Select Committee on Treasury Sixth Report


96. The possible transition to membership of the euro was not analysed in the 1997 assessment of the economic tests. In a recent lecture[183] the Chief Economic Adviser to the Treasury highlighted previous decisions on exchange rate policy, including the return to the Gold Standard in 1925 and the devaluations of 1947 and 1964 as well as the experience of sterling in the ERM in 1990. One of his lessons from the 1925 decision in particular was that the then Government "did not undertake a full economic analysis of the economic consequences including any short­term transitional issues so that the economic consequences were fully understood". He went on to say that the opinion at the time was that "the actual exchange rate chosen did not matter, for in the long run the system would adjust and adjust successfully. No one really attempted to point out how long and difficult the short run might be". The Chancellor announced in February the addition of a further supporting study covering "the transition to the euro".[184] In his evidence to the Committee he gave further details, saying there was a "need to understand what might be the implications of a transition to EMU as part of the requirements of sustainable and durable convergence". We examine below some of the possible implications of how the transition might be accomplished.

Maastricht criteria

97. The process of joining monetary union is that the Commission and the ECB prepare a report to ECOFIN on whether the Member State has achieved the "high degree of sustainable convergence" necessary to join the eurozone. Taking account of this report the Council then makes the decision as to whether the country can join.[185] The criteria used to judge convergence were established in the Treaty of the European Union, and have become commonly known as the Maastricht criteria. These criteria are:

­  Price stability: an average inflation rate within 1.5% of the three EU countries with the lowest inflation

­  Sustainability of the government financial position: measured as the planned or actual government deficit being less than 3% of GDP and government debt being less than 60% of GDP, unless these figures are exceeded for temporary and exceptional reasons or the deficit has declined continuously and substantially and comes close to 3% of GDP.

­  Long­term interest rates: the durability of convergence, measured by an average nominal long­term interest rate not more than 2% above that of the three eurozone members with the lowest inflation rate.

­  Exchange rate stability: the observance of the normal fluctuation margins provided for by the Exchange Rate Mechanism (ERM) for at least two years, without devaluations at the candidate's own initiative.

98. Whether these criteria are still in every respect appropriate, for the UK or other applicants, as a means of assessing fitness for membership, is now a subject of some debate. The UK easily meets the criteria on interest and inflation rates. On the Harmonised Index of Consumer Prices measure, which allows cross-country comparisons, the UK has one of the lowest inflation rates in the EU and has had so for several years. Long term interest rates are also close to those in the eurozone. The Budget 2003 projections of the public finances comfortably meet the criteria for debt, with debt forecast to remain close to 40% up to 2007/8, and the fiscal deficit projected to be 2.3% of GDP in 2002/03, rising slightly in 2003/04 to 2.4% of GDP and 2.1% in 2004/05, before falling below 2% for the remainder of the forecast period. Mr Regling told us that "if a country has a deficit of above 3% and applies for [euro] membership, that would not make sense really because it is one of the convergence criteria that is taken very seriously and was taken very seriously in 1998 when it was decided which countries would join"; he also believed that today's "euro area members would not be willing to accept a country that, at the time when the country applies" for membership has a deficit above 3%.[186] We recommend that the Government should clarify whether they regard it as their policy to keep the deficit within the 3% limit required by the Maastricht treaty. We note that any deficit exceeding 3% on the treaty definition may preclude the UK from applying for membership of the euro. The relevant UK financial year would be 2003-04, for an application during the latter part of 2004.

183   Cairncross Lecture 4 December 2002 Back

184   See Q 999 Back

185   TEC Article 122 Back

186   Q 467 Back

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