Europe split by potty rules

Observations on the single currency

What if the pro-euro dream had come true on 9 June, with Gordon Brown announcing that the five tests had been passed and Britain was now preparing for an early referendum? No sooner would the "pro" campaigners have ridden out to battle than they would have been cut down in the crossfire of the latest dispute among the eurozone members. In recent days, there has been a very public row between the big spenders France and Germany, on the one hand, and the small but prudent countries and the European Central Bank on the other.

All countries need to maintain sustainable public finances, and in the UK the fiscal rules are designed to ensure this happens. But inside a monetary union, members have to agree the rules with other countries. In the eurozone, the Stability and Growth Pact limits budget deficits to 3 per cent of each country's GDP and sets a target of zero deficit on average over the longer term. Crucially, the rules were set at a time when inflation was seen as the main enemy. The real threat, however, now comes from low growth or deflation.

The problem is not just that the two largest euro economies, France and Germany, are currently breaking the rules, and propose to continue offending in 2004. Nor is it the fury of countries such as Ireland and Austria which have conformed to the rules, despite the economic and political costs. The deeper problem is that Europe apparently lacks the ability to change a set of rules that most people outside the Central Bank think is potty.

In the run-up to Brown's announcement, the pro-euro lobby argued that the rules don't matter because everyone breaks them. That is simply foolish. A second argument, that we have to join the euro if we are to change the rules, is almost as hard to sustain. Although the case for reform gets ever stronger, powerful voices still defend the status quo. Senior ECB officials insist the problem is not the Stability and Growth Pact but those countries that refuse to honour it. The UK would be dismissed as one of the recalcitrants if it had by now joined the euro.

Europe's fiscal rules are a bigger barrier to UK entry than the housing or labour markets. This autumn's intergovern-mental conference, coinciding with the appointment of Jean-Claude Trichet as the new head of the ECB (a Frenchman rumoured to favour reform), would be the ideal forum for change. But the UK, outside the eurozone and above the self-interested squabbling of its members, may turn out to have the best platform to argue the reform case.

Matthew Taylor is director of the Institute for Public Policy Research