With permission Mr Speaker: for many decades governments formed from both sides of this house have made the case for Britain’s engagement in the EU.
And it is right that at every point we show that every decision we make on Europe is made in Britain’s national economic interest.
So today I will
- first, set out the economic context for the euro decision;
- second, the case in principle, in the national economic interest, for membership of the euro;
- third, the detailed conclusions of our assessment;
- and finally, the policy changes that our country must now make.
Let me start with the economic context.
Since 1997 every economic decision of this government has been designed to build and then entrench stability in order to achieve, for Britain, high and sustainable levels of employment and growth.
This commitment to put stability first led us to adopt a new fiscal and monetary regime, to make the Bank of England independent, to cut debt substantially; it has given us low inflation, low interest rates and low unemployment; and it is this commitment to long-term stability, growth and employment that is the foundation of our decisions today.
Mr Speaker, central to the pursuit of stability, growth and employment by governments of both parties has been our membership of the EU.
Our assessment shows that Britain’s trade with the EU has grown from just over 40% of our total trade in 1973 when we joined to 55 % today.
And membership of the EU is central to stability, growth and employment for another reason. Just as Britain benefits from being part of Europe, so too Britain stands to benefit from an enlarged Europe that is more integrated into the global economy – with globalisation increasingly moving Europe away from an exclusive trade bloc to a Europe which has to look outwards not least to the USA, a Europe which to meet global competition has to liberalise and reform.
So, in addition to our decisions on the euro, we today make proposals that by reducing tariffs, regulatory and competition barriers to EU-US trade will fulfil our objective of a fully effective transatlantic economic partnership between Europe and the USA. And following the joint declaration by all EU Finance Ministers placing, for the first time, labour market flexibility and structural economic reform at the heart of the new European economic policy guidelines, the government will later this week publish our further proposals for economic reform in Europe.
I have no doubt that an enlarged Europe pursuing – like Britain – economic reform, and – like Britain – modernising monetary and fiscal policies, will be conducive to British stability, growth and employment; and around this I believe a modern pro-European consensus in Britain can be built.
It is in this context – with stability the foundation, with membership of the EU central to our economy – that we must decide whether joining the euro now is in the national economic interest. It is a decision of far reaching consequence, indeed – because it is irreversible – one of the most momentous economic decisions our country has to take, and one that must contribute to the attainment of stability, growth and employment.
When in 1997 I set out the government’s position on the euro I listed the potential benefits for Britain of a successful single currency in transparency of costs, currency stability, trade and long-term interest rates.
The detailed work set out in the background papers published today allows us to set out these benefits with even greater precision.
The first benefit is lower transaction costs for business and consumers. We estimate these as worth around 0.1 to 0.2% of GDP, £1bn a year, the gains greater for smaller companies and the gains permanent.
The second is diminished exchange rate volatility, with gains for both large and small companies especially in the manufacturing sector with again potentially the greatest gains for smaller companies.
The third benefit is greater cross-border trade and thus the potential for increased commerce and growth.
Our assessment makes clear that, with the advent of the single currency, trade within the euro area has already expanded and that, with Britain in the euro, British trade with the euro area could increase substantially – perhaps to the extent of 50% over 30 years.
Next interest rates. For 30 or 40 years continental Europe has been able to combine stability with consistently lower interest rates than in Britain, to the benefit of business and of course homeowners.
Indeed over the last 30 years interest rates in Britain have had to be, on average, 3% higher than in Germany.
With Britain in the euro, business could benefit through greater access to a more integrated European capital market.
And if, on the basis of sustained and durable convergence, we could lock in stability for the long-term, then business could see a cut in the cost of borrowing on a sustainable basis with a long-term boost to cross border investment flows and foreign direct investment in the UK.
So I can today confirm the principled case: our view that membership in a successful single currency would be of benefit to the British people as well as to Europe is strengthened by the results of our assessment.
While we argue the case in principle for joining, there are those who rule out joining the euro forever as a matter of dogma even if it were shown to be in the best economic interests of the country. That cannot be right for the future of Britain.
The government’s view is that if the economic case is clear and unambiguous then the constitutional issue, while a factor in the decision, should not be a barrier to entry.
