Should Britain have joined the Euro?

What is striking, looking back at Brown’s arguments, is the extent to which they reflected his obsession with “stability”. This was a chancellor who really did believe he had abolished boom and bust.

All of this looks like hubris now. Even as he delivered his verdict on the tests, Brown was presiding over the greatest boom and bust in modern British history. Barely four years later, shortly after he had taken over as prime minister, he was confronted with queues forming outside Northern Rock, the first of several British lenders to fail. The government had to spend more than £40 billion recapitalising the banks, while the budget deficit blew out to around 10 per cent of GDP. Though the boom had its origins far beyond Britain’s shores, the bust which his system was supposed to have made impossible proved fatal to his own career.

Still, Brown had reason to fear that euro entry could produce an even bigger boom-and-bust nightmare than the ERM debacle of 1992. That crisis was triggered when Britain had to keep interest rates high to defend the pound as the Bundesbank tightened to cool a post-reunification boom. Because British mortgages were almost entirely variable-rate, rate rises passed quickly through to borrowers, and house prices collapsed. George Soros – thanks to research by a junior member of his team, a certain Scott Bessent – bet that the government could not keep raising rates under sustained speculative attack. He was right.

Brown feared the same feature of the mortgage market would leave Britain vulnerable inside the euro. A study published alongside the 2003 assessment of what might have happened had Britain joined in 1999 backed him up: eurozone interest rates would have been inappropriately low for Britain, fuelling the housing boom and overheating the economy. He judged the same held true in 2003 – even though the gap between UK and eurozone rates had narrowed to around 1.75 percentage points – and that the fallout would have been far more painful in the euro, with much of the adjustment falling on the labour market.

Alternative Histories

Brown would later claim that the eurozone crisis vindicated him, given that Spain and Ireland suffered precisely the kind of boom and bust he feared. Britain had its own boom and bust, but it was much shorter, thanks to a sharp depreciation, a central bank quicker to embark on quantitative easing, and a government that could rely on that central bank as it spent billions bailing out the banks. It is hard to argue with that assessment. Indeed, the protracted trauma of the eurozone crisis, and its drag on growth across the continent, helped turn British sentiment against the European project as a whole by the time of the 2016 referendum.

Yet with the passage of time, it becomes harder to say who emerged best. With the exception of Greece, the former bailout countries have long since recovered their lost ground and are now growing faster than Britain, with falling debt ratios and lower borrowing costs. There is little evidence that the euro has held the former crisis countries back.

A stronger objection is that had Britain been in the euro when the crisis hit, it would have been too big to save and could have blown the single currency apart. More likely, surely, is that the eurozone would have been forced to innovate faster, creating facilities that would have let Britain borrow to recapitalise its banks had it been at risk of losing market access. In that respect, Britain inside the euro might have brought a quicker resolution to the crisis – and perhaps a more stable and prosperous currency area today.

Any counterfactual must also take account of the benefits forgone by staying out. Brown himself acknowledged in 2003 that these were real, and the Treasury estimated that membership could boost trade with the euro area by up to 50 per cent and raise national income by between 5 and 9 per cent over 30 years. Certainly, the pattern of British growth would have been very different inside the euro. The price of exchange-rate flexibility has been a higher cost of capital to compensate for greater volatility. That has surely shaped the kind of foreign investment Britain attracts, which has skewed towards financial flows routed through the City rather than greenfield investment.

The Tests Today

So what would a chancellor conclude if they ran the same five tests today, judged purely on the economics and leaving politics aside? Here is my verdict, taking each in turn:

