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Thursday, 14 October, 1999, 16:19 GMT
Is the UK ready for the euro?

Gordon Brown
The Chancellor wants Britain to meet tough economic tests

BBC News Online examines the government's economic tests and whether the UK is close to meeting its self-proclaimed targets.

The campaign for Britain in Europe has now moved into high gear.

But the government - and now the campaign - has been careful to say that it will only consider joining the euro if that is in the UK's economic interest.

The government has set five tests that would have to be met before the government would put any proposal for Economic and Monetary Union (EMU) to the electorate in a referendum.

Key tests

The euro tests
In fact, most of the government's criteria point in the direction of Britain's membership of EMU.

However, the government has given itself considerable leeway in framing its questions.

It has set as its key test the convergence of the UK economy with those of its European partners - something which will not become clear until well after the next General Election.

Convergence is the key test because the other questions already suggest their own answers.

The second test, concerning flexibility, is very much about what the government intends to do anyway.

It is committed to encouraging flexible labour markets, bringing more people into the workforce and reducing the burden on employers.

And it also wants to encourage more competition in product markets to bring lower prices to consumers. It has therefore been investigating prices of major spending items like cars, and giving the regulators more powers to fine companies who act to restrict competition.

The answers to the third and fourth questions are also fairly clear.

In principle, many in the City and international investors strongly favour UK membership of the euro. The City is worried that it could lose business to other European centres like Frankfurt and Paris. International investors want to ensure that there is a stable currency relationship between the pound sterling and European currencies, as much of their production is exported to other EU countries.

But of course, neither the City nor industry would want euro membership at the expense of a major disruption to the UK economy.

Nor would any government - hence it self-evidently would want euro membership only if it thought it would increase jobs, growth and stability.

That's where convergence comes in.


Convergence means that the economic cycles of the main European economies, like France and Germany, should run together with the UK's economic cycle.

When the UK is in recession, so should Germany; and when it is in recovery, the Continental economies should be growing fast as well.

If that were not to happen, then joining the euro could cause serious problems for the UK economy.

That's because in the euro-zone there is one common interest rate for all countries.

If the UK was still in recession, while Germany and France were growing fast, the European Central Bank (ECB) would probably want to raise interest rates to slow them down - which could drag the UK economy further down.

Conversely, if the UK was growing fast, but the Continent was in recession, then the ECB might want to cut interest rates - which could fuel a house price explosion in Britain.

Something like that has already happened in the Republic of Ireland, whose economy has been booming while the rest of Europe has been weak. Since the ECB cut interest rates, house prices in Dublin have soared.

But if the economic cycles are aligned, then the action taken by the ECB will be appropriate for both the UK and the rest of Europe.

How close is convergence?

One reason why the government has delayed its decision is that it is not yet clear whether Britain's economic cycle is moving closer to Continental Europe.

In the past, the UK has more closely followed the US economic cycle.

But there is some evidence that the effect of the Asian crisis - which reduced growth in both the UK and Europe - has brought the economic cycles closer. And so has the faster than expected economic recovery in Britain.

While Germany economy has been expected to grow faster than that of the UK's, the UK's growth is expected to pick up more sharply during 2000, possibly reaching 2.7%.

Interest rates are still much lower in Europe, however, and there are worries that moving too quickly to join would boost inflation in the UK.

But the government is hoping that its reforms to labour and product markets will help curb inflation in the future.

Wait and see

It is still unclear how effective these reforms will be in making Britain's economy more 'inflation-proof'.

And it won't be until the end of the economic cycle - when we enter another recession - that it becomes clear whether the UK's economic cycle has aligned with its European neighbours.

Last year, the government's own assessment was noticeably sceptical:

"Currently the UK economy is clearly not in line with many other European countries. Having suffered a deep recession in the early 1990s there has been reasonably strong growth subsequently.

"However, growth in other countries in Europe has generally been much weaker, unemployment is high and there is considerable excess capacity."

The convergence criteria are broadly drawn - and that will give both eurosceptics and euro-enthusiasts plenty to argue about in the years to come.

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