each other in the same way again
Lady Chatterley's Lover: Racy underwear for fans of DH Lawrence's equally racy tome

Fashion: Ooh, Lady Chatterley!

Take inspiration from DH Lawrence's racy tome with equally racy underwear
8 best children's clocks

Tick-tock: 8 best children's clocks

Whether you’re teaching them to tell the time or putting the finishing touches to a nursery, there’s a ticker for that
Charlie Austin: Queens Park Rangers striker says ‘If the move is not right, I’m not going’

Charlie Austin: ‘If the move is not right, I’m not going’

After hitting 18 goals in the Premier League last season, the QPR striker was the great non-deal of transfer deadline day. But he says he'd preferred another shot at promotion
Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

How Isis profits from destruction of antiquities

Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

'If we lose touch we’ll end up with two decades of the Tories'

In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea