Franco-British Council
The Pound, the Euro and
the Dollar
Report of a seminar held in Paris
15 March 2007
Christopher Johnson
The Author
Christopher Johnson is an economist former chairman of the British section of the FrancoBritish Council.
Franco-British Council
British Section
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Fax: 020 7976 8131
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© Franco-British Council British Section 2007
cover design by Henry Paker
printed in Britain by TKO Print
ISBN 978-0-9555131-1-4
CONTENTS
Report
Introduction
4
Currency market shares and exchange notes
4
Central Bank differences and similarities
5
The fiscal-monetary policy mix
6
Structural reforms
7
UK membership of the euro
7
Appendices
i
British Participants
9
ii
French Participants
10
iii
Agenda
11
THE POUND, THE EURO AND THE DOLLAR
The participants from the two countries were welcomed by Jean Guéguinou, President of the
French section of the Council. Lord Radice, Chairman of the British section, and Professor
Christian de Boissieu, were co-chairmen of the seminar. The main themes covered were the
present state of play as regards the currency market shares and exchange rates of the three
major currencies; the monetary experiences of the UK and the euro area in terms of a
comparison of central bank differences and similarities; and the economic policies behind the
pound and the euro, covering the fiscal-economic policy mix and structural reforms. The
question of UK membership of the euro was touched upon more to explain why it was off the
agenda than to expound its potential benefits.
Currency market shares and exchange rates
In the opening session, Professor Agnès Bénassy-Quéré outlined the market shares of the
three currencies in international finance, to show that we were in a tripolar world. The euro
has overtaken the dollar in the international bond market, with 47% against 37% of bonds
outstanding at end-September 2006. The two currencies are nearly equal in cross-border
bank assets, with the euro accounting for 38% and the dollar for 40% at end-June 2006. The
dominance of the dollar still prevails in the market for official reserves, which were 66% in
dollars and 24% in euros at end-2005, and in the foreign exchange market, where 44% of
transactions were in dollars and 19% in euros in April 2004. Meanwhile, the pound has
overtaken the yen to become the third most important currency, with 8% of the international
bonds, 6% of cross-border bank loans, and 4% of official reserves. Only in the foreign
exchange markets does the yen still lead the pound, with 20% against 17%. The importance
of financial flows between the City of London and the euro area has become dominant in the
global financial system since the euro was created.
She argued that the euro’s rise as an international currency would allow it to share some of
the advantages of the dollar. The US can make an exchange rate gain by borrowing in its
own currency and investing in stronger currencies; it can get seignorage by the use of its own
banknotes outside its territory, it can avoid exchange risk by invoicing in its own currency, and
it can play a bigger role in the architecture of the international monetary system. William
Keegan recalled the debate over the sterling balances in the 1960s to show that there were
also disadvantages in having an international currency if its holders lost confidence in it.
Agnès Bénassy Quéré showed that exchange rates between the euro and the dollar have
been misaligned, and much of the movement between them had been due to interest rate
differentials. The euro had been weak when it should have been strong, and was now strong
when it should be weak. French politicians were excessively nervous about the exchange
rate, and were too ready to blame the European Central Bank, making it a scapegoat for poor
economic performance, as another participant put it. The pound had risen because of its
higher interest rate, but had for some time had a stable relationship with the euro. Professor
Marcus Miller proposed a gigantic $500bn swap agreement between the dollar and the euro
to stabilise their relationship. Thierry Walrafen pointed out that one of the merits of the euro
had been the avoidance of exchange rate crises within the area, which had been one of the
main motives in setting it up.
The UK’s economic performance had been better than that of the euro area, argued
Professor Iain Begg. It was pointed out that this was one reason for the loss of British interest
in joining the euro. The UK benefited from having a higher employment rate than France,
which counteracted its lower productivity, and from having more Information and
Communications Technology investments, thanks to lighter product market regulation. But
the minimum wage was higher in Britain than in France, and spending on social protection
was similar in the two countries. British unit labour costs were rising, while they were static in
France. The UK had a big current account deficit; the euro area was in broad external
balance, but this concealed a wide variety of performances, with Germany in surplus and
France, and even more, Spain in deficit. It was harder for Italy to increase productivity than it
had been for Germany, argued Simon Tilford, but the Netherlands had shown that
competitiveness could be regained by an increase in productivity.
