Alice in Euroland

Date : 12 January 2003

To : The Editor, The Business

From : Nagindas Khajuria

Subject : UK & The EURO

Alice in euroland

Sir - Nagin Khajuria (Letters, 5/6 January) refers to your editorial a fortnight earlier in which you set out the ideal interest rates for certain euroland countries. Khajuria suggests that this is a pointless exercise since each country has the same exchange rate, via the euro, with the result that there has to be one interest rate set across euroland as a whole (it currently stands at 2.75%).

Khajuria is missing the point. Where a Euroland country's actual interest rate is significantly different to the optimum interest rate for that country's economy, the country concerned will suffer economic damage - typically, either unemployment will be too high or inflation will be too high as a result of having the wrong interest rate.

I currently compute that the UK needs an interest rate of 4.4%, and euroland 2.8% - close to the actual rates of 4% and 2.75%, respectively. I use the well-respected Taylor Rule, which expounds that the current interest rate for an economy at any given point in time is a function of that economy's inflation rate and output gap. I estimate that Germany currently needs an interest rate of 0%, putting the country in broadly the same position as Japan, which apparently needs (and, indeed, has) an interest rate of around 0%.

Germany's actual current interest rate of 2.7%, therefore, is hopelessly map propriate. The resulting economic damage being wrought - with the Germany economy barely growing at all and with soaring unemployment must be clear for all to see.