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The
United Kingdom and EMU The ECB,
however, would deliver low inflation. The belief that a broad EMU meant
a weak euro was always a nonsense. Especially in the short run, the
ECB’s policies were likely to support a strong euro. In the longer
run, the fact that Euroland was as closed (as regards trade) as the
United States, would encourage a policy of benign neglect of the
euro’s external value, not unlike the policy of the Fed and the US
Treasury towards the dollar. At the same time, coordination between
monetary and fiscal policy in Euroland was likely to be a problem. The
German-Dutch wing of the ECB mistrusted EuroXI as an attempt to
undermine the independence of the central bank. This concern was
certainly not without merit, but there appeared to be little awareness
within the ECB’s upper echelons that independent agents can choose to
coordinate and cooperate. Buiter
argued that a key issue for the continental EMU members was whether the
impetus for structural reform of labour, product and financial markets
– so noticeable in the run-up to EMU – would fizzle out now that the
prize had been won. EMU did not create a technical economic case for a
greater degree of harmonization of regulatory, tax and subsidy policies,
or for a larger federal European budget. The greater market integration
that would follow from the gradual implementation of the Single European
Act, however, would force national policy-makers to harmonize taxation
and regulation of highly mobile factors of production. To the extent
that EMU was indeed the next step in the European federalist agenda, it
might create a political momentum towards a greater degree of
centralization or harmonization of certain aspects of economic and
social life. Buiter was
clear in his view that the United Kingdom would join EMU, and that it
would do so as soon as a referendum on the issue could be won, following
the next general election, and as soon as the existing EMU members were
willing to let the country join. In this connection, the ‘famous
five’ economic tests – convergence of business cycles and economic
structures, flexibility, long-term inward foreign investment, the future
role of the City (of London), and higher growth, stability and a lasting
increase in employment – had no real operational content. When the day
came, proponents of EMU would argue that all the criteria had been met;
opponents would assert that the United Kingdom had flunked all five. The costs to
the United Kingdom of being outside EMU were numerous. First, there
would be no UK voice in the ECB and EuroXI. Until the country became a
member of EMU, it would have only second-fiddle status in the political
concert of Europe. Second, there would be transaction costs. Since
membership was going to ensue eventually, and the transition costs would
therefore be incurred in any case, the country would lose out on the
benefits of lower transaction costs for a number of years. Third, there
was likely to be some damage to London’s position as an international
financial centre. This was likely to be minor at first (for example, the
need to keep accounts in two currencies rather than one), but could
become more serious if the United Kingdom’s outsider status were to be
perceived as more enduring. International financial centres could be
located just about anywhere: many financial transactions no longer
required a physical market place. The employment created by the
financial services industries, however, tended to be geographically
concentrated because of conglomeration and face-to-face networking
externalities. Other factors such as language, infrastructure and
quality of life also played a role. These locational preferences were
quite tenuous, and therefore should not be taken for granted. Fourth, there
was the threat of a gradual demonetization of sterling and the
complications this would create for monetary management in the United
Kingdom. Both the numeraire and invoicing function of sterling, and its
means of payment (or medium of exchange) function, would be gradually
eroded. Finally, there was the risk that when the UK government
eventually wanted to join, the existing EMU members would not let it or,
at least, would impose delays or create other inhibitions or obstacles. Existing EMU
members would also incur some costs. The adoption of an ECB model and modus operandi that perpetuated some of the worst continental
features of central bank secrecy, lack of openness and absence of
collective and individual accountability was not in the long-term
interests of Euroland. With closer UK involvement at the outset, the
statute law of the Treaty of Maastricht and the Treaty of Amsterdam
could have been refined and improved with the assistance of a healthy
dose of British ‘real-time constitutional design’. By the time the
United Kingdom was brought on board, the operating practices,
conventions and procedures of the ECB were likely to be much harder to
change in a direction of greater openness and accountability. Thus the
United Kingdom’s outsider status would weaken the liberal,
market-oriented coalition in the EU to the benefit of the dirigiste
front. Turning
to the question of whether the United Kingdom would (or should) have to
participate in a ‘narrow-band ERM II’-type arrangement prior to
joining EMU, Buiter observed that the letter of the law was ambiguous.
The old membership criterion (2-year ERM participation with good
behaviour prior to EMU) applied to the first-wave decision, but not
necessarily to the latecomers. The United Kingdom’s EMU derogation
created further ambiguity. The old criterion, moreover, had been
violated by Italy and Finland. If it were to be extended to the
latecomers, it was unclear what the relevant ERM bands would be: 2.25%
or 15%. Lawyers could
be left to discuss these constitutional niceties. From the point of view
of sensible macroeconomic management in the United Kingdom, it was
important that any move to reimpose a narrow-bands ERM regime should be
resisted. A fixed-but-adjustable peg under free international capital
mobility was an accident waiting to happen. The story of the collapse of
the ERM in 1992–3 could be re-read with profit. If an ERM
II-type arrangement were adopted for the United Kingdom, the inflation
target set for the Bank of England by the UK government would have to be
abandoned, to be replaced by an exchange-rate target. Only if the
defence of the currency peg (or narrow band) were given absolute
priority over all domestic objectives could such a policy be credible.
The benefit from credibility would be that a given impact on the
exchange rate could be achieved with a smaller change in interest rates. An
alternative – and, in Buiter’s view, a superior – strategy would
be to maintain the existing inflation objective until the date that the
UK government decided it wished to join EMU and the existing EMU members
decided to accede to this wish. This decision would involve two key
elements: a date and a rate. Once these had been decided, they would
become irrevocable and credible. When a date and a rate had been set,
the priority of an independently chosen UK inflation target would
inevitably become compromised. The closer the accession date became (and
the closer the spot rate to the accession rate), the more UK
interest-rate management would be constrained by the post-accession
interest-parity condition with the other EMU members. One option for a
relatively painless accession would be to adopt the inflation target of
the EMU members (assuming the ECB decided to have one) as soon as the
date and the rate were chosen.
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