Originally published in the DAILY TELEGRAPH


Friday, July 2, 1999


Much Too High a Price to Pay

Martin Feldstein



"Last year, the leading economist Martin Feldstein gave an

American view of why the euro was bad for the European Union;

today, he explains why Britian should stay out"



The experience of EMUs first six months provides clear evidence of the problems that membership would entail for Britain. If Britain were to join, it would be forced to have the same monetary policy, the same interest rates and the same exchange rates as every other EMU member, no matter how inappropriate for Britain at any point in time.

The result would almost certainly be a higher average level of cyclical unemployment and a higher inflation rate than Britain could achieve if it retained control of its own monetary policy.

The central problem of a monetary union is that it inevitably imposes the same monetary policy on economies that are in different cyclical positions. The European Central Banks recent decision to cut its key interest rate by 0.5 per cent may have been right for Germany, where GDP declined at the end of 1998 and where inflation is less than one per cent. But an interest rate cut was not appropriate for Ireland, Spain, Portugal and others, where growth is strong and inflation is rising. With monetary union, there is no way to escape this one-size-fits-all approach.

A related lesson of the rate cut is that the ECB will make decisions on the basis of what is good for "Europe as a whole". This will give great weight to Germany and France, because of their size and cyclical similarity, whenever there is a conflict among different countries.

The single currency means not only a single monetary policy for all EMU members, but also an end to exchange rate adjustments that reflect each countrys domestic situation. In contrast, the pound can now fluctuate in response to Britains level of domestic demand, helping to offset domestic weakness by increasing exports.

EMU would also increase inflation in Britain. With an independent Bank of England and a focus on price stability, Britain outside EMU can achieve the low rate of inflation that it desires. The inflation rate in euroland will depend on how the ECB behaves in the future. Germany, with its antipathy to inflation, will not be able to dominate European monetary policy, because each

member has an equal vote at the ECB.

In addition, EMU countries are no longer as disciplined as they were in the past by the fear that an inflationary monetary policy would lead to an embarrassing devaluation of their national currency. While recent experience has already shown the problem of a single monetary policy for a diverse Europe, all this has been happening in a relatively benign economic environment.

If Britain were a member of the monetary union and experienced a serious recession, while the German and French economies were fighting strong demand and inflationary pressures, the resulting Europe-wide monetary policy would be incorrectly tight for Britain, even though arguably correct for "Europe as a whole". If Britain joined EMU, its future inability to control its own interest rate would permanently raise the average cyclical unemployment rate.

The desire of businessmen to reduce uncertainty through a stable exchange rate is easy to appreciate. But it is important to recognise that shifting from the pound to the euro would not mean a stable exchange rate for British business, since the value of the euro will fluctuate relative to the dollar, yen and other currencies. For many British businesses, a shift from the pound to the euro could mean greater fluctuations in the overall exchange rate at which they buy and sell.

I am always surprised by the extent to which public debate in Britain focuses on going into EMU at a "favourable rate". While a relatively low value for the pound would initially help British exporters (but hurt British firms that use imported materials and components), this is only a temporary effect.

There will be changes in technology, in preferred industrial locations and in consumer preferences that could cause British firms to lose market share if the British currency cannot adjust to maintain competitiveness.

Londons ability to remain the key financial city of Europe does not depend on joining EMU. The Citys preeminence reflects the favourable regulatory environment, the good financial industry infrastructure and the tax rates and quality of life that make London attractive to financial executives from a variety of countries.

The adverse economic effects of joining EMU are substantial and can be justified only if Britain wants to be a more fully integrated member of the federal state that is evolving on the Continent. Britain does not need to join in order to be heard in European deliberations, since it already has an important voice through its membership of the EU. And, contrary to the apparent hope of some British politicians, Britain is unlikely to be a leader of such a Continental coalition.

The coming decades will decide whether Germany or France assumes the dominant role. Viewed from America, it is not clear why Britain would want to make major economic sacrifices and give up economic sovereignty in order to join such a federal system.

The author is president of the National Bureau of Economic Research, Cambridge, Massachusetts.