Central bank differences and similarities
The discussion focussed on the role of the three central banks in managing the three
currencies. Marian Bell, a former member of the UK Monetary Policy Committee, thought
there were more similarities of the monetary frameworks than differences. Price stability was
the main goal for the Bank of England and the European Central Bank, while the Federal
Reserve had the two other goals of economic growth and employment. Both central banks
tried to be transparent, accountable and credible in such a way as to anchor inflation
expectations. The members of the UK Monetary Policy Committee were individually
accountable, which could lead to surprises in the decisions reached, and their votes became
public, while the ECB Council members reached decisions by consensus, and were more
political (excessively so, in Derek Scott’s view), in that most of them represented their own
countries. This difference led to differences in methods of communication. The Bank of
England did not send out signals in advance of its decisions, while the ECB tried to do so. It
was no longer clear that the Bank of England’s Monetary Policy Committee gave greater
transparency compared with the ECB, with early Press conferences, and the Federal
Reserve, with a statement and members’ votes published at the same time as interest rate
decisions.
The differences between the Bank of England and the ECB were brought out by Jean-Pierre
Landau, Deputy Governor of the Banque de France. The ECB had a policy based on two
pillars, of which the monetary aggregates were one. In the UK, the Chancellor of the
Exchequer set the inflation target, whereas the ECB set its own target. The methods of
communication were also different. The policy interaction between the Bank of England and
the Treasury was relatively close and easy, because of the one-to-one relationship.
Christian de Boissieu drew attention to the importance of asset prices in the thinking of central
banks. He questioned whether there needed to be a monetary pillar (it was generally
conceded that monetary aggregates were a good source of information, without necessarily
being a target) and thought that accountability would be improved if the discussions of the
MPC and ECB Council were published.
The fiscal-monetary policy mix
This survey of the central banks led naturally to one of the main themes of the seminar, the
policy mix between monetary and fiscal policies. Christopher Allsopp, also a former member
of the MPC, pointed out that the policy mix was bound to be different as between the UK and
the euro area, because the UK had a one-to-one relationship between central bank and
Treasury, while in the euro area the ECB had a multiplicity of governments to deal with. The
UK was thus not a good model. The Treasury set fiscal policy taking into account the likely
monetary policy reaction of the Bank of England. Fiscal policy did not matter very much for
macroeconomic management, because it had become internal to a system controlled by the
Bank of England’s interest rate. In the euro area, governments had each to devise their own
fiscal policy against a common monetary policy over which they had no control. This led to
instability in that national fiscal policies might not be compatible with each other. The ECB
had in fact been more active against unemployment than against inflation, conforming to a
“Taylor rule” based on both output and prices, such as could be used to explain in the
behaviour of the US Federal Reserve. The main objective of fiscal policy should not be so
much the deficit or the debt, as the real exchange rate, which had to be controlled by working
on comparative labour costs, given no possibility of changing nominal exchange rates. This
could be done through incomes policy in smaller countries where it was easier to implement,
such as Ireland or the Netherlands.