And my conclusion is that if, on the basis of the five economic tests, membership of the euro is shown as good for sustaining British jobs, business and future prosperity then it is economically right and in the national interest to join.
Indeed, our assessment on trade and output is that inside the euro UK national income could rise over a 30-year period by between 5 and 9%, boosting, subject to convergence, potential output and national wealth by up to one quarter percentage point a year, worth up to £3bn a year, delivering higher living standards and lower prices for consumers and households.
And just as there are risks of joining before a clear and unambiguous case has been demonstrated, so too there are risks in delaying these potential benefits once sustainable and durable convergence has been achieved.
So from the assessment we have done I have no doubt:
- first, about the potential benefits to Britain and the British people of joining;
- second, the potential risks of delaying the benefits of joining;
- and third, the advantages inside the euro area of greater influence over policy towards the euro and thus Europe.
Provided the crucial tests are met concerning the British economy, it is our intention to join. If – on the basis of the five tests – we can make a clear and unambiguous case, then this government’s view is that it is in the national interest to recommend to the British people to vote yes in a referendum to join the single currency.
In short, if the economics are right for Britain, we should join.
So let me turn to the conditions that have to be met if we are to secure the potential benefits of the euro.
We must be sure that there is cyclical and structural convergence between Britain and the euro area – and the flexibility to withstand stresses and strains.
Indeed the more flexibility in the economy the easier it is to tackle problems that arise from the divergence of business cycles.
Sustainable convergence means the British economy can live on a permanent basis with euro area interest rates, able to advance our objectives of high and stable levels of growth and employment and sustained and stable funding of our schools, hospitals and other public services.
The flexibility required is – as I said in 1997 – sufficient flexibility, sufficient to be able to adjust our economy quickly to any shocks that arise so that we do not put at risk these objectives. So it is my duty to demonstrate in detail, whether we have secured, for Britain:
- convergence, that is compatibility with our European partners that is sustainable – the first test;
- sufficient flexibility – the second test;
- and can affirm conclusively and confidently to the British people that the potential benefits for investment, financial services and employment, growth and trade – the other three tests – can indeed be realised.
The five tests are our stability guarantee: to meet them would ensure that we will not put at risk our economy or our public services.
With the tests met, Britain in the euro can enjoy the benefits I have outlined – greater trade, investment and employment. If we entered with the tests not met at the wrong exchange rate then – just as with the ERM in 1992 – we could see unemployment rise, public service investment fall and growth stall.
The discipline of the five tests is to ensure there will be no repeat of the experience of the ERM when Britain joined at the wrong rate and at the wrong time without either convergence or flexibility and the potential benefits could not be realised.
In our 1997 assessment we took the view that a period of stability was required to ensure that business cycles and structures converged sustainably and durably.
We concluded that UK interest rates were higher than in the euro area and remained higher because of structural differences, particularly in the housing market.
The new assessment we publish today also shows that, because of a lack of convergence with the euro area, joining in 1999 – as some in this house advocated – would not have secured the stability inside the single currency that we have enjoyed outside it.
Cutting interest rates substantially to join the euro below the level that would have been right for Britain in the short-term, and joining at an exchange rate that was too high for the long-term, could have locked us into another cycle of stop-go economics.
But I can tell the house that the consistent polices we have pursued since 1997 – an independent central bank, new fiscal rules, lower debt, housing market reform, greater flexibility in labour, capital and product markets including an independent Competition Commission – have contributed to meeting, quite comfortably, the Maastricht criteria for nominal convergence – in a better position than some current members were in 1997 and even are now – but are also leading towards the sustainable convergence and greater flexibility required by the five tests.
We can report that since 1997 there has been significant progress in achieving cyclical convergence.
The short-term interest rate divergence between Britain and the euro area has fallen from 4 percentage points to 1.75 percentage points.
Long-term interest rates have virtually converged today at around 4%.
Over the last six years there has been a weaker euro and a stronger pound. And the inflation rate has been on average 1.1% below the euro zone average for the last 3 years.
Over recent months the euro exchange rate has strengthened against Sterling and the Dollar and we are today publishing an independent study examining the sustainable level for Sterling reflecting economic fundamentals.
