A CEPR report, analysing the policy implications for the United Kingdom of the single European currency, was published in May 1997. The report was the result of a high-level independent panel study, chaired by Rupert Pennant-Rea (Caspian Securities Limited). At a CEPR meeting on 3 June 1997, Pennant-Rea outlined the main findings of the study.

The study recognised that the UK government had four possible strategies for EMU: 1) join at the start; 2) decide to join, but at a later date; 3) agree to wait and see; 4) decide in principle not to join. The panel concluded that, whatever decision the government eventually took, there would be big changes in the economic environment, and these changes would require policy responses. Some were widely recognised already: for example, a decision to join EMU would require that the Bank of England have more than operational independence over monetary policy. But other implications of joining had not been as carefully analysed. For instance, being in a monetary union would be less problematic for the United Kingdom if its sensitivity to interest rates were more like that of other EMU members. Could that be engineered and, if so, how? Any such policies would take time to implement and bear fruit, which therefore affected the date when it would be sensible to join EMU.

If the United Kingdom were to join at the start, five conditions would have to be met. First, the central bank would have to be fully independent by the end of 1998. The government would therefore have to attach high priority to drafting and passing a new Bank of England Act that was different, in important respects, from that outlined on 6 May 1997 by the Chancellor, Gordon Brown, when he announced his plans to give the bank operational independence. Second, there would need to be a significant tightening in macroeconomic policy. Interest rates in EMU’s first-wave candidates were currently 3% below UK rates, and the gap might be wider in a year’s time. Consequently, the United Kingdom would have to be subject to an interest rate probably much lower than it needed for its current cyclical state. The third and fourth requirements were, respectively, a lower exchange rate, and – to compensate for the loss of autonomy over monetary policy – enhancement of automatic fiscal stabilizers. Finally, the tax incentive to use debt needed reducing. This would help make the transmission mechanism of monetary policy in the United Kingdom more like that in other EMU candidates.

The second option – a decision to delay entry by, say, three or four years – would ease or eliminate the practical problems of trying to achieve these outcomes in time for the start of EMU. It would not be imperative to make the Bank of England fully independent by the end of 1998, though legislation should not be delayed for long. It would also be desirable to bring in legislative measures to enhance the fiscal stabilizers; they would then have a chance to start working. But the bigger advantages of delay related to conjunctural and exchange rate concerns. By 2001 or 2002, the EMU interest rate may well be broadly what the UK economy would need in its then cyclical circumstances.

A wait-and-see strategy was the position of the ‘pragmatic agnostic’: if EMU works, then join at some unspecified date. This had the obvious advantage that some of the uncertainties about EMU – on the operation of monetary policy; on the demand for, and value of, the euro; and on the strains generated by a single short-term interest rate for all the ‘ins’ – would be reduced. But in order to keep open the option of joining EMU some way down the road, it would still be desirable to reduce the fiscal deficit and remove tax incentives to use debt. It would also be sensible to draft the forthcoming amendments to the Bank of England Act in a way which would allow it to operate as part of the European System of Central Banks should the United Kingdom join EMU.

Finally, if the United Kingdom were to stay out of a monetary union, how the value of sterling fluctuated against the euro would be of great significance. The sterling-euro exchange rate would be much more important for UK business than any current bilateral rate. Sharp fluctuations in the former would be more damaging than similar fluctuations in the latter. And because countries inside the single currency area could not independently do much to alter their competitiveness against UK goods, they would be likely to be more sensitive to the exchange rate implications of UK policy. The surest way for the United Kingdom to minimize discrimination against UK-based firms would be to participate actively in the development of the single market. If the government decided to stay out of EMU, this participation would be even more important – and, perhaps, more difficult too. Much would depend on attitude. If the United Kingdom was seen as a ‘constructive agnostic’ on EMU, it would be listened to on subjects such as competition policy. If it came across as a whinging outsider, it would be ignored.