• Convergence: Brown considered this test close to passed in 2003, and it would be hard to argue that it isn’t passed comfortably now. The gap between Bank Rate and the ECB’s main refinancing rate is down to 1.1 percentage points, and UK inflation is now at or below the euro area’s for the first time in years. More than 90 per cent of mortgage balances are now on fixed rates, removing the vulnerability that was exposed in 1992 and that most worried Brown.
• Flexibility: Brown judged this test a fail on the grounds that inside the eurozone, the UK would lose the exchange rate as a shock absorber, along with national control of interest rates and fiscal policy. But in the intervening decades, the eurozone’s fiscal rules have been honoured more in the breach than the observance, and during both the eurozone crisis and the Covid pandemic, the EU created instruments to help member states cope with shocks. Meanwhile, Britain’s labour market is more flexible than most, and would become more flexible still with the restoration of free movement. The biggest concern is that the single market itself still has too many internal barriers to trade and the movement of labour. With that proviso, I would judge this test a pass.
• Financial services: Brown judged this test passed in both 1997 and 2003. Since then, Brexit has cost Britain significant European business, while the higher cost of capital Britain now faces has been ruinous for the London stock market. Inside the euro, the ECB’s concerns over the clearing of euro-denominated transactions would fall away, since a London-based clearing house would come under ECB supervision and have a direct line to ECB liquidity; outside, London’s equivalence expires in 2028. Against these gains would need to be weighed the costs of EU regulation – though the UK would once again have an influential say in shaping it. What once seemed a slam-dunk pass may today be a qualified pass, subject to negotiation.
• Investment: Brown declared this test not met in 2003, primarily because he had concluded that the convergence and flexibility tests were not met. But I think he underestimated the long-term consequences of Britain’s higher cost of capital and exchange-rate volatility for UK investment. British governments like to congratulate themselves on attracting foreign direct investment, but much of this has taken the form of purchases of UK financial assets that have weakened the national balance sheet, while business investment has been among the lowest of any major economy. I would rate this test a clear pass today.
• Growth: Brown acknowledged in 2003 that his assessment of this test was largely a function of the first two. On the same basis, if those are met today, this one must surely be considered passed too. The caveat concerns the stability of the eurozone itself: banking union remains incomplete, capital markets are fragmented, and it is unclear whether the bloc could cope with a French debt crisis. Whether this test is passed is thus a political judgement rather than an economic one, and it hinges on whether you believe Jean Monnet’s dictum that Europe will be forged in crisis.

Stronger In?

On Brown’s own terms, then, the scorecard looks very different from 2003. But even if all tests were passed, euro entry would carry costs. Inside, Britain would give up the exchange rate that cushioned the blow in 2008, and the right of its central bank to buy its government’s debt without conditions. Any future shock specific to Britain would have to be absorbed through wages, jobs and fiscal restraint – the medicine Greece, Spain and Portugal were forced to swallow. That is a real trade-off, even if it is one that many of the most hardline Brexiteers, frustrated at Britain’s inability to tackle its fiscal challenges or deliver the supply-side reforms needed to boost productivity, now eye with new admiration. Sometimes there is value in an external constraint that removes the easy option of devaluation.

Besides, it is worth asking what Britain’s monetary sovereignty is buying it today. That brings us back to where we started. Britain currently pays almost a full percentage point more to borrow than Greece, more than France, and nearly two points more than Germany. A floating pound and an independent central bank did not spare Britain the Liz Truss debacle, when gilts and sterling fell in tandem. Nor have they spared Britain a cost of capital that has quietly starved it of investment for a generation. Inside the euro, Britain would not automatically borrow at German rates – as France is discovering, membership is no substitute for fiscal credibility. But it would gain access to the eurozone’s backstops and a voice on the ECB’s governing council, rather than being a price-taker.

What’s more, if the EU succeeds in building a genuine Savings and Investments Union, with far deeper capital markets and a larger supply of common safe assets, the euro’s role as a global reserve currency will grow. Britain as a euro member would then regain some of the “exorbitant privilege” it enjoyed when sterling was the world’s reserve currency, and which America enjoys today, bringing lower borrowing costs and a lower cost of capital.

Of course, those are big “ifs”, and a French bond crisis could yet bring the eurozone down: if France lost market access, it might prove too big to save without the kind of painful reforms its political system seems incapable of delivering. Even so, given the seismic costs of a break-up, geopolitical as well as economic, the pressure on governments and policymakers to “do whatever it takes” would be overwhelming. In any case, Britain would hardly be immune to a euro collapse, in or out of the single currency. Its own economic self-interest hinges overwhelmingly on the euro remaining a strong global currency.

My verdict is that while the domestic politics of the euro are far more toxic than they were in 2003, the economics point in a different direction. It would be hard for the Treasury today to argue that the bulk of Brown’s five tests had not been met. What would remain is a political decision, based on a judgement about the long-term stability of the eurozone and the willingness of the British public to agree to a significant pooling of sovereignty. That has implications for any future rejoin campaign. Those making the case for rejoin should not fall into the Brexiteer trap of treating euro entry as unspeakable. The honest answer is not “never”. It is: “Not now – but the case is stronger than you think.”

An extended version of this article was first published on Simon Nixon’s Wealth of Nations Substack as the second of a two-part series on Britain and the euro