The issue at the present time is however being sure that there is structural convergence that is sustainable for the long-term and we also have to be sure that, if real interest rates or business cycles do diverge, Britain will have the necessary flexibility to sustain stability, growth and employment.
We do not know whether or how shocks will occur but there are risks for the UK and let me give the house two specific examples – one from housing, one of inflation generally – of how in the new circumstances we would need to respond.
Take the challenge of an inflation rise particular to Britain from, say, the housing market. For a 1% rise in British inflation, the British interest rate would, other things being equal, tend to rise by 1.5%. The real interest rate – that is, the interest rate after taking account of inflation – would therefore rise by 0.5% as we brought inflation under control and back to its target.
Inside EMU, Britain’s economy would be one fifth of the euro area economy. A 1% inflation rise specific to the UK which would, today, lead to a British interest rate rise of around 1.5% would lead to a euro-area interest rate rise of about a third of a percent — a real interest rate fall for the UK of around two thirds of a percent. As a result, real interest rates for Britain which ought to increase could actually decline. And it is for this reason that, inside the euro, governments need other forms of flexibility.
And, if inside the euro Britain’s inflation rose faster than that of the euro area, Britain would suffer a loss of competitiveness. So to restore lost competitiveness a period of higher inflation than the euro area would have to be followed by a period of inflation lower than the rest of the euro area.
These two examples show why it is important to learn the lessons not just from the experience of the euro area but also from how the states and regions adjust flexibly in the United States monetary union. In other words we must be sure of sustainable convergence and that if business cycles do diverge or shocks arise Britain has the price and wage flexibility – and fiscal flexibility – to ensure stability.
Our assessment finds that obstacles to convergence do not lie in the provision of small business finance or large company finance where in fact overall, on business finance, the UK economy is found to be not more interest rate sensitive than others.
The issue in housing, where we are more interest rate sensitive, is not the attainment of identical market structures with other countries – all countries have unique features of their market – but the fact that to deliver stability in Britain the combination of house price inflation and volatility — and the impact of both on consumption — has generally led to interest rates higher than other countries.
Indeed most stop-go problems that Britain has suffered in the last 50 years have been led or influenced by the housing market. The volatility of the housing market and potential for higher inflation is a problem for stability that we are determined to do more to address to produce greater stability and reduce the risks of inflation irrespective of the decision on the euro.
Because Britain has experienced difficulty in balancing housing supply and demand, we propose to build upon and extend the reforms already announced by the deputy prime minister in respect of planning and supply – including simpler planning guidance, speeding up decisions, reserve powers to call in applications, and the case for binding local plans – and, having asked Kate Barker to conduct a review of issues underlying the lack of supply and responsiveness of housing in the UK, we will bring forward further proposals in the Pre-Budget report and Budget on how we can produce greater stability in our housing market.
And because Britain has had a different system of housing finance – just 7 % of mortgages in the UK are at long-term fixed rates – we are learning the lessons from other countries, where for example in America they securitise long-term fixed rate mortgages, and an independent review is now examining the structure of mortgage finance including the case for – and how we can help the development of – the long-term fixed rate mortgage market in the UK.
So further housing market reforms will be put in place over the coming year – reforms right in any event for the British economy – reforms that will help ensure that, by having a reduced propensity to house price inflation, stability can be further entrenched.
It is right to consider a further change that is right in itself and will foster convergence – a new target for domestic inflation.
The advantage of the current indicator of inflation – RPIX – is that it is known; well understood; and has served us well.
The advantage however of the internationally recognised index of consumer prices – HICP – is that it is a better measure, will improve the quality of our target, is in line with best international practice and is used by every other G7 nation but Japan, and by our neighbours in Europe.
I turn from issues of convergence to issues of flexibility. To strike the right balance between fairness and flexibility in pursuit of full employment, we have introduced a minimum wage and a new tax credit system which guarantees a national minimum income for single persons and couples aged over 25 and families. So no-one need fear that when they move jobs or move areas, they lose national income guarantees.
