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.