Experts split over effect on inflation: Christopher Huhne looks at how the 'hard ecu' system might operate

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The Independent Online
THE proposal for a 'hard ecu' is that Europe should add a 13th currency to its existing 12: a common currency that would have a life of its own. Savers and investors could sell pounds and buy hard ecus, receiving a certain interest rate for them.

The hard ecu would be run by a European Monetary Institute, which would set its interest rates with the objective of ensuring that its target exchange rate against the pound, mark, franc and so on was never devalued. It would therefore be the 'hardest' currency in the Community in the sense that no other currency would provide such a good store of value.

The present Ecu is quite different. It is made up of slices of other Community currencies weighted according to their economic importance, and goes up and down in line with them.

The proponents of the hard ecu argue that it could eventually be a widely used currency as Europeans decide to dispense with their own national currencies. They say it is a realistic route to a single currency.

Moreover, it would put pressure on European governments to keep their inflation down, which would help to create conditions in which all the European countries could share a single currency and a single interest rate. This anti-inflationary pressure would arise because if a country were running a lax policy, investors would sell its currency and buy hard ecu.

However, the claim that the hard ecu would help beat a path to monetary union was greeted by considerable scepticism on the Continent when the British government proposed it in 1990.

Critics argued that inflation has to reach Latin American levels before there is any real attempt on the part of people or businesses to use other currencies such as the dollar. Since Europe generally enjoys fairly low inflation, the hard ecu would be no more likely to take off as a widely- traded European currency than, say, the present German mark.

There is more debate about whether the 'hard ecu' would encourage lower or higher inflation. The Germans worried that it could boost the supply of money in the Community, and stimulate inflation. The British argued that any creation of a hard ecu could only be in exchange for national currencies, so that there would be no overall rise in the money supply. But this implies that national governments do not merely allow their own money supplies to rise in compensation.

However, the hard ecu might also prove too anti-inflationary in some circumstances. If it always rose in line with the strongest Community currency it might take on similar characteristics to the German mark, whose high interest rates were imposed on the rest of the countries in the exchange rate mechanism and ultimately caused its breakdown.