Mr. George looks at the prospects for the UK economy and developments
towards European Monetary Union Speech by the Governor of the Bank of England,
Mr. E.A.J. George, at the Liverpool and District Bankers' Institute Bi-Annual Dinner in
Liverpool on 12/3/97.
It is a very enjoyable - and vital - part of our job at the Bank of England to keep
in touch with what is going on around the country. And we work quite hard at it - through visits
like this one; through our non-executive directors who have business interests in the regions and
through our network of regional agents.
Now the purpose of these contacts is to help us understand the reality behind our
precious monetary and economic statistics, and to help us understand what is pre-occupying you.
The economic reality I would say is not at all bad. Looking back over the longer
term, I detect an important change in attitudes in this country: where before people - both
employers and employees - tended to look inwards and backwards, seeking to protect what they
had had, now, it seems to me, they are increasingly looking outwards and forwards to new
opportunities. It is a fundamental change. And over the past four years or so it has been
complemented by a more stable macro-economic environment than most of us can remember in
our professional life time. Putting these together has brought us consistently low inflation;
steady and sustained growth; and gradually falling unemployment. And interest rates have been
lower and less volatile over this period than they have been for more than thirty years.
Some people, it's true, still say to me that all this has not had much effect on
them - it's not like it was in the boom times! And I recognise, of course, that economic
conditions do vary across regions and sectors and between individual companies. More than ever
before it's a tough competitive world.
But what most people say to me these days is that steady growth and low inflation
is exactly what they want so that they can make rational, long-term, decisions in their own
businesses, which is what enables them to face the global competition. The major
preoccupations that I hear are about whether our recent, more stable, economic environment will
continue, and about the implications - good or bad - for that environment of a move to a single
European currency.
Let me say a word first about our domestic economic prospects before turning to
Europe.
In fact, Mr. Chairman, we set out the Bank's views on the domestic economy at
some length in our quarterly Inflation Report only last month. But in summary we have seen a
gradual pick-up in the pace of activity over the past year, driven by domestic demand - notably
consumer spending - so that the money supply and both demand and output are now growing at
above-trend rates. Other things equal we would expect that to continue.
The picture is, however, complicated by the exaggerated strengthening of sterling
since last summer - particularly against the European currencies - which probably reflects
uncertainties affecting the Continental countries at least as much as developments in our own
economy. This strength of sterling poses, for the time being, a genuine monetary policy
dilemma. It will lead to a fall in inflation in the short run - over the rest of this year - as import
prices fall. And it makes life very difficult for UK manufacturers exposed to international
competition, so that our external trade position is likely to deteriorate - and that may have a
longer-lasting effect on inflation. But these effects may not be enough to offset the gradual
emergence of inflationary pressure looking forward to next year, stemming from continuing
above-trend growth of domestic demand.
On that basis we advocated a moderate tightening of policy in order to slow the
domestic expansion to a pace that can be sustained in the medium and longer term.
Let me be quite clear, for those who insist on over-dramatising these things, we
were not calling in the Inflation Report for "an immediate interest rate hike to bring an incipient
boom to a juddering halt!" I should like to think that in the present more stable environment that
kind of language is anachronistic. What we in fact expected over the next couple of years is
continuing growth somewhat above trend with inflation picking up towards 3%, though rising
which by our own past standards is a relatively benign outlook. What we are seeking to do is to
moderate the pace of expansion before inflationary pressures begin to build in order to ensure
that the outlook remains benign next year, and a year after, and well into the future. And that,
Mr. Chairman, is precisely what most business people - whether in industry or commerce or
financial businesses - tell us they would want us to do. It is also the purpose of the
Government's Inflation Target.
Let me then turn to Europe and the question of monetary union.
I do not think anyone questions that economic prosperity in Europe is crucial to
economic prosperity in this country. Our fundamental interests are the same. And not many
people question that the effective functioning of the European single market can make a major
contribution to our collective prosperity - it is a positive sum game in our mutual interest. It is
clear I think too that the single market in Europe will function more effectively if each member
country pursues disciplined macro-economic policies in a context of structural, supply-side,
flexibility - again as a matter of national as well as collective interest. So much it seems to me is
common ground in all 15 EU member countries - and indeed beyond. Whatever happens in
relation to monetary union it is vital, it seems to me, that we hold on to this fundamentally
important consensus.
Moving on from there to the narrower question of monetary union, the potential
economic benefits and risks have now become much clearer, and are rather well illustrated by
our own present monetary policy dilemma. On the one hand, any manufacturer will tell you
after his experience since last summer - about the great advantage of intra-European exchange
rate certainty. On the other hand, with the single currency comes the single monetary policy
the single, one-size-fits-all interest rate throughout the euro-area. The risk very simply is that the
single interest rate may not in the event suit the domestic monetary policy needs of all the
euromember countries - just as the present level of German interest rates of around 3%,
reflecting the disappointing weakness of the German economy, would not at this point suit the
UK - where, as I have said, we need to moderate the pace of our economic expansion.
The potential economic risks, as well as the potential benefits, were recognised
when the Maastricht Treaty was signed - and the famous "convergence criteria" were put into
the Treaty precisely in order to limit the risks. Looked at from an economic perspective it would
be a considerable mistake for monetary union to go ahead without reasonable confidence of
genuine, sustainable, convergence between its members; and it would be a mistake for any
individual country to apply to join - or to be allowed to join - unless it had achieved genuine,
sustainable, convergence. But at the end of the day it is a political process - and no-one should
underestimate the political determination on the Continent to proceed according to the Treaty
timetable. I only hope that those who will make the decision really appreciate that if the
economics of monetary union were to turn out badly - resulting in policy tension between the
euro-member states - then it is unlikely to have its intended effect of advancing political
harmony either.
