DURING Britain's long general election campaign, Mr Gordon Brown declared that he would be an "Iron" Chancellor of the Exchequer if Labour was elected. His surprise announcement on Tuesday of a radical reformation of Britain's monetary policy regime should ensure that "Iron" remains an appendage to his title.
By relinquishing control over interest rates to the Bank of England, he has - in all likelihood - ushered in a new era of British macroeconomic stability. The move also has significant economic implications for Ireland as it has markedly reduced the risks associated with entry into Economic and Monetary Union (EMU) in the absence of Britain.
It is difficult to recall many examples of a British Chancellor of the Exchequer sacrificing political advantage for public gain. Mr Brown's courageous move is such an example. The courage lies not in the economic risks associated with the move - the economic advantage of the new system is without doubt; it is that by giving the Old Lady of Threadneedle Street control over interest rates, he has voluntarily sacrificed a powerful weapon for future elections.
The contrast between the new system and the old regime could not be more stark. Previously, British chancellors could "trick" the electorate into believing the economy was in better shape than it was. This was achieved by maintaining an easy monetary stance in the run-up to an election. Low interest rates boosted the "feel-good-factor", while the inevitable high inflation hangover only took hold in the election aftermath. The boom-bust cycle which ensued was damaging for the economy in the long-run and its toleration contributed to Britain's relative economic decline.
The Conservatives were masters at engineering the political economic cycle. The elections of 1983, 1987 and 1997 also coincided with boom periods. The fact that the tactic failed in this year's election indicates the damage that the appearance of sleaze and division inflicted on Mr John Major's government.
The relevance to Ireland of Mr Brown's bold monetary initiative relates to its likely effect on the behaviour of sterling. The boom-bust economic cycle which existed under the previous monetary regime tended to produce large swings in the value of sterling as well. Periods of sterling overvaluation were followed by dramatic collapses in the value of the currency.
Sterling's tendency to exhibit excessive volatility has been correctly identified as posing a major danger for Ireland should it enter EMU without Britain. Given that Britain is our largest trading partner, a sterling collapse once EMU commences would place Irish industry at a substantial competitive disadvantage.
In the ESRI's (now famous) study on the economic implications for Ireland of EMU, considerable attention was devoted to the probability and consequences of a sharp sterling drop. The study concluded that EMU membership in the absence of Britain was likely to have a net positive effect of 0.4 per cent on Ireland's GNP (resulting in 10,000 extra jobs).
However, in reaching this figure, the ESRI subtracted a whole 1 per cent of GNP due to the added risk of a negative economic shock. By far the greatest risk is posed by the possibility of a rapid sterling depreciation. By reducing the probability of this occurring, Mr. Brown's initiative has increased the likely benefit of EMU for Ireland.
Although empowering the Bank of England with control over monetary policy should ensure that sterling is a more stable currency in the long term, there is no guarantee that the pound will trade steadily against it ahead of the commencement of EMU. This is due to two factors:
Firstly, the Bank of England has gained independence at a time when the British economy is overheating and sterling is overvalued against the core European currencies. Whether sterling stages an orderly decline from those levels will depend more on Mr Brown's first budget than on the Bank of England's approach to the problem. On the evidence to date, it must be hoped that the Chancellor will do the prudent thing and introduce a tight budget (which would reduce the likelihood of a sterling collapse). However, this cannot be guaranteed.
Secondly, there is considerable uncertainty relating to the level at which the pound will convert to the euro. Speculative attacks on the pound, as witnessed last week, could lead to large swings that are independent of any sterling movement.
The reassuring point, though, is that both of these issues will be resolved by the time EMU commences. Thereafter, we can expect sterling-euro to exhibit more stability than sterling-deutschmark has done.
For this reason, at least, we can say: "Thank you, Mr Brown."
