The EMU debate has livened up over the past few months. Several economists have argued strongly against Ireland joining EMU, in this paper and elsewhere. Yet, to date, the anti-EMU view has had no perceptible effect on any actual decision. This doesn't mean that the anti-EMU alarm bells have been redundant.
By drawing attention to the problems of adjusting to EMU, they have alerted public opinion to the need for serious preparation to cope with the challenges of a single currency. But the question still remains: why have they had so little impact on policy? Initially, the main thrust of the anti-EMU case was that, with Britain not participating, Irish firms would be vulnerable to sterling volatility, especially sterling weakness. Any sustained decline in sterling beyond 105p pounds has caused real problems in the past. While the present exchange rate of 83p indicates that sterling has a long way to fall before it would cause difficulties, we should not be complacent.
But, post-EMU, the problem of sterling volatility will be easier to cope with for two reasons. First, what really hurt Irish business during past bouts of sterling weakness was not just competitive pressure from Britain, but that it was combined with sky-high interest rates. In the EMU, if sterling weakens, we will no longer have to contend with emergency interest rates to placate speculators betting on a pound devaluation. Second, after EMU, devaluation will not be an option. There will be no pound to devalue. There will, as a result, be intense pressure on Irish firms, employees and Government to adopt more flexible pricing and wage bargaining strategies than in the past. Recently, EMU critics have shifted emphasis from the sterling factor to the loss of an independent monetary policy. This change in emphasis is driven by concern over Irish inflation. After EMU, interest rates will be determined by the needs of the European, not the Irish, economy. While all members of EMU will be in the same quandary in this respect, Irish economic conditions have tended to be particularly divergent from the EU average because of the Irish economy's closer links with the British and US economies. Hence we are likely, the arguments goes, to have low euro rates when the Irish economy needs high interest rates, and vice versa.
The anti-EMU case assumes that the past pattern of economic fluctuations will continue into the future. But this view is open to challenge. First, cyclical fluctuations in the Irish economy did not just happen. To a considerable extent they were induced by pro-cyclical fiscal policy. That is, historically, Irish governments have tended to inject too much money into the economy during booms and too little during recessions. Under EMU fiscal guidelines the scope for such policy mistakes will be much reduced and fiscal policy will be much less destabilising. Second, account should be taken of Ireland's rapidly changing economic relations with the outside world. As economic relations with the Continent deepen, fluctuations in the Irish economy are likely to become more synchronised with continental EU countries. Hence, the problem of different cyclical patterns between Ireland and Europe and of "wrong" euro interest rates for the Irish economy may be less acute than opponents of EMU suggest.
Even if Ireland's cycles and our EMU partners remained divergent, to stay out of EMU may not be the best option. The anti-EMU's vision of a highoctane Irish Central Bank, fine tuning the economy from year to year and providing soft landings or quick recoveries a la carte, is highly implausible. It reflects an exaggerated faith in the effectiveness of counter-cyclical monetary policy in a small open economy like Ireland's. Such a policy would require flexible exchange rates an often unstated assumption of those advocating it. Thus, if our Central Bank increased interest rates to slow down the economy, this would result in a stronger pound. How much stronger we don't know. That would be for the foreign exchange market to decide. A few years down the road we might need lower interest rates, with a weaker pound. To be sure, the Federal Reserve Bank in the US operates such a system quite successfully. But Dame Street is not Washington DC. Interest rate adjustments which generate large, uncontrollable swings in our exchange rate could impose disproportionately heavy costs on Irish business.
Some EMU critics recommend that the Central Bank should focus on an effective exchange-rate target for the pound, thus steering a middle course between fluctuations in sterling and the euro. However, the closer the Central Bank adheres to a fixed exchange rate target, the more circumscribed its power to implement counter-cyclical policies. Staying out of EMU could involve serious economic loss to the Irish economy. The benefits of price transparency, reduced transactions costs, diminished uncertainty, cheaper access to the EU capital market, would be foregone. An opt-out decision could also impact unfavourably on foreign investment. Investors are reassured by Ireland's commitment to EMU and our closeness to the decision centre of European economic policy.
Suppose, even more seriously, that EMU abstention were to weaken the Government's commitment to fiscal control? We know that the Maastricht criteria provided the discipline, focus and all-party support for fiscal balance that has played a crucial role in Ireland's growth. To argue against participating in EMU on the grounds that our economy has been doing well with the present 15 per cent EMS band misses the point. An important part of the reason why things have been going well is that we have been committed to EMU. Some argue that EMU fiscal constraints will undermine the Government's capacity to respond to a severe economic downturn. But, far from damaging the economy, the EMU target of a zero budget deficit in the medium-term will ensure fiscal balance and a better managed economy. Provided we generate fiscal surpluses during the boom, an effective counter-cyclical fiscal policy could be operated without breaching the 3 per cent budget deficit limit. The arguments of those advocating postponement (or cancellation) of EMU entry have been oversold. They exaggerate the dangers of being in EMU and underplay the dangers of staying out. Moreover, with time, the down-to-earth practical gains from having a common currency with continental Europe could prove more important than now appears.
The author is Whately Professor of Political Economy, Trinity College Dublin. His book, Economics for Business, has recently been published by Prentice Hall.
