My Lords, we are in the middle of the most serious economic crisis of my adult lifetime. It is more serious than when I was a Treasury Minister in my youth in the late 1960s, and it was bad enough then.
One of the most threatening aspects today is the weakness of sterling. However, the future of sterling outside the eurozone seems to be a taboo subject for both the Government and the Conservative Opposition. When I raised the issue of the pound and the euro last July, no one else took it up. The same was true in our debate on the economy last December, when the very mention of the euro produced a groan from the Conservative Benches. On the last occasion that I debated the issue, I mentioned as part of my concern the longer-term threat to the City if we stayed out of the eurozone, but the future of the City now seems a minor issue compared with the threat to sterling.
Why is the outlook for Britain particularly gloomy, as the IMF confirms? In addition to the banking crisis there is a serious question mark over the credibility and stability of the pound. A funding crisis combined with a currency crisis is an explosive mixture. We are dangerously exposed outside the comfort of membership of a big currency area such as the eurozone.
If there were a serious run on sterling we would face an appalling prospect. We might even have to put up interest rates and cut spending at the very time when we need lower interest rates and increased public spending. Even if, as we all hope and on the whole expect, we can avoid a serious run on the pound, in the longer term with our high public sector deficit, we are likely to have to maintain a much tighter monetary and fiscal policy than the eurozone, with much higher nominal interest rates to mop up the liquidity that we have created during this crisis. We will for some time be condemned to a lower rate of growth.
Before the credit crunch we were doing reasonably well. I suppose we were doing better than I expected, but not as well as the Government boasted. Our productivity deteriorated somewhat compared with the average of the eurozone since the launch of the euro, but again, the relative decline in our productivity, however serious, is a comparatively minor matter. More important, the eurozone's average cyclically adjusted deficit declined from 2.7 per cent of GDP in 2004 to 1.2 per cent in 2007. Ours increased and will be dramatically higher by 2010. If we had been members it is likely that our deficit would be lower because we would have needed a tighter fiscal policy to make up for lower interest rates. That is highly relevant to the biggest issue before us now—credibility and stability.
The pound is a barometer of international confidence. Its decline, however welcome to exporters, reflects the view of foreigners on the future of our economy. The pound has fallen dramatically in the past six months. The credibility of our fiscal policy is now in question, with the risks of holding sterling high and the rewards low and likely to become even lower. Why should anyone want to hold sterling assets? Foreign holders of sterling will want to reduce their exposure. The threat to the future of sterling is not just an immediate problem; it could well affect the level of foreign direct investment in the longer term. I have always thought that the possible decline in foreign investment in Britain was one of the strongest arguments for joining the euro. I confess that that did not happen—at least, not yet—but it is a real threat now.
Let me sum up the argument about the dangers of sterling in very simple terms. I am a very keen sailor. If you are sailing a small boat you can explore creeks and harbours that you cannot get into with a larger boat with a deeper keel. A small boat has its advantages. But if I am caught out in a force 10 storm, by God I want to be in a bigger boat. Our prospects would be a lot less threatening if we were comfortably in the eurozone.
When the issue is raised we are always told by the Conservatives that we must keep the right to set our own interest rates and keep a floating pound. I would seriously ask those who believe that these arguments are decisive to read the set of essays to which the noble Lord, Lord Lea, referred, which include some carefully argued and authoritative contributions from eminent economists and financial and other experts—I contributed but I do not count myself one of them. It is called Ten Years of the Euro: New Perspective for Britain. I recommend it. These essays show that the case for an independent monetary policy and a floating exchange rate is far weaker than is the current fashionable view.
Monetary policy works with time lags that can be very long, and its effects are variable and uncertain. It is often said, for example, that control over our interest rates is needed to prevent asset bubbles, but the deputy governor of the Bank of England has admitted that interest rates are not a suitable instrument for preventing asset bubbles. The dangers of bubbles are best dealt with by appropriate regulation, and our regulation failed. We are a small, open economy. One of the ways monetary policy has effect is through the exchange rate, yet that often goes up and down unpredictably. Foreign exchange markets are, in effect, a financial casino. Many fears, phobias and sudden mood changes motivate foreign exchange traders and their principles. A floating exchange rate is not a good stabiliser. The idea that we can set our own interest rates entirely to suit our own domestic circumstances is likely to prove somewhat illusory. It is likely that international considerations and influences will exercise an increasingly important influence.
There are other major advantages to being part of a large economy. Being a member of the eurozone would mean that, as a whole, it would be less important to specialise in financial services. The ratio of outstanding debt to GDP in a large economy is lower. Luxembourg and Ireland have highly developed financial services, but they have the eurozone as a source of liquidity. If they had not had that, they may well have followed Iceland. A large economy is too big to fail. The UK is quite large, and it is not likely to go bust, but as our currency is vulnerable, British Government-backed loans will have to be issued on unfavourable terms. To maintain aggregate demand, it is much more effective to stimulate action by co-operation than through national manipulation and exchange rate flexibility.
My final point is political. Co-ordination is going to be more important. We will require a new European regulatory regime. It will be very important to us, and what will be our influence? Denmark and Sweden, like us, wanted to retain their independent sovereignty, but Denmark, Sweden and new members now all want to join the eurozone. There has been a dramatic swing of opinion in Denmark and Sweden, quite apart from in Iceland. We are likely to find ourselves outside the zone and more isolated than in the past, and it is not likely to be splendid isolation.
More generally, to be a central part of an influential political group will become more important as we live in a very uncertain world. It is said that we are going to face the Asian century. It may be that we will. I am not sure; I do not know. What is going to happen in China? Will China maintain its prosperity without democracy? It is likely to face very considerable strains indeed. European co-operation will be more important than ever, and if we do not join the eurozone, our influence will be less than it has been.
We cannot join tomorrow. The Conservatives have a gut reaction against the European Union and have never been more anti-European. The Government are not anti-European in principle, as the noble Lord, Lord Lea, said. They are still committed to membership of the zone, but they seem scared to discuss the matter publicly. They are afraid of public opinion. Not to take the option seriously at this time is wholly irresponsible. We must recognise that opinion may change very suddenly. It changed very suddenly in Ireland; it changed in Denmark, and seems to be changing in Sweden. After all, it changed pretty dramatically during the referendum campaign of 1975, so to rule out the option is an irresponsible action, and the least the Government should do is to start a serious debate.