One choice is, as it were, the path of temptation. The siren voices are saying: 'Forget about the exchange rate mechanism. The defects in the system you have just discovered will not be attended to as long as the Bundesbank has anything to do with it. If the French want to give the franc up for the mark, that is their business. In the meantime we have a golden opportunity to exploit our new flexibility and get the economy moving again. Get interest rates down to 8 per cent by the end of the year and carry on to 6 per cent by the time of the Budget. Don't listen to the killjoys who say that the fall in the pound's value will re-ignite inflation. It might have done once, but with low levels of capacity utilisation, continuing debt deflation and rising unemployment, there is not much chance of that - forget about the Treasury model and look at how well the economy responded when we came off the gold standard in 1931.
'What about Europe and the Maastricht treaty? Well, what about it? Even if Maastricht is not already dead in the water, it certainly will be if we don't ratify. Save yourself a lot of bother and unpleasantness with your own party by stating that as we cannot say when, or even if, we are going back into the ERM, it would be an act of bad faith to ratify a treaty which presupposes that we will be in the system and operating within narrow bands some time in 1994. If that means a two-speed Europe, never mind. What is more likely, judging by the French vote, is that our vision of a looser and wider Europe is a lot nearer to what most of Europe's citizens really want than their benighted political leaders have, until now, realised.'
The alternative, let us call it the path of virtue, goes something like this: 'All right, we've suffered a tremendous setback and the experiences of last week have left us sadder and wiser men. But the logic behind the policies we were pursuing was right then and is still right now. The objective should be to return to the ERM as soon as we think we can and to ratify the Maastricht treaty once a solution has been found to the problems of the Danes. Above all else, we continue to put the securing of permanently low inflation at the top of our priority list. That was the main reason we went into the ERM in the first place, and it was working. Maybe we could achieve the same results through a domestically tailored monetary policy and a floating exchange rate. But past experience tells us that we are not much good at that sort of thing, and it would take a long time before anybody believed that we were going to be just as tough on inflation without the Bundesbank breathing down our necks.
'Before what happened last week, we were very close to breaking the UK's inflationary psychology - admittedly at great cost in economic pain. That is still a prize of incalculable value in the battle to make the UK a fully competitive economy. Inflation corrupts every economic relationship and destroys the stability and confidence of society. If we give up on inflation now, we will have betrayed all those who have lost businesses, jobs or houses during this recession - their suffering will have been rendered pointless. And that is exactly what will happen if we let sterling go in our desire to cut interest rates. We all know that in the end a substantial devaluation in an economy which imports about a third of its total output means higher prices. Do we really want to go back to the policies of stop-go? What's more, if we decide that we can't just let the pound go into free fall, we may not be able to cut interest rates by much anyway. The pound is not the dollar. Interest rates in Europe are pretty much set by the Bundesbank whether you are in the system or out of it.
'Of course the other reason for going into the ERM, although not one which cut any ice with Mrs Thatcher, was that our exclusion from it was making our European policy less effective at a moment when the Community was about to make one of its periodic leaps forward. If we were to have a hand in the architecture of the Maastricht treaty, we had to show that we wanted to move in roughly the same direction as the other 11. That argument still holds in spite of the buffeting Maastricht has had. Indeed, if we are to achieve what we want from next month's special European Council in getting the Danes back on board and securing greater openness and less interference from Brussels, it is vital that other member states do not suppose that we have abandoned the 'heart of Europe' in favour of retreating to a lonely lair to lick our wounds. A European Community which develops without constructive input from Britain will still have influence over our lives, but may be greatly less to our taste. Do not believe that because of the French referendum the Community really wants to turn itself into a politically minimalist free-trade area - that is a historic delusion which British politicians and officials have been prey to since the early Fifties, and one which has been disastrous for the national interest. The prospect four years from now if we stick to our guns is a Europe moving cautiously forward along the lines we argued for at Maastricht and a Britain which can compete with the best.'
Notwithstanding the series of ill-judged and grumpily anti-European interviews given by his Chancellor over the past few days, all the signs are that John Major will choose, if he has not already, the path of virtue. He will not believe the assurances that massive devaluation will not stoke inflation and so will prove unwilling to sanction dramatic interest-rate cuts. He will want to return to the ERM when German interest rates are settled on a declining path and he is convinced that there is a greater commitment to making the co-operative arrangements work as they should. He will do so not because the ERM is anything other than a flawed system, but because nothing else will look any better six months from now as a pole for monetary policy. If British ratification is the only obstacle left to the Maastricht treaty coming into force, he will do whatever is necessary to get the Bill through Parliament next year rather than break his word.
The difficulties of this course are immense, and will require political leadership of a high order and not a little courage. But the alternative is too awful to contemplate. The path of temptation might bring with it the promise of a very much easier life over the next six months, but everything distinctive which Mr Major stands for would have been abandoned. Quite simply, there would no longer be any point to his premiership. He would be seen as a man of straw, bankrupted by expediency. He might survive, but survive for what?Reuse content