Monetary union may not be so irrelevant after all

According to my calculations, 1996 is just two years away. Further research reveals that the next general election need not take place for almost three years - until May 1997, to be precise.

I can therefore exclusively reveal that the next general election may not take place until after the EU heads of government meet to decide, under the terms of the Maastricht treaty, whether the conditions for European Monetary Union have been met.

I make these points because the uneasy truce in the Conservative Party on the European issue seems to be based on the assumption that the question of EMU is now effectively off the agenda.

For example, the Chancellor told the Treasury Select Committee last week that 'anyone who started talking about the prospects of a single currency in the Council of Finance Ministers would be regarded as having taken leave of his senses'.

He went on to dismiss EMU as a 'tedious irrelevance' which would not trouble the present Parliament and might not trouble the next.

He may be right. It is possible to imagine a political scenario involving a defeat for Chancellor Kohl in the German federal elections in October and/or the election of Jacques Chirac in the French presidential elections next May, either of which would make EMU most improbable this century.

But it is also possible to imagine the re-election of Chancellor Kohl along with a victory for Edouard Balladur or Jacques Delors in France. In that case it is far from fanciful to suggest that the leaders of Germany and France would see it as their 'historic duty' to implement Maastricht as quickly as possible.

Simple majority

Let us recall what was agreed in the treaty. The EU heads of government must meet no later than 31 December 1996 to decide whether a simple majority - at least seven - of EU members can proceed to EMU.

If no date can be set at that summit, the move to EMU is intended to take place automatically on 1 January 1999, when a minority of member states - presumably only two - could form a monetary union.

The clear intention of the treaty is that the Council of Ministers should decide by qualified majority both when EMU should start and also who should be in it.

This means, in theory, that no individual country could veto the process - not even Germany. Furthermore, only Britain and Denmark have the constitutional right to step aside from monetary union if the Council of Ministers decides they are qualified to join.

Presumably this raises the insane possibility that one or more countries might be forced to join EMU when they did not want to. In the real world this obviously could not happen, but it does demonstrate the degree of automaticity intentionally built into the treaty.

British opponents of EMU have reassured themselves with the thought that this automaticity is tempered by the conditions which have to be met before EMU can go ahead. These conditions relate to consumer price inflation, bond yields, budget deficits and public sector debt ratios.

On price inflation and bond yields, the majority of members in fact already meet the Maastricht requirement. Assuming that there will be no major inflationary shocks in the next few years - and there is no particular reason to think that there will be - the only large countries which seem likely to have to worry about these criteria are Italy and Spain. The rest should match up.

The budget criteria, on the other hand, seem at first sight to pose an insurmountable problem. At present only Luxembourg meets both of the suggested limits and most other countries are moving away from the limits rather than towards them.

However, two points are relevant here. First, budget deficits will start to improve quite sharply from next year onwards as European economies move into a phase of strong recovery.

Second, and much more important, the precise numerical limits for the budget deficit - 3 per cent of GDP - and the public sector debt ratio - 60 per cent of GDP - are in fact only intended to be illustrative guidelines as to whether budget deficits are 'excessive'.

Provided that countries are making satisfactory progress towards these numerical guidelines, the Council of Ministers can deem the budget criteria to be met.

In other words, if there is a strong political will to proceed towards EMU the treaty, quite intentionally, allows the council to turn a blind eye to failures to meet the budget limits.

There is one more convergence requirement, which is that any currency qualifying for EMU should have been within the 'normal' bands of the ERM for at least the previous two years with no change in the central parity over that period.

Here the supporters of monetary union have enjoyed a huge slice of luck, since the 'normal bands' in the treaty were clearly intended to be the narrow bands of the ERM.

The drafters of the treaty apparently used the word 'normal' instead of 'narrow' because there was a possibility that some countries might move to super- narrow bands before 1997.

But the upshot is that the break-up of the narrow bands last year will not prevent the transition to EMU, since the current 15 per cent fluctuation bands can now be defined as the 'normal' bands. On such twists of fate can history turn.

Despite this stroke of fortune for EMU, most economists felt in the immediate aftermath of the ERM debacle last August that the narrow bands would have to be stitched back together before a single currency could be created.

The original intention of the Maastricht drafters was that the eventual transition to the final stage of monetary union would be almost imperceptible, since economic convergence would already have been achieved and currencies would have been virtually fixed for a prolonged period ahead of EMU.

The idea was that the final stage before EMU would be a proving ground for the real thing.

However, there were always doubts about whether this would prove feasible. There was no guarantee that the narrow bands would have been compatible with the absence of capital controls among member states for a period of up to five years ahead of EMU.

A particular fear was that the market would expect one final realignment just before full EMU in order to ensure that no serious competitiveness problems would be locked into the monetary union.

Problems eliminated

This expectation could have led to speculative attacks on the parity grid, possibly forcing late realignments which would breach the convergence criteria of the treaty.

These problems have essentially been eliminated by the operation of wide bands, since any feasible realignment to allow for competitiveness divergences can now be comfortably accommodated within the 15 per cent fluctuation margins.

An increasing number of economists are beginning to speculate that EMU may involve a 'big bang' directly from wide bands to full union. Although scarcely a fashionable concept in 1994, perhaps monetary union is not such a 'tedious irrelevance' after all.