The Credit Crunch Bites
As many leading figures such as Peter Sutherland have suggested, the 5 economic tests which determine the suitability of the UK joining the Euro are possibly outdated.If you study the October 2008 European Commission forecast for 2009 suggests that the UK would still meet the public debt criterion -however this will be much more unlikely in 2010. Aside from this the UK would easily fulfil the inflation test – 1.9% versus the average of 1.9% for those EU members which perform the best (Sweden, France and Spain/Austria). So the 1.5 percentage points of leeway versus these states would not have to be used at all. Looking at the interest rate critera in the long-term versus those states’ bonds is also met very comfortably. But the UK ostensibly fails two vitalcriteria: there is a good chance that the budget deficit could be as high as three times the actual limit and it would be difficult to argue that sterling is stable – whether in the ERM or not. But that is the Standard economists’ reading of the Maastricht Treaty text. Importantly, the authors left the political leaders some flexibility. The reports on the actual data will be drawn up by the European Commission and Central Bank in following a precise formula but the Finance Ministers only use them as “the basis” for their “assessment” of whether an “excessive deficit” exists on the basis of “planned” deficits. That assessment is passed to the Heads of Government who then “confirm which Member States fulfil the necessary conditions for the adoption of the single currency.”
Why might the political leaders of the Eurozone be persuaded to take such a risk? It could well be that in fact they are now nervously looking at the economic implications for their own countries of this massive sterling depreciation. So a major recession in Britain is manifestly bad for the volume of the Eurozone’s exports, but the real problem would be unparalleled cost competitiveness in third country markets. Based on current exchange rates, the Britains competitiveness is now at about 74 versus the Eurozone 15 or EU 27 – matching the extreme cost competitiveness of the mid 1990’s (see Figure 2). Unit labour costs for the whole British economy have exceeded the Eurozone average by 1.4% annually between 1997 and 2006, but have slowed to about the same as the Eurozone since. This explains the steadyloss ofcompetitiveness that has progressively manifested itself in the ever burgeoning current account deficit. So it would be easy to suggest that the first phase of sterling weakness to say mid-2008 was just a necessary counterbalance to our reduced competitivess.
