Designing and Choosing Macroeconomic Frameworks: The Position of the UK after 4 years of the Euro

Fiscal and monetary policy framework have become increasingly popular as disenchantment with active stabilisation policy has increased. In order to maximise the gains in terms of welfare and output frameworks need to be designed to achieve targets efficiently and stabilise the volatility of the economy. We evaluate the current fiscal and monetary frameworks in the UK and the Euro Area, and suggest where they can be improved. The UK has notably worse productivity than the Euro Area, and the design of policy frameworks can be utilised to help remove this difference by promoting stability and raising investment. The UK economy went through major regime changes in the 1990s and as a result it has experienced more stable outcomes in the last few years. We evaluate the possible structure of outcomes if the UK remains outside EMU or becomes a member, and conclude that inflation, real interest rates and the level of government borrowing would be similar in both cases. However, it should be the case that further gains to stability and hence to potential productivity are available if the UK becomes a member of EMU. The UK and the Euro Area countries currently have economic cycles that are coherent, experiencing very similar cyclical positions. Although interest rates differ, it is clear that these small differences in rates have little impact on the cyclical position of these economies. In addition we find no evidence that output in the UK is excessively sensitive to changes in interest rates, at least when compared to the other large European countries.