David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

29.6 Antecedents of the eurozone
policy in EMU was to be set by an independent central bank, mandated to achieve price stability as its
principal goal.
There were two sets of criteria, one for monetary policy and nominal variables and one for fiscal policy.
The monetary criteria said that, to be eligible, a potential entrant had to have low inflation, low nominal interest
rates (market confirmation oflow inflation expectations) and two prior years in the ERM without any devaluation.
This last requirement was to prevent competitive devaluations or 'last realignments' as EMU approached.
The fiscal criteria said budget deficits must not be excessive, interpreted to mean that budget deficits should
be less than 3 per cent of GDP and that the debt/GDP ratio should not be over 60 per cent. Tight fiscal
policy would mean there was little pressure on the central bank to print money to bail out fiscal authorities.
In 2009 Greece admitted that its previous national statistics had been inaccurate and that its budget deficit
was much larger than had previously been reported. This immediately led to speculative pressure against
an EMU member state, precisely what the Maastricht Treaty had sought to avoid.
At the time, many economists complained that the Maastricht criteria were caution taken to extremes. An
independent central bank with a tough constitution was an adequate commitment to low inflation. It was
unnecessary to constrain fiscal policy as well. Indeed, since national governments would no longer have a
national interest rate or national exchange rate policy to deal with purely national circumstances, leaving
them fiscal room for manoeuvre might be a good idea.
The Maastricht deal reflected the balance of power in the negotiations. At the time, Germany ran the EMS
and trusted itself to do so in its own interests. Why would Germany give up such a good position? Only if
EMU was going to be super-safe. The Maastricht criteria were the price of getting Germany on board.
Sterling and UK membership
Why was the UK reluctant to join both the ERM and EMU? First, until the late 1980s, North Sea oil made
sterling behave differently from other European currencies. As UK oil production slowed down, this
objection evaporated.
Second, whereas the core countries of Europe are now very integrated with one another, offshore UK is less
integrated with the rest of Europe. A common policy may be less suitable. Table 29 .5 shows the composition of
UK trade and how it has changed since the UK joined the EU in 1973. The trend is clear. The UK is becoming
more integrated with continental Europe all the time, even if from a lower baseline than some other European
countries. If this trend continues, the issue is eventually not whether the UK should join but when.
Third, the UK has greater macroeconomic sovereignty: it seems to have more to lose. Whereas ERM
countries had already allowed the 'single' interest rate to be set by Germany alone, sterling floated during
the entire period except for the two years of its ERM membership during 1990-92.
However, the absence of capital controls and the power of the speculators limit monetary sovereignty
whatever the exchange rate regime. The Bank of England has often wished to raise interest rates for
domestic reasons, to cool down a housing boom, but been unprepared to do so because higher interest
rates would bid up further the value of the floating
pound, exacerbating the woes of UK exporters. The
Bank has often found itself hoping for interest rate Table 29.S UK trade patterns (0/o)
rises in Frankfurt and Washington that would allow
EU North America
it to raise sterling interest rates without causing a
further appreciation of sterling. 1970
Finally, Black Wednesday (16 September 1992)
made it hard for UK politicians to enthuse about
EMU. While Chancellor, John Major took the UK
into the ERM in 1990 to combat rising inflation at
2005
34
17
62 1 1
Rest of world
Sources: UN, /nternationol Trade Statistics; www.statistics.gov.uk.
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