By George Irvin
There are a number of glaring misconceptions in the current debate. In fact, at present it’s a debate unworthy of my first year graduate students!
Take the Gordon Brown’s apparent concern that by adopting a lower eurozone interest rate, the housing boom would be fuelled, which in turn might keep consumer spending buoyant. What’s wrong with more consumer spending? It certainly isn’t going to be inflationary, since if we adopt the EU’s HIPC measure of inflation, inflation in the UK is below the eurozone average. In fact, inflation is slightly below the BoE’s ‘symmetrical’ 2½% RPIX target. The only objection I can think of is that if the UK ‘boom’ continues much longer, the ‘bust’ might be that much greater. But the evidence at the moment is that the housing boom has peaked; we can keep it that way by slowing mortgage refinance. To engineer a soft landing, therefore, we should lower the interest rate; ie, adopt lower eurozone interest rates—and while we’re at it, link mortgage finance to long-term rather than short-term rates! In sum, this objection to EMU is minor, transient and can easily be solved.
How about convergence? The Treasury says we are at least as convergent as the 10 new entrants, though since Britain’s economy is bigger, our degree of convergence makes a difference. There are two well-rehearsed arguments about this. First, everybody agrees that the UK is not wildly out of line with the eurozone. Indeed, there is less convergence between Scotland and southeast England than there is between the UK and the eurozone average. So what are we waiting for? On the Treasury’s logic, Scotland should leave the UK common currency area. (Readers might recall that the UK is itself a common currency zone.) Second, there is ample empirical evidence to suggest that economies entering a currency area tend to converge as a result of EMU. Readers may wish to consult the recent report by David Begg, Olivier Blanchard et al which has all the relevant tables and graphs.
Like many Keynesian economists, I share the view that the Maastricht Treaty and the Stability and Growth Pact that followed it need to be revised (Larry Elliot please take note!). It is precisely for this reason that I favour EMU at soon as possible. Outside the eurozone, Britain is powerless to influence a debate which is now raging in Brussels. (Anyone who does not believe there is a eurozone debate should take note of comments by Romano Prodi, Pascal Lamy and various other luminaries at the Commission.) The point about capping budgetary expenditure and public indebtedness is that it was necessary in the run-up to EMU to convince financial markets that the eurozone meant business, particularly since many euro-sceptics were prediction a run on the lira, the escudo or whatever before the currencies finally locked together. But once EMU took place (1 Jan 1999), the cap was no longer necessary.
Let me explain. As Paul Krugman once remarked, the Fed does not cap the budgets of New York or California; neither state can print money. The same is now true of Germany and Italy. Economics ministers, please take review your Economics 101! Unless a deficit is monetised, it is not inflationary; public borrowing from the non-bank public does not drive up prices. The only thing it can drive up is interest rates, leading to private sector ‘crowding out’. Under current near-deflationary conditions in the eurozone, the risk of crowding out is zilch! We need more deficit spending – on roads, health, education or whatever – because such spending will improve growth expectations and revive private sector ‘animal spirits’. Keynes said it all in the 1930s – a major problem in both the UK and the EU is that we’re returned to pre-Keynesian orthodoxy about ‘flexible’ wages and wealth effects.
At the risk of repetition, the current Treasury-led debate in Britain is a sham! Bankers are obsessed with interest rates, and particularly jealously guarding their own. Let the suits that sit ’round tables in London and Brussels come together to talk about a growth strategy for the EU. Britain cannot afford to stay out of the only debate that really matters!
This article was contributed by George Irvin, Associate Professor of Economics, ISS, The Hague; he may be contacted at George@Irvin.com. The opinions expressed at those of the author and not necessarily those of Federal Union.