I would not at this stage care to put much money on the outcome - central bankers
are a naturally cautious breed. But the prudent planning assumption is that monetary union
probably will go ahead on time - at least among a limited group of countries. The question then
is what would that mean for you.
Let me start with the timetable. A final decision on whether to go ahead, and who
should participate, will need to be taken next spring. That would open the way to the immediate
setting up of the European Central Bank so that it could complete its preparations for the
irrevocable fixing of exchange rates with effect from 1st January 1999.
It is important to be clear what the irrevocable fixing of exchange rates means. It
does not mean that the participating national currencies would instantly disappear. They would
continue to exist initially as separate denominations, or sub-units, of the euro, which would have
become a currency in its own right. The DM or French franc or whatever would in effect relate
to the euro just as pence relate to the pound - except that the fixed conversion rate would be a
great deal more complicated, extending to six significant figures!
There would be no euro banknotes or coins at that stage, only book entries in
euro-denominated bank accounts for those who wished to use them. No-one would be compelled
to use the euro; but equally no-one would be prohibited from using it or offering
euro-denominated facilities. The European Central Bank and the National Central Bank
members of the European System of Central Banks would denominate their transactions in
financial markets in euro, although euro-denominated amounts would be convertible into
national currency denominated amounts and vice versa through the payments system for those
that wished. To provide added impetus, national governments will denominate new debt issues
in euros, and some at least may also convert their outstanding debt to the euro-denomination.
Our working assumption is that banks and others active in the wholesale financial
markets will in fact choose to transact most of their wholesale business in the euro-denomination
more or less from the start. And we assume that they will wish to offer euro-denominated
facilities to major business customers that wished to use them. So, for example, non-financial
companies, including large retailing companies, with an active business in other euro-area
countries may wish to be able to quote prices or undertake transactions in euros from an early
stage, although they would certainly still need to transact most of their local business in national
currencies for some considerable period.
On the other hand, we would not expect there to be much demand for banking
facilities denominated in euros either for individuals or for the vast majority of smaller local
businesses much before euro banknotes and coins become available in late 2001 or early 2002.
At that point, the conversion of retail facilities into euros might proceed quite rapidly during the
subsequent six-month period when national currency notes and coin are to be withdrawn - but
again the principle of no compulsion and no prohibition would apply. Retail conversion is of
course a massive undertaking. But the timetable does at least provide some 4-5 years from now
for people to prepare.
The bottom line in all this is that if EMU goes ahead on time and whether the UK
is in or out, the impact on your business will depend very much upon the nature of the business
you are in.
Up to now, we at the Bank have concentrated mainly on ensuring that the banking
system and the wholesale financial markets will be ready to operate in euros from Day 1,
because they will be affected first, and they will be affected whether or not the UK is a part of
the "first wave". But we are conscious of the developing thirst for information from the rest of
the business community. With this in mind, we have co-operated with the CBI and the British
Chambers of Commerce in organising regional workshops - including one to be held here in
Liverpool on 23 April. We are participating too in seminars organised by the Forum of Private
Business - and I am sure that if you are interested you will be able to prevail upon Stan
Mendham, who I am delighted to see here this evening, to organise such a seminar here too! If
you are really lucky, 007 might even provide you with a short Bank of England guide:
"Introduction of the Euro - what does it mean for business?" which, for reasons that I can't quite
understand, in this case comes absolutely free.
The picture is rather different if the UK were to opt out of monetary union - at
least for the time being. In that case the euro will be a foreign currency in the UK, and
businesses, where appropriate, will need to cope with it from the 1 January 1999 just as they
cope now with transactions and contracts denominated in deutschemarks, dollars, yen and the
like. But the huge difference between the 'in' and the 'out' scenario will be that notes and coins
would not be introduced in this country if we are an 'out', so that for most of us life would go on
very much as normal.
Mr. Chairman, I have dwelt on the practical side of monetary union very briefly
this evening, because I fear that the practicalities may be overlooked in the passion of the debate
about the principle. But in my youth - which seems a very long time ago now - I was a boy
scout, brought up with the motto "Be Prepared". It is vital in this context that we are indeed
prepared, whatever the outcome, and the Bank is determined to do all that we can to ensure that
we are.
And provided we have properly prepared ourselves I do not believe that monetary
union need hold great terrors for this country whichever way the decision goes when the time
comes. If it is decided that EMU is a safe club for the UK to join then I think this country is as
well placed as any to live with its disciplines. If on the other hand, we remain on the outside but
continue to behave responsibly - in our national interest, but also as a member of the EU - then I
think the fears for inward investment, or for the future of the financial services industry in this
country, will prove to be exaggerated. The economic reality is that businesses - whether
financial or non-financial - will expand their activities in this country so long as it is profitable
for them to do so. They would be answerable to their shareholders if they behaved in any other
way.
The key to economic prosperity in this country, Mr. Chairman, lies in continued
macro-economic discipline in a context of structural, supply-side, flexibility, and that is true
regardless of monetary union. Provided - in or out - we persist in that, then we can continue to
deliver a business climate of steady growth with low inflation for as far ahead as we can see.
That is the best possible prospect for the bankers here this evening - and the best possible
prospect for their customers.
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