That might create room for a somewhat lower interest rate in this area in the coming years and thereby ease the situation for the consolidation of government finances in the countries with the greatest problems. At present, however, there are no mechanisms for bringing such a policy about. Thirdly, even if the fiscal position in all the countries