A mandate for convergence

A mandate for convergence

Bulletin article
Kitty Ussher
01 June 1999

The government is missing a trick by failing to encourage the Bank of England to play an active part in ensuring Britain's economic convergence with the euro-zone.

The prime minister has repeatedly said joining EMU requires the UK's "sustainable convergence with the economies of the single currency". This doesn't mean exchange-rate targets - which, history has shown, are difficult to defend - but a real convergence of business cycles so that the interest rate set by the European Central Bank is the right one for Britain.

In political terms the best time for the euro referendum would be in the honeymoon period following a general election, which points to late 2001. So, presuming the government wants Britain to enter, it should spend the next few years making sure that the economy moves into synch with the euro-zone. This would prevent an economic jolt when Britain signed up, and also would make a referendum easier to justify.

At present, it looks as if the UK and euro-zone economies may dovetail of their own accord. The EIU expects economic growth in the euro-11 to be 2.4 percent in 2001, not far off its forecast of 2.2 per cent for the UK. But forecasting the future is an inexact science: turning convergence into reality should be a specific policy aim. Of course the Treasury can achieve this to a large extent by itself: fiscal policy will remain the prerogative of the Chancellor even inside the euro-zone. But it would be far more effective to use fiscal and monetary policy together.

There has been much praise of the Bank of England's symmetrical inflation target of 2.5 percent. But the Bank's mandate should be altered to include a secondary target of business-cycle convergence with the euro-zone economy. One way to do this would be to widen the inflation target to a band of, say, 2-3 per cent. That would give room for the secondary target to kick in when the inflation rate was satisfactory.

Such a move would remove one of the remaining uncertainties of the government's economic policy and therefore be well-received by the markets. And, by increasing the expectation that joining is inevitable, it might yet become a self-fulfilling prophecy.

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