Gelato, Italian Elections, and the Euro...

Certainly the election campaign has been intriguing. Berlusconi had a decent enough lead a few weeks ago but Veltroni has plugged away and even Reuters are now saying it's too close to call... I suspect Berlusconi will win and be back in power... but hope Veltroni can do enough to hold the Senate at least. Actually there isn't much difference in economic policies between the two groups.

Meanwhile the people I pass in the streets look as well off as ever and seem to be enjoying life. Officially, of course, the Italian economy has been stagnant for the last few years with low or zero growth, with Italy struggling with membership of the Euro. Unofficially things seems a bit better off - indeed last year the Italian car market was the second most buoyant in Europe (maybe "it's the black economy, stupid").

For years Italy simply coped with higher inflation by depreciating the Lira and thereby stayed competitive. Now they can't do that. Clearly "a one size fits all" European monetary policy under the Euro is problematic.

Which brings me onto the Euro. The Guardian was asking on Saturday whether Britain should now reconsider joining given that the pound is at €1.20 and falling, and that locking in to such a competitive rate would benefit British exporters. Its view was that this would inhibit the ability of the Bank of England to cut interest rates further and that therefore we should stay out.

This seems to miss the point in that if the UK was to join the Eurozone, interest rates would come down anyway (UK rates are currently at 5% and Eurozone rates at 4%).

In fact, there remain some very strong arguments in favour of joining the single currency... in principle if not in practice. If Britain were to join then exchange rate uncertainty would be eliminated so there would be more trade and hence more growth.

Bear in mind that when BMW bought Rover back in 1994 when one pound bought Dm2.40. They invested heavily and budgeted for a turn-around plan with sterling in the range 2.70 to 2.80. When they sold out in 2000, sterling was at an effective rate of Dm3.30, and as much as 20% overvalued. In other words, there is a cost for staying out, namely exchange rate volatility, which messes up investment planning. Add in the elimination of transaction costs and access to cheaper finance (as interest rates would be lower) and I'd suggest that most Midlands businesses that trade internationally would benefit from us joining the Euro at such a competitive rate.

And yet. I said 'in principle if not in practice' as the Eurozone adventure still seems caught up on some overly rigid rules. Firstly, it has enshrined an overly Moneterist perspective at the heart of policy, aiming for price stability; here in the UK we aim for inflation of 2% - in other words a little bit of inflation is OK to oil the wheels of the economy. In the Eurozone we've probably seen higher interest rates than was really needed as a result, and slower growth as a result.

Secondly, the Stability and (No-) Growth Pact has effectively negated the ability of countries like Italy to stimulate the economy through fiscal policy, despite reforms in 2005. The UK's 'golden rule' has been criticised of late by the Tories, but it's much more sensible and flexible than the SGP, as capital expenditure is counted separately. It has meant more investment in schools and hospitals, which was badly needed after 1997. As the last Italian PM said when he was President of European Commission, the Stability Pact is 'stupido'. He should know, if anyone does.

So, despite some strong arguments in favour of joining, the Stability Pact still puts me off. Until it's reformed properly, we should stay out. A typical British attitude to Europe, I'd guess, unfortunately.

Right, gelato over and back to work.