The Pound and Monetary Economic Policy Independence: A Summary of the Case for Retention

An ISR Business & the political-legal environment study


1. Introduction and overview

2. The lessons of the ERM experiment

3. The main arguments for keeping the pound and monetary policy independence

4. The claimed benefits of adopting the euro

5. The physical costs of converting the currency

 1. Introduction and overview

This article summarizes the main economic and political arguments for Britain’s retention of the pound and monetary economic policy independence. It is an edited extract from British Withdrawal from the European Union: A Guide to the Case For published by Industrial Systems Research. The article looks at the costs of Britain’s past involvement in the European Union bloc’s monetary economic unification project before outlining the key arguments for keeping the pound and independent flexible national interest and exchange rates. The case in short for Britain to stay out of the EU single currency project is that the overall business-economic and political-constitutional costs would substantially exceed any benefits.

2. The lessons of the ERM experiment

Britain formally withdrew from the European Union’s programme of Economic and Monetary Union (EMU) in 1992. This programme initially involved trying to fix the interest and currency exchange rates of the member countries and then developed into the creation of a single currency with a European Central Bank and a common monetary economic policy for the bloc as a whole.

The British government’s involvement in the Exchange Rate Mechanism (ERM) in the late 1980s and early 1990s was highly damaging both economically and politically. ERM involvement entailed the artificial political rigging or attempted rigging of interest and exchange rates at levels that were often quite unsuitable for the British economy. The dysfunctional consequences included:

inflation followed by deflation and the stifling of economic growth and investment;

loss of international competitiveness;

large scale business bankruptcies, unemployment, and housing repossessions; and

massive increases in governmentbudget deficits and indebtedness.

After a prolonged recession, economic recovery began almost immediately after the UK monetary authorities quit the ERM, allowed sterling to depreciate, and started to cut interest rates in 1992.

Among other things, the value of British exports to Continental Europe and the rest of the world rose by between one-third and one-half respectively over the next three-four years.

To date, Britain has continued to prosper outside the ERM and the EU’s Economic and Monetary Union programme. Its system of inflation targeting and independent management of monetary affairs by the Bank of England has proved highly credible in the international financial markets and has constituted a sound foundation for on-going economic growth and stability.

Overall, the ERM debacle provided a costly but instructive practical demonstration of the negative economic effects of EU membership – while the sustained economic gains that followed gave some indication of the potentially massive benefits that could result from British withdrawal from the EU bloc as a whole.

3. The main arguments for keeping the pound and monetary policy independence

Scrapping the pound in favour of the euro still has some keen and influential UK advocates. However, there is a powerful economic and political case for retaining the pound and UK national monetary economic policy independence. Major arguments in summary are:

1. the high business-economic and political costs of Britain’s past involvement in international interest and exchange rate rigging schemes in general, and the EU’s Exchange Rate Mechanism in particular: economically inappropriate rates producing inflation/deflation, unemployment, bankruptcies, and negative housing equity (etc.);

2. significant deficiencies in the policy aims and methods of operation of the European Central Bank – in particular, the mandatory sole emphasis on keeping inflation low and ignoring problems of low growth and unemployment in particular national economies and the euro-zone as a whole;

3. low British inflation and the generally sound management of monetary affairs in the UK by the Bank of England since it became politically independent in 1997;

4. continued comparatively high levels of foreign inward investment, economic growth, international export success, and employment in Britain outside the euro-zone;

5. the irrelevance of the euro and the issue of UK euro-zone membership to the success and workings of the City of London as a global financial centre;

6. the irrelevance of such claimed benefits of a single currency as transaction cost savings and ease of doing business so far as the great bulk of British domestic commerce and foreign trade is concerned;

7. the fact that now the euro has been introduced into Continental Europe and euro-denominated bank accounts, credit cards, and hedging facilities (etc.) are readily available in Britain, there would be virtually no significant additional gains to be had even by dedicated UK euro-zone traders from replacing the pound with the euro;

8. the persisting lack of real sustained convergence between the British and Continental EU economies in terms of inflation, interest rates, overall demand and supply capacities, housing markets and finance, international trade patterns, and other structural-cyclical variables – and thus the continuing requirement for Britain to have its own, differently-oriented set of monetary economic policies;

9. the general economic benefits of having independent, flexible exchange rates and scope for national currency devaluations to help cope with problems such as low productivity or lack of international cost-competitiveness in the short- to medium-term;

10. the danger that if and when Britain entered the euro-zone, the pound (like e.g. the German mark) would be permanently fixed against the euro at an overly high rate of exchange – with seriously negative implications for UK export price competitiveness and/or import costs;

11. the on-going requirement for sterling to have different global foreign exchange rates from Continental European currencies because of the greater internationalization of the British economy and the very different world trading and investment relationships that many of its major firms and industries have;

12. the comparative weakness and/or instability of the euro for much of the period since its launch – caused by such things as widespread lack of market confidence in the currency, continuing large net outflows of capital from the euro-zone, and various intractable structural problems as well as cyclical economic factors;

13. the fact that British trade with the euro-zone has not been adversely affected by retention of the pound. Indeed, since the euro’s launch, British exports to the euro-zone have risen and imports have fallen – both during periods of a weak euro/strong pound and periods of strengthening of the euro as a result of comparatively high interest rates (etc.);

14. the limited general relevance of average UK manufacturing price competitiveness and export profit margins vis-à-vis the euro-zone to the British economy – mainly because of the UK’s much greater dependence on the sale of higher-value-added products and services, Britain’s more globalized trade and investment relationships, and the major importance of the pound-US dollar exchange rate;

15. the general economic advantages of having independent, flexible interest as well as exchange rates. Without these, monetary policies cannot be geared to national economic requirements;