With this national framework for fairness in place, it makes sense to recognise that a more considered approach to local and regional conditions in pay offers the best modern route to full employment. In addition, in the south-east, where professionals have benefited from London weighting and other arrangements, many lower paid workers have missed out. So in future we plan to publish data on regional prices and inflation; remits for pay review bodies and for the public sector including the civil service will, within their nationally determined frameworks, include a stronger local and regional dimension; and the reform of housing benefit will remove disincentives to work or to move. These measures – which will be put in place over the coming year – can make Britain, with already the lowest unemployment of the main industrialised countries and 1.5 million more jobs than 1997, the most employment friendly country in the world.
The other form of flexibility is fiscal flexibility.
And because of our history of stop-go, prudence dictates a cautious approach.
Mr Speaker, some countries have proposed new domestic procedures for faster and more effective adjustment of their fiscal policies in the euro area
In the principles we have applied to British monetary policy – to ensure stability and flexibility – we have insisted on clear symmetrical rules, well-understood procedures, and enhanced transparency.
Central to this is the open letter system – a means for dealing with potential pressures
To promote stability and flexibility in future, the same principles should be applied to any new arrangements for British fiscal policy inside EMU.
So to ensure stability inside the euro area we will consult on the case for an open letter system on fiscal policy and a new and additional fiscal rule. We propose a regular fiscal stability report published on a pre-announced timetable to parliament, ensuring that fiscal decisions are fully transparent and accountable – and made by parliament; an assessment in it of the gap between actual and trend output in the economy; and when actual output materially diverged from its trend, an open letter sent by the Treasury to parliament setting out the government’s response.
In this way, in EMU, the principles underpinning our monetary policy regime which has been successful in delivering stability would be mirrored in a similar fiscal policy regime.
So let me give me give the conclusions on each of the five tests, the full details of which, the benefits and the challenges, are set out in the Treasury’s assessment and the 18 accompanying documents, which cover in an open and full way all aspects of economic policy – and all of which are now available for open public debate.
On long-term interest rates we have made significant progress in lowering inflation expectations and establishing a platform of stability.
There are grounds too for optimism about increasing compatibility of business cycles and market structures.
Today interest rates which were 4% above those of the euro area are now 1.75% higher.
Structural differences remain that could pose a risk to stability unless addressed, which they are by the proposals I will put forward today.
The assessment shows that considerable progress has been made to reform markets in the UK and euro area.
Flexibility – right in itself for every economy – has improved in the British and European economies. And the more flexibility in the economy the easier it is to deal with problems when cycles diverge and the better it is for our competitiveness.
Yet as the persistence of volatility in inflation rates within the euro area demonstrates, we cannot be certain that there is as yet sufficient flexibility to deal with the possible stresses.
It is for these reasons that we are making structural reforms that will bring increased flexibility.
The assessment shows that inside the euro there will be new opportunities for investment in particular foreign direct investment.
And at all times by continuing to maintain macroeconomic stability and encouraging flexibility the government will continue to ensure that the UK retains our position as a magnet for foreign direct investment.
We have taken particular account of the views, the qualitative evidence from Japanese, other Asian, American and European investors many of whom have said membership would be beneficial and is important to them.
There can be confidence that on the basis of sustainable and durable convergence, a successfully operating EMU and UK membership of it on the right terms would boost investment and FDI over the longer term.
On financial services:
The assessment shows that in or out of the euro UK financial services, wholesale and retail, are and will remain competitive. Future integration of financial markets inside the euro could promote the kind of diversity, flexibility and risk diversification seen in the capital markets of the USA, making it easier for a more flexible Britain to win business throughout the euro area.
On employment, stability and growth, the fifth test:
The potential benefits in increased trade and competition and then higher long-term levels of output and employment are significant. Without sustainable convergence and sufficient flexibility, we would not realise the potential benefits for stability, jobs and investment.
Mr Speaker, it is because we will never put stability at risk that the tests we set were and are indeed high ones: namely to show a clear and unambiguous case for British membership.
So we conclude the financial services test is met.
We still have to meet the two tests of sustainable convergence and flexibility
Subject to the achievement of sustainable convergence and sufficient flexibility, the tests for investment and employment would be met.
