First, will EMU be a success? Second, will the UK join and if so, when? Third, what are the costs of the UK not being in the first wave, both to the UK and to the EMU members? Fourth, if the UK were to join EMU in due course, should it (be required to) adopt an ERM-style narrow exchange rate band for some period prior to joining?

• EMU will almost certainly survive. The only threat to its continued existence will be the popular perception that the ECB lacks political legitimacy. The lack of openness, transparency and accountability written into the statutes of the ECB and apparently about to be reinforced by the ECB’s own ‘common law’ operating procedures could yet undermine the viability of the whole enterprise. It is to be hoped that a culture of openness will nevertheless be established. The ‘17 year rule’ for the publication of the minutes of the ECB (as close to ‘not now, not ever, never’ as one can get) does not bode well, however. The ECB will have to learn that independence, far from being inconsistent with openness and accountability, cannot, in a democratic society, survive without these two awkward customers. The UK arrangements for central bank independence, while far from perfect, are far superior to those likely to be operated by the ECB.
• The ECB will deliver low inflation. The belief that a broad EMU meant a weak euro was always a nonsense. Especially in the short run, the ECB’s policies are likely to support a strong euro. In the longer run, the fact the Euroland is as closed (as regards trade) as the US, will encourage a policy of benign neglect of the external value of the euro, not unlike the policy of the Fed and the US Treasury towards the US$.
• Co-ordination between monetary and fiscal policy in Euroland is likely to be a problem. The Germano-Dutch wing of the ECB mistrusts EuroXI as an attempt to undermine the independence of the central bank. While this concern is certainly not without merit, there appears to be little awareness among the ECB top level that independent agents can choose to co-ordinate and co-operate.

Professor Buiter argues that a key issue for the continental EMU members is whether the impetus for structural reform of labour, product and financial markets that was so noticeable in the run-up to EMU will fizzle out now that the prize has been won.

EMU does not create a technical, economic case for a greater degree of harmonisation of regulatory, tax and subsidy policies, nor for a larger Federal European budget. The greater market integration due to the gradual implementation of the Single European Act will force national policy makers to harmonise taxation and regulation of highly mobile factors of production. To the extent that EMU is indeed the next step in the European Federalist agenda, it may create a political momentum towards a greater degree of centralisation or harmonisation of certain aspects of economic and social life.

Yes.

As soon as a referendum on the issue can be won following the next general election and as soon as the existing EMU members are willing to let the UK join.

The famous five economic tests:

• Convergence of business cycles and economic structures
• Flexibility
• Long-term foreign investment in the UK
• The City
• Higher growth, stability and a lasting increase in jobs

have no real operational content. When the day comes, proponents of EMU will argue that all five have been met. Opponents will assert that the UK flunks all five.

• No UK voice in the ECB and EuroXI.
• Until the UK is a member of EMU, it will have second fiddle status in the political concert of Europe.
• Transaction costs. Since the UK is going to join anyway, and will therefore incur the transition costs in any case, the country will lose out on the benefits of lower transaction costs for a number of years.
• There is likely to be some damage to London’s position as an international financial centre. This is likely to be minor at first (TARGET irritations; the need to keep accounts in two currencies rather than one) but could become more serious if the UK’s outsider status were to be perceived as more persistent.
• International financial centres can be located just about anywhere. Many financial transactions no longer require a physical market place. The employment created by the financial services industries tends to be geographically concentrated because of conglomeration and face-to-face networking externalities. Other factors such as language, infrastructure and quality of life also play a role. These locational preferences are quite tenuous, however, and should not be taken for granted.
• The threat of a gradual demonetisation of sterling and the complications this creates for monetary management in the UK. Both the numeraire and invoicing function of sterling and its means of payment or medium of exchange function will be nibbled away at gradually.
• The risk that when the UK will want to join, the existing EMU members won’t let it (or at any rate not without delays and other aggravation).

• The adoption of an ECB model and modus operandi that perpetuates some of the worst continental features of central bank secrecy, lack of openness and absence of collective and individual accountability. The statute law of the Treaty of Maastricht and the Treaty of Amsterdam could have been refined and improved with a healthy dose of British ‘real-time constitutional design’. By the time the UK gets on board, the operating practices, conventions and procedures of the ECB are likely to be much harder to change in a direction of greater openness and accountability.
• Britain’s outsider status weakens the liberal, market-oriented coalition in the EU at the expense of the dirigiste front.

• The letter of the law is ambiguous. The old criterion (2-year ERM participation with good behaviour prior to EMU) applied to the first-wave decision, but not necessarily to the late-comers. The UK’s EMU derogation creates further ambiguity. The old criterion was violated by Italy and Finland. If it were to be extended to the late-comers, it is unclear what the relevant ERM bands would be (2.25% or 15%).
• The lawyers can discuss the constitutional niceties. From the point of view of sensible macroeconomic management in the UK, it is important that any move to re-impose a narrow-bands ERM regime should be resisted. A fixed-but-adjustable peg under free international capital mobility is an accident waiting to happen. The story of the collapse of the ERM in 1992-3 can be re-read with profit.
• If an ERM II-type arrangement were adopted for the UK, the inflation target set for the Bank of England by the UK government would have to be abandoned, to be replaced by an exchange rate target. Only if the defence of the currency peg (or narrow band) is given absolute priority over all domestic objectives, can the defence of such a peg be credible. The benefit from credibility is that a given impact on the exchange rate can be achieved with a smaller change in interest rates.
• An alternative, and superior, strategy would be to maintain the existing inflation objective until the date that the UK government decides it wishes to join EMU and the existing EMU members decide to let the UK in.
• This decision involves two key elements: a date and a rate. Once these have been decided, they will be irrevocable and credible. When a date and a rate have been set, the priority of an independently chosen UK inflation target will inevitably become compromised. The closer the accession date is (and the closer the spot rate to the accession rate), the more UK interest rate management will be constrained by the post-accession interest parity condition with the other EMU members. One option for a relatively painless accession would be to adopt the inflation target of the EMU members (assuming the ECB decides to have one) as soon as the date and the rate are chosen.

The research underlying this presentation was supported by a ROPAs grant from the ESRC.

CEPR is a network of over 450 Research Fellows based throughout Europe, who collaborate through the Centre in research and its dissemination. CEPR helps its Research Fellows to develop projects, obtain their funding, administer them and disseminate their results. The Centre’s research ranges from open economy macroeconomics to trade policy, from the economic transformation of Central and Eastern Europe to regionalism in the world economy. CEPR is an ESRC Resource Centre. For further information about CEPR, please contact Rita Gilbert, External Relations Officer, Tel 44 20 7878 2917, Fax 44 20 7878 2999 or by email on rgilbert@cepr.org

Willem Buiter is Professor of Economics at Cambridge University, a Member of the Monetary Policy Committee and a Research Fellow in CEPR’s International Macroeconomics programme. The views expressed in this presentation are those of Professor Buiter and not those of the Monetary Policy Committee, the funding organizations, nor of CEPR which takes no institutional policy positions.

‘Transition Issues for the European Monetary Union’
Willem H Buiter and Anne C Sibert

CEPR Discussion Paper No. 1728

‘Notes on ‘A Code for Fiscal Stability’’
Willem H Buiter

CEPR Discussion Paper No. 1831

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