16. the danger that after it joined the euro-zone, Britain – like (say) Germany or Ireland – would be saddled with fundamentally inappropriate base interest rates: either too high or too low;

17. the disproportionately large economic effects that any given changes in base interest rates by the ECB would have on Britain inside the euro-zone because of the much greater magnitude of variable short-term mortgage, personal, and business overdraft debt in the UK;

18. the major negative effects on economic stability and performance in Britain of losing the capacity to expand or contract the money supply in line with real national economic activity and growth levels, losing national control of monetary policy generally, and having to resort to inadequate and dysfunctional policy alternatives such as manipulating tax rates or imposing prices and incomes policies. Euro-zone rules state that governments should not go into temporary budget deficit even during cyclical economic downturns “except in exceptional situations”. In practice, national governments have regularly breached the cap on national budget deficits exceeding 3% of GDP.

19. the likelihood that EU monetary union will be followed by fiscal union – involving direct central bloc taxation, increased cross-border financial redistribution, and moves to raise comparatively low national tax rates (in Britain and other countries) up to a common EU standard;

20. the negative effects of loss of monetary and associated fiscal and general economic policy independence on national political independence and democracy;

21. the high costs of physically converting notes and coins, vending machines, tills, and accounting systems (etc.) from sterling to the euro; and

22. the strong possibility that the EU single currency project will eventually collapse altogether (e.g. as a result of persistent chronic national fiscal deficits) in the same way that other experiments in international currency union have failed in modern history – thus necessitating further massive effort and expenditure in reintroducing sterling and converting back from the euro.

In short, the case for Britain to stay out of the EU single currency project is that the overall business-economic and political-constitutional costs would substantially exceed any benefits.

4. The claimed benefits of adopting the euro

Supporters of the single EU currency project have claimed that British exporters, importers, and tourists would benefit considerably from UK membership. It has been alleged that their foreign exchange transaction costs would be substantially reduced and that they would face fewer risks and difficulties caused by a fluctuating and/or over-valued currency.

However, trade with the Continental EU is only a very small portion of total economic activity in Britain. The great bulk of British commerce (up to 90% annually) is purely domestic. Over 97% of British businesses have no significant on-going trading relationships with Continental EU buyers and sellers at all. Overall, less than 15% of British total output is exported annually to the rest of the EU and only around 15-20% of British export-oriented direct overseas investment goes to EU countries. Not only is the annual volume of EU trade much smaller than non-EU, it has also been much less profitable than non-EU trade over the years. Britain has had a persistently adverse trade balance with the rest of the EU since it joined the bloc.

Even before the euro’s launch, it was estimated that savings in sterling-euro transaction costs from abolishing the pound would only amount to 0.1-0.2% of GDP annually. The transaction costs on (majority) non-EU trade would of course still remain. However, now that the euro has been introduced any potential savings on EU transaction costs have been reduced still further by the fact that:

British traders with the main Continental EU economies now no longer have to deal in multiple currencies but in only one or two; and

free or cheap euro-denominated current bank accounts, international credit and cash cards, and direct debit and other facilities by which Britons can pay euro-zone suppliers are readily available.

Most of the alleged costs, complications, and risks of multiple exchange rates, currency fluctuations, or lack of product price transparency and comparability in Continental trade and markets (etc.) have disappeared now that British and other foreign traders have only one currency to change their pounds, dollars, or yen (etc.) into when buying and selling in the euro-zone.

Promoters of the euro have also argued that its adoption would substantially enhance price transparency, choice, and competition across the EU. However, the largely English language-based internet with additional language translation and instant price comparison and currency conversion facilities also does this – and on a global rather than merely West European regional scale.(1)

Thus there would be little or no benefit even to dedicated British euro-zone exporters and other traders operating in the main Continental EU markets from abolishing the pound – while all the massive political-economic costs of euro membership to the British economy as a whole would remain.

5. The physical costs of converting the currency

If Britain were to join the EU’s monetary union project, the physical costs of replacing the pound with the euro would amount to many billions of pounds. These conversion costs would have to be borne by all UK businesses and households even though (as said) less than 15% of British commerce is actually with the euro-zone.

The main direct conversion costs to businesses would be those of:

changing prices, tills, and vending machines;

adapting computerized and manual records, accounting, and other systems; and

providing staff training and customer information.

Forecasts of the costs have varied. Lloyds-TSB bank has estimated that the average cost of the changeover to a British small or medium sized firm would be £2,000, and that the total UK conversion cost would amount to £6 billion. However, accountants KPMG have warned that the average large company with more than 5,000 employees would face a substantial multi-million pound conversion bill. The accountancy firm Chantrey Vellacott has estimated that the total cost to British business of converting to the new currency would be around £32 billion. On top of this, they calculate that the cost to central and local government of currency conversion would be £3.4 billion.

In addition to its own in-house technical-operational costs, the UK Treasury would have to:

pay for the printing of the new money;

contribute to the on-going annual running costs of the European Central Bank; and

hand over 80% (or more than £20 billion) in UK official gold and currency reserves to the ECB for management.

However, whatever the precise costs of initial physical sterling-to-euro currency conversion, these would pale alongside the massive on-going costs to the British economy of adopting fundamentally inappropriate euro-zone interest rates and/or being locked into an uncompetitive and inflexible regional currency exchange rate in an increasingly globalized economy.


1. See e.g. Electronic Future or Euro Past? How the Internet is Leaving the Euro Behind, Business for Sterling, 2000.

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Further reading from Industrial Systems Research:

British Withdrawal From the European Union: A Guide to the Case For 

Thumbnail Brit withdr. EU

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