The policy mix in the euro area was sub-optimal, according to Christian de Boissieu. There
was mistrust between the monetary and fiscal policy authorities, which had been a feature of
the French presidential election campaign, with candidates calling for changes in the ECB’s
remit. The ECB could have had lower interest rates if governments had had tougher fiscal
policies, although the cost of credit had not constrained the French economy. There should
be more powers for the Eurogroup, as the fiscal policy counterpart to the ECB. At present,
the Eurogroup discussed everything and decided nothing. The Stability and Growth Pact to
control public debts and deficits was a guarantee of sustainability of fiscal policies, but it was
not in itself a sufficient fiscal policy. There was a case for exempting public sector investment
from the fiscal deficit rules, on the lines of the British “golden rule”, which aims at balance
over the cycle in the current budget, but allows for a deficit to finance public investment for the
future. The Lisbon targets on domestic policies such as increasing employment were more
important than the fiscal-monetary policy mix. It was pointed out in the discussion that the
ECB had acted in a counter-cyclical manner, with low interest rates when the economic cycle
was low, but governments had acted pro-cyclically, allowing deficits to increase as the cycle
had turned upwards, instead of using better performance of the economy to carry out
structural reforms and curb deficits. Government fiscal policies in the euro area, unlike the
UK, got no feedback from monetary policy, which did not change in response to a single
country’s behaviour. The feedback had to be from the real economy, in particular from the
real exchange rate, based on relative unit labour costs.
The ECB had an impossible task in setting an interest rate suitable for all countries, according
to Derek Scott, who put forward the “Walters critique”, named after a former economic adviser
to Mrs Thatcher. The ECB interest rate was too low for high growth countries and too high for
low growth countries. If the high growth countries also had high inflation, their real interest
rate would be even lower, and if the low growth countries also had low inflation, their real
interest rate would be even higher. He predicted a crisis in the euro within the next five years
because of this. Neil O’Brien pointed to Italy as a country which needed higher interest rates,
but had been a free rider on the back of lower rates set by the needs of Germany and other
countries. He called for stronger market mechanisms to force a tighter fiscal policy on Italy
through higher bond rates.
Structural reforms
Senator Philippe Marini argued that there was no guarantee that the euro was sustainable,
and there was a question mark over its credibility. It provided illusory comfort behind a
protective shield, but what were the members doing behind the shield? There needed to be
more integration of producer prices, and more harmonisation of indirect tax to create a single
market corresponding to the single currency. Germany had done best in lowering its real
exchange rate by domestic fiscal and economic measures, but this had left France, Italy and
Belgium less competitive because they had not yet taken similar measures.
The real exchange rate within the euro area, and against the dollar and the pound, was widely
recognised as the main policy objective for member governments. Structural reforms were
needed in the wake of Germany’s success, with Portugal being the worst case, with low
growth and lagging productivity. France was somewhere in the middle, with structural reform
made more difficult because the country was neither in rapid growth making it possible, nor in
an outright crisis making it necessary. Reforms were not necessarily harder on the lower
socio-economic groups, pointed out Simon Tilford, because they might remove some of the
privileges of the “insiders” to the advantage of the “outsiders”. Reforms were judged more
acceptable in the UK than in France; the Rover car factory had been easier to close down
than a car factory in France would have been.
The inadequacy of structural reform was highlighted by Iain Begg, when he argued that the
euro area itself would not pass the five tests laid down by the British Treasury for the UK to
join the euro. There was not enough convergence, either in growth rates or in external
deficits. Flexibility was lacking in labour markets, particularly in France. Investment in the
public sector was made more difficult by the terms of the Stability and Growth Pact. The euro
had been good for the City of London, but this was an advantage to a non-member rather
than to the members of the euro. The euro might be good for growth and jobs, but this was a
future possibility rather than a present fact.
UK membership of the euro
The French seemed more interested than the British participants in whether or when the UK
would join the euro. Lord Radice, in his introduction, said that British entry was still
theoretically on the table, but no British Government was likely to want to join for several
years, because it would not want to risk its reputation in a referendum. The UK had continued
to prosper, while the economic performance of the euro area had been sluggish. This
perception was one reason for the lack of interest in the UK in joining the euro, Christopher
Johnson argued. He cited a recent study by Richard Baldwin showing the euro had brought
about a modest increase in trade among its members, and almost as big an increase with
non-members such as the UK, because firms which had invested resources in building up
exports were using them to export to both the euro and the non-euro countries in the EU. He
also drew attention to a recent poll showing that a majority of Europeans thought that the euro
had been bad for their own country, but not so bad for other euro countries – an example of
the “grass is greener on the other side” syndrome. The French say that the euro became
unpopular after its introduction in 2002 because shoppers noticed that frequently purchased
small items were rounded up in the new euro prices, but were not so aware that infrequently
purchased large items had become cheaper. He concluded that if in several years’ time all
the new members of the EU eventually joined the euro, it would be politically difficult for the
UK to stay outside. The UK might just slip into the euro when no one was looking.