So I am today announcing major reforms, right for the British economy, reforms which will be implemented over the next year and will greatly assist the process of achieving sustainable and durable convergence and the flexibility necessary for Britain to succeed sustainably within the euro zone and realise its potential for trade and investment
Under Bank of England legislation it is my duty to set the inflation target. I have written to the governor of the Bank of England today stating that subject to confirmation at the time of the Pre-Budget Report I intend to change the inflation target at that time. The inflation target for Britain will be set on the consumer prices definition. I can confirm that pensions and benefits and index-linked gilts will be calculated on exactly the same basis as now. We have said throughout that we do not believe it necessary or right to rejoin the ERM.
I am asking by the time of the Pre-Budget Report for interim reports on the step changes we need in the planning and supply of housing and on the market for long-term fixed rate mortgages.
I am today publishing for consultation our proposals for a new system within EMU of fiscal reporting to parliament.
As part of radical reforms at a national, regional and local level, I propose that by next year almost all pay remits for public sector bodies will include a regional or local pay dimension.
And we will publish six monthly reports on trends and progress in flexibility in labour, product and capital markets.
At this particularly uncertain time for the world economy – with adjustments only recently in the exchange rate – and when we do not know the future path of growth and inflation rates in Britain and Europe, it is right prior to the point of transition, and in the light of progress, to consider both the exchange rate and the balance of monetary and fiscal policy.
We will also continue to pursue our objective of a Stability and Growth Pact that takes into account the economic cycle, debt sustainability and public investment – and seek reform of the European Central Bank. It is also important that we resolve the uncertainties over the European Convention and we will continue to pursue our objective of tax competition and reject tax harmonisation in Europe.
We will report back on progress in all these areas of reform in the Budget next year.
It is this resolve to implement far reaching reforms in our economy that is the practical and best expression of our intent. It is a reform agenda – right for Britain’s economic interest and right to help meet the five tests; a reform agenda on which I believe there is a realistic prospect of making significant progress over the next year.
The government believes that the implementation of these reforms, right in themselves, would help towards sustainable and durable convergence and flexibility, so that we can, within the euro area, achieve high and stable levels of growth and employment and deliver our objectives for public services.
We will report on progress in the Budget next year. We can then consider the extent of progress and determine whether on the basis of it we make a further Treasury assessment of the five tests which – if positive next year – would allow us at that time to put the issue before the British people in a referendum.
I can announce – the publication of the draft Referendum Bill this autumn;
- the introduction of further paving legislation for additional departmental allocations for preparations;
- the publication today of the full and complete version of the British National Changeover Plan setting out the possible timetable for a changeover, the management of it, the impact on consumers, business, financial services, the voluntary sector and the public sector;
- I propose Scottish, Welsh and Northern Irish preparation committees that will examine local, regional and sectoral preparations;
- I am also asking representatives from consumer organisations, local authorities, the voluntary sector and the Regional Development Agencies to join the Standing Committee on Euro Preparations;
- I will publish a detailed report on euro preparations within government, the public sector and across the economy this autumn;
- I will shortly be issuing guidance to local authorities on preparations;
- and from the publication of the changeover plan will come a period of information and discussion in each region and nation of the country, including in each constituency.
So in this statement we strengthen our commitment to and support for the principle of joining the euro – showing that the gains to the country and to our businesses are greater than anticipated.
We have shown how financial services would benefit from membership of the euro.
We have shown how with sustainable convergence and flexibility, investment can benefit from membership of the euro.
We have shown how with convergence and flexibility, employment can benefit from membership of the euro.
We have shown the critical importance of achieving sustainable and durable convergence and I have announced major reforms to be implemented immediately and over the next year
At all times we have and will put stability and the national economic interest first.
We have set out the real benefits to Britain of membership of the single currency; shown that with the achievement of sustainable convergence and flexibility all five tests could and can be met; and laid down the concrete and practical steps which we will follow.
Radical steps which set out a new direction for reform.
Steps which set out the clear path ahead for Britain.
And with a programme of European economic reform benefiting Britain, I believe a modern long term and deep seated pro-European consensus in Britain about Britain’s role in Europe and Europe’s role in the world can and will be built.
And I commend this statement to the house.
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