Euro: the pieces come together

Topic: EconomicsEconomic Concepts
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Last updated: April 21, 2019

The post-September 11 reality means, “round the world, nations are instinctively drawing together”, according to the prime minister. Therefore, we should think more seriously about drawing together with our European partners and join the euro. Taken to its logical conclusion, the argument appears to be that the terrorists – who he insists will not achieve anything – have made the argument for joining the single currency more compelling. I would not, of course, accuse the prime minister of anything so crass. A couple of things appear to have prompted Blair’s decision to speak up on the euro.

One was that there was a strong suggestion going round, just a week or so ago, that euro entry had been kicked into the very long grass. The government in general, it was said, and the Treasury in particular, had plenty of other things to worry about than the euro. The Treasury, having encouraged the view immediately after the election that public services were a far greater priority than the euro, was not, I should say, briefing that we should now forget about the single currency, But last week’s speech was intended to correct any such impression.

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The other timing point was that, in pro-euro circles, the autumn had always been seen as the time when the government should put down a stronger marker in favour. A window opened ahead of the January 1 introduction in Europe of euro notes and coins. The prime minister had intended to climb through it on September 11; in the speech he never delivered, for obvious reasons, at the Trades Union Congress. He did so more enthusiastically last week. It is now possible to discern, even more than before, a plan for turning round hugely sceptical public opinion.

It begins with those euro notes and coins.Assuming euroland gets through the logistical nightmare of converting to the new physical currency in the first two months of next year, British holidaymakers taking those cheap Ryanair and Easyjet flights will encounter the new notes and coins quite quickly. They may even be able to spend them at home, with the pro-euro pressure group Britain in Europe claiming that half the big retailers here will accept them.

Familiarity and convenience may soften opposition. There is also a real possibility that, for the first time since before America’s long boom of the 1990s, Europe will look like an economic safe haven.Everybody is being hit by the global slowdown but Europe should do better, if only for a short time, than America and continue to do a lot better than Japan. Europe had to start looking good to persuade people euro entry might be worth doing. Because of America’s woes, that might be starting to happen. There is also, of course, the political dimension. Four months on from a landslide election victory, Blair is lord of all he surveys, his position strengthened rather than weakened. Those worries about delaying the election until the autumn because of foot and mouth look to have been misplaced.

The Tories, faced with a huge rebuilding exercise, remain, in the public mind, the embodiment of the anti-euro case. As long as this persists, a referendum will be winnable. Will we get one? Contrary to some reports, Gordon Brown was not thrown into deep gloom by Blair’s reviving of the euro issue.

On the morning of the speech, Jonathan Powell, the prime minister’s chief of staff, rang Ed Balls, Brown’s right-hand man and chief economic adviser, to clear the relevant passage. The chancellor had no problem with it as long as it emphasised the primacy of his five economic tests.That does not mean the two share the same view on the euro. Brown thinks entry would be highly problematical unless any referendum was won by a decisive margin. Blair, in contrast, thinks the government should go for it, subject to the tests, even if victory is not assured.

If you ask two economists whether Britain is more or less ready to join the euro, you will get at least two different answers. Maurice Fitzpatrick of Tenon, the accountant, has his own convergence index and it shows that Britain and euroland were not converged on January 1, 1999 and, perhaps surprisingly, have grown apart since.John Hawksworth of Price Waterhouse Coopers, in contrast, says there has been a coming together of Britain and euroland over the past three years, although not by enough to permit entry. Assessing whether Britain has achieved Brown’s requirement of “sustained and durable convergence” is proving challenging. On the face of it, as my chart shows, Britain and euroland are more in step than for years, on both growth and interest rates.

Scratch below the surface, however, and significant doubts remain.Despite operating far closer to capacity than euroland, as shown by lower unemployment and a non-existent “output gap”, Britain also has a lower inflation rate. Part of that, perhaps most of it, reflects sterling’s continued overvaluation against the euro. Officials are working through every possible measure of convergence, and remain on course to produce their assessment over the next 18 months. The process is continuing through the present economic turbulence, the argument being that the question of whether Britain is ready depends on long-run fundamentals, not short-term volatility.Will Britain be part of the euro by 2005? Entry required a strong prime-ministerial commitment, a successful passing of the five tests and an overcoming of hostile public opinion. For the pro-euro camp, which has had a good week, it is now a case of one down, two to go.

PS The news has been full of job losses but consumers have carried on spending. The CBI’s distributive-trades survey showed that in September retailers enjoyed their best month since October 1996. New car registrations for the month, at 443,265, were up by 25% on a year earlier.Some slowdown is inevitable in the coming months, and it already seems to be happening in the housing market. But it is hard to square these figures with the idea of a collapse in consumer confidence or, as some economists said three weeks ago, that spending would immediately grind to a halt. Some economists think that because consumer spending has been so strong the Bank of England should not have cut interest rates much, if at all, this year. That seems to me plain wrong.Apart from the fact that we do not know what would have happened to spending in the absence of the cuts, the Bank’s monetary policy committee decided well before September 11 that to maintain growth at a time of weaker world growth it would need consumer spending to remain strong.

It could, in other words, put its worries about imbalances in the economy to one side. It did so again last week, reducing interest rates to 4. 5%. These are uncertain times and business confidence is dire but, in the light of the Bank’s actions, a recession in Britain remains highly unlikely.

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