The great British debate over the single currency has focused almost exclusively on whether or not to join. Barely any attention has been paid to the crucial questions of how economic policy must change if the UK is to participate in economic and monetary union (EMU) or how policy must adapt if the country decides to stay outside. In or out, the UK will be affected by EMU and its policy machine must react. Doing nothing is not an option.

A new CEPR Report takes up these issues, presenting an assessment of the implications of EMU rather than its desirability. The authors, an independent panel of experts, recognise that the UK government has four possible strategies for EMU:

• Join at the start.
• Decide to join, but do so later.
• ‘Wait and see’, the pragmatic agnostic’s position: if EMU works, then join at some unspecified date.
• Decide in principle not to join.

The first option, joining at the start, now looks highly unlikely. But even if circumstances changed dramatically, joining in the first wave would require a fully independent central bank by the end of 1998. The government would therefore have to put a high priority on drafting and passing a new Bank of England Act. In important respects, this legislation would have to be different from that outlined by the Chancellor, Gordon Brown, when, on 6 May 1997, he announced his plans to give the Bank operational independence.

Joining at the start would also require: a lower exchange rate; enhancing automatic fiscal stabilizers to compensate for the loss of autonomy over monetary policy; and reducing the tax incentive for companies and households to use debt. This last requirement would be necessary in order to help make the transmission mechanism of UK monetary policy more like that in other EMU candidates.

Interest rates in EMU’s ‘first wave’ candidates are now 3% below UK rates, and that gap may well widen. There would need to be significant tightening in macroeconomic policy before UK interest rates could be allowed to fall by such a large amount; rates this low would not be appropriate, given the UK’s current position in the business cycle.

Option two, a decision to delay entry by, say, four or five years would make it easier to achieve these things in time for the start of EMU. It would not be imperative to make the Bank of England fully independent by the end of 1998, though legislation should not be delayed for long. It would also be desirable to bring in legislative measures to enhance the fiscal stabilizers: they would then have a chance to start working.

But, the Report argues, the bigger advantages of delay relate to timing and exchange rate concerns. By 2001 or 2002, the EMU interest rate may well be broadly what the UK economy needs at the stage of the cycle it will then be in.

A ‘wait and see’ strategy, the third option, has the obvious advantage that some of the uncertainty about EMU – on the operation of monetary policy; on the demand for and value of the euro; and on the strains generated by a single short-term interest rate for all the ‘ins’ – will be reduced.

But in order to keep open the option of joining EMU sometime in the future, it would still be desirable to reduce the fiscal deficit and remove tax incentives to use debt. It would also be sensible to draft the amendments to the Bank of England Act (required under the plans to grant it operational independence) in a way that allowed the Bank to operate as part of the European System of Central Banks should the UK join EMU.

Under option four, where the UK decides in principle to stay out of a monetary union, the issue of greatest significance would be how the value of sterling fluctuated against the euro. The sterling-euro exchange rate would be much more important for UK business than any current bilateral rate now. Sharp fluctuations in the rate would be more damaging than a similar fluctuation in a bilateral rate today.

What’s more, because countries inside the single currency area could not independently do much to alter their competitiveness against the UK, they would be likely to be more sensitive to the exchange rate implications of UK policy. The Report concludes that the surest way for the UK to minimize discrimination against UK-based firms is to participate actively in the development of the single market.

If the UK stays out of EMU, this participation will be even more important – and perhaps more difficult too. Much will depend on attitude. If the UK is seen as a constructive agnostic on EMU, it will be listened to on subjects such as competition policy. If it comes across as a whingeing outsider, it won’t.