Appendix i
BRITISH PARTICIPANTS
Co-chair:
Rt Hon Lord Radice
Chairman, Franco-British Council
Chairman, House of Lords
European Committee
Ann Kenrick
Secretary-General, FBC
Christopher Allsopp, CBE
New College, Oxford and Director, Oxford
Institute for Energy Studies
Former member of the Bank of England
Monetary Committee
Marcus Miller
Professor of Economics and AssociateDirector of ESRC, Warwick University
Edward Bannerman
First Secretary, Economics and Finance,
British Embassy
Iain Begg
Visiting Professor, European Institute,
London School of Economics
Marian Bell
Independent Economic Consultant
Former member of the Bank of England
Monetary Committee
Christopher Johnson
Economic consultant and writer
Former Chairman, FBC
William Keegan
The Observer
Neil O’Brien
Director, Open Europe
Henry Paker
Publications, FBC
Sir Peter Petrie
Former Advisor to the Governor of the
Bank of England, Former Chair, FBC
Former Ambassador to Belgium
Derek Scott
Former Economics advisor to Tony Blair
Deputy Chairman, Open Europe
Simon Tilford
Head of the Business Unit, Centre for
European Reform
Observer
Iona McCall
Economist, Macro Policy Projects, HM
Treasury
Appendix ii
FRENCH PARTICIPANTS
Coprésident :
Christian de BOISSIEU
Président délégué du Conseil d’Analyse
économique
Olivier GARNIER
Directeur général adjoint
Société Générale Asset Management
Philippe d’ARVISENET
Directeur des études économiques
BNP PARIBAS
Renaud GIRARD
Grand Reporter, Le Figaro
Agnès BENASSY-QUERE
Directrice du CEPII
Jean GUÉGUINOU
Ambassadeur de France
Président de la Section française du
Conseil franco-britannique
Jean-René BERNARD
Inspecteur général des finances honoraire
Vice-Président et Trésorier de la Section
française du Conseil franco-britannique
Jean-Pierre LANDAU
Sous-Gouverneur de la Banque de France
Alain BIENAYME
Professeur agrégé de sciences
économiques à l’Université de ParisDauphine
Pierre BILGER
Inspecteur général des finances honoraire
Sylvie BLUMENKRANTZ
Sous-directrice de la Section française du
Conseil franco-britannique
Laurent BONNAUD
Docteur en histoire de l’Université ParisSorbonne
Banque de financement et
d’investissement,
BNP PARIBAS
Guy CARRON DE LA CARRIERE
Professeur à l’Institut Catholique de Paris
Membre du Comité de rédaction de la
« Revue politique et parlementaire »
Françoise CROUIGNEAU
Rédactrice en chef international
LES ECHOS
Jean-Marie LE BRETON
Ancien Ambassadeur
Vice-Président de la Section française du
Conseil franco-britannique
Mathilde LEMOINE
Directeur des études économiques
HSBC France
Philippe MARINI
Sénateur de l’Oise
Rapporteur général de la Commission des
Finances du Sénat
Henri PIGEAT
Ancien Président de l’AFP
Président des Editions ILISSOS
Vincent REMAY
Conseiller du Président d’EURONEXT
Gérard ROUBICHOU
Secrétaire général de la Section française
du Conseil franco-britannique
Thierry WALRAFEN
Inspecteur général des Finances
Ministère de l’Economie, des Finances et
de l’Industrie