Central bank envy



Philip Stephens had a piece in yesterday’s FT arguing that Britain might be better off had it joined the euro, contrary to what most people believe. I’m no fan of the euro, and I’m not sorry Britain stayed out, but I think he has a point. The idea that Britain dodged a bullet by staying out, I think, is wrong. Central banks, by their nature, lack the knowledge to be able to set interest rates capably, and it’s a mistake to think that one or another would be ‘better’, except in hindsight.

Yes, the euro was a bad idea – a case of hoping that water would run uphill if its designers wanted it to. And the mistake of imposing interest rates set to meet Franco-German needs onto fast-growing economies like Ireland and Spain is now being witnessed (if not learned). But would Britain have followed Ireland into apocalypse, had it been in the euro? I think it’s unlikely. Britain avoided Ireland’s fate because it was already much more economically developed than Ireland was during the Celtic Tiger years.

The euro’s lower interest rates would probably have inflated bubbles in Britain a bit more than the Bank of England’s rates did, but don’t know if there would have been a huge difference. Maybe having the pound was better than being in the euro, but probably only marginally so. Stephens is right to highlight this.

He’s on much shakier ground when he says that the UK would have mirrored Germany’s decent economic performance by being in the euro. Stephens fails to acknowledge the strength of developed non-eurozone European economies. Sweden, which also stayed out of the eurozone, grew by around 5% in 2010, more than Germany’s 3.6% and a lot more than the overall eurozone’s 1.7%. I’m skeptical about the value of direct comparisons between countries, but the case is inconclusive in either direction.

The point worth taking from Stephens’ piece is that the Bank of England wasn’t especially competent during the 2000s, and we shouldn’t thank it for helping the UK avoid an Irish-style crisis (which may be brewing in its own right, thanks to government overspending). Central banks are naked in the dark when it comes to interest rates, and we shouldn’t be applauding our own – or envying others – when dumb luck avoids catastrophe.