Business

Sir Mervyn, the UK and the euro

  • 16 May 2012
  • From the section Business
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Mervyn King
Bank of England governor Sir Mervyn King's comments carry weight

It would be bad news for the UK if the eurozone crisis ends in a messy break-up but it is not the worst-case scenario. The worst-case scenario is that the crisis does not end at all.

That was one clear message from Sir Mervyn King's forceful remarks on the euro crisis today.

The governor often says it's not his place to tell other countries what they ought to do. Then he often goes ahead and does it.

He talked of the eurozone "tearing itself apart" in a crisis that shows little sign of being resolved - because, unlike the UK and US, they have not confronted the solvency problems at the heart of the crisis head-on.

The European Central Bank, he said, had performed "heroically" in buying time for the eurozone's governments. But that time "had not been used to reach lasting solutions".

He has said similar things before, often forcefully. But in today's febrile atmosphere, his words carry more weight.

The same applies to his careful, but pointed, confirmation that the UK authorities have indeed been drawing contingency plans for a country leaving the euro, "and have been for some considerable time".

How would a messy continuation of the crisis affect us?

As usual, the BoE's new forecasts for inflation and growth do not allow for the possibility of a euro break-up, which they consider to be truly "incalculable".

But they do include the impact of continued uncertainty about it - for example, the fact that fears about Europe continue to push of bank funding costs.

The Office for Budget Responsibility (OBR) has made the same judgment in its recent reports. When it comes to forecasting models, the impact of a euro break-up simply "will not compute".

But, as I suggested to the governor in my question at the press conference, it's not just that the effects are uncertain - it's also that they may run in different directions.

If the departure of Greece and, perhaps, a few others results in faster growth for those economies than they would on the current trajectory - over 10 years, say - then the net impact on the UK could actually be positive.

That would be even more likely, if the short-term mess resulting from a "Grexit" turned out to be containable, as many hope but none can confidently predict.

As the OBR noted last year, it is also possible that a Greek exit would push down the UK government's cost of borrowing even lower, due to safe haven flows into sterling. In other words, it could save the government money, though it's pretty clear that a further rise in sterling would not be good news for the economy overall.

None of this is to say that a Greek exit would be a good thing for the UK. But it is important, as ever to consider the alternative scenarios for Greece and the rest of the eurozone.

None of those bode very well for the UK either.

As Sir Mervyn was at pains to emphasise, this is not a simple matter of "in or out" - or even, in David Cameron's rather undiplomatic phrase, "make-up or break-up".

Whether the eurozone ends up with 17 members or none, the governor seemed to be saying, is actually much less important than how and when the long-term imbalances at the root of the crisis get resolved.

European policymakers, I suspect, will not rush to thank him for his kind and timely advice. If he wants to lecture them about "resolving" the region's long-term debt and competitiveness problems, they might reasonably add, it would be helpful if he could include some specifics.

How exactly, for example, does Sir Mervyn think you could agree to restructure the private debt that is causing so much trouble, in an era of 24-hour news and round-the-clock leaks?

The lesson at the heart of Sir Mervyn's lecture is a useful one for UK policymakers. They tend to think that the messy survival of the euro would always be better for the UK than messy euro exits.

That could very easily be wrong.