Ceteris paribus

The Bank of England (source Freefoto.com)

The title is a Latin phrase used in economics which means “all other things being equal”. The prediction of what difference any specific alteration to economic policy will make is always hedged by this consideration. You can never be sure exactly what will follow from any particular change because there are many different things going on in the economy at the same time and the impact of that change needs to be analysed against a background that is changing itself.

The notion that all other things stay the same is never true, but it is a useful theoretical tool when trying to identify the semblance of order in a world of chaos. It is useful, but it can also be dangerous.

As an example, think about the people who say that the financial crisis currently engulfing Britain would have been even worse if Britain had already joined the euro.

Eurozone interest rates have generally been a bit lower than UK rates over the last ten years, so if low interest rates were part of the fuel of the British housing bubble, even lower rates would have been even worse. Not only that, but the recent devaluation in sterling against the euro will solve the UK’s problem because it will make exports to the eurozone more competitive and thus boost production and output in Britain. Ceteris paribus.

But other things would not have stayed the same. There is the obvious point that eurozone interest rates are set to take into account the needs of the eurozone as a whole: had Britain joined the euro, the eurozone interest rate would have followed a different course and not the same one that it actually followed.

Furthermore, the fall in the sterling exchange rate has been accompanied by a collapse in world economic demand, so even if goods and services exported from the UK are now cheaper, no-one actually wants to buy them. Britain’s trading position is getting worse, not better, despite the fall in the pound. All other things are not equal.

But there is a bigger and more important point. The policies that were followed in the UK were intended to be successful in a floating pound economy. In the euro, they would also have been rethought. The over-emphasis on financial services and the City of London, the reckless increase in house prices and their use as a source of income for consumer spending, the disregard of some long-term economic fundamentals: all of these mistakes would have had to be handled differently had Britain been in the euro.

I am not saying that everything would have been rosy – it is entirely possible that different mistakes would have been made in place of the mistakes that actually were made – but it is likely that the economy would have sailed on a better course and it is certainly untrue that things would necessarily have been worse.

There is more to joining the euro than simply reprinting the banknotes with a different name on them. All kinds of other economic and political consequences flow from membership of the single currency: most of them are beneficial but all of them need to be taken into account.

In this way, membership of the euro is like membership of the EU as a whole. It is not simply a policy so much as a strategy. It has far-reaching implications for politics, economics and society as a whole, and will only succeed fully if those implications are understood.

Success in Europe is not merely a question of ratifying the right treaty or voting the right way in a referendum, important as those things are. Success in Europe depends on politicians and others recognising the scale and importance of the European project and making the continual and necessary changes. Europe is not only a matter of theory but also a matter of practice. Quod erat demonstrandum.

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