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Why we should stick with sterling Samuel Brittan: Financial Times 09/05/03 We are on the verge of publication of the Treasury Report on Gordon Brown's famous five tests. From then on discussion will be at two levels. There will be an esoteric debate on how to interpret the 2,000 pages of Treasury documentation which, like the Bible, will contain plenty of material for people of all persuasions to cite. There will also be much lower level discussions of Blair-Brown politics. Now is almost the last chance of common sense discussion at an intermediate level. As I am neither an English nor a European nationalist, I find no over-riding political reason either to push the euro project or to oppose it. The economics seem to me to favour continuing with a floating exchange rate with which the British Treasury and Bank have, I hope, learned to live. My own support for UK membership some years ago was based on the view that it was the one way to ensure an operationally independent central bank. Such a central bank was laid down in the Maastricht Treaty and acceptance of its role was a condition of euro membership. Since the establishment of the Monetary Policy Committee by the Chancellor in 1997 and its relatively successful track record, this particular reason for UK membership has gone. Suppose however we had not had the MPC. This is one of the less remote historical hypotheticals. If Ed Balls, the chancellor's economic adviser, has failed to persuade him, or if Gordon Brown has failed to persuade the prime minister - as happened with successive chancellors under the Thatcher and Major governments - Bank of England independence could easily have fallen by the wayside. The question of what I should then have been saying is of more than personal interest as it brings out some rather important changes in the economic scene. The difficult part is to establish the counterfactual. The easy answer is that everything would have been in a sorry state and that I should have embraced the euro as a way out, as I earlier did the Exchange Rate Mechanism. But a little bit of realism is in order here. It is easy to forget how far institutions changed in the 1990s after the shock of ERM departure. The Conservative chancellors Norman Lamont and Kenneth Clarke had between them established both an inflation target and the current system of regular Bank of England Inflation Reports. Another innovation was the published minutes of the monthly meetings between the chancellor and Bank governor, which became known as "the Ken-Eddie show". It would have been very difficult for any chancellor to have consistently gone in the face of well argued Bank of England assessments; and indeed in the Clarke period the departures from Bank advice were minor. It is true that there was a once for all reduction in inflationary expectations when the MPC was established; but the macroeconomic record of low inflation and rising employment began under the Conservatives in the recovery from the 1991-92 recession and continued under Labour. So it is perfectly possible that a Gordon-Eddie show would also have resulted in reasonably stable policies. There is however one crucial factor which would argue against joining the euro even without the MPC. The present model of monetary policy is based on a single weapon - the one club of the short term interest rate and the one target of 2½ pc inflation. Other desirable objectives such as economic stability and avoidance of unnecessary unemployment come about as a by-product. This model will have to be re-thought if the danger becomes one of prolonged stagnation with nominal interest rates bumping against the zero lower limit. There is a very active debate going on, especially in the US Fed, about the unconventional policies which would then be required to maintain demand. The relevant point is that nearly all such novel polices involve close cooperation between the governments and the central bank. This is much easier when the central bank has to contend with one government than if it has to contend with 12 or more all with different objectives, priorities and operational theories. Joint policy then would be a nightmare, even if the restrictions imposed by treaty obligations could be surmounted. The difficulty of achieving coherent "anti-deflation" policies in the present state of the European Union has worried even strong supporters of euro membership such as Adair Turner, formerly head of the CBI. After the great inflation of the 1970s, the priority was to lock the monetary cupboard to prevent governments trying to expand their economies unsustainably fast for short term advantage. We may be coming into an era where the priorities are different and require cooperation rather than arm's length relations between the fiscal and monetary authorities. Keynes is often reported to have said "when the facts change I change my mind". It is unlikely that he said anything so banal. He is more likely to have said "When I change my mind I say so, what do you do?" Either way, the arguments point to shelving euro-membership, while making it easy for British residents to use the euro if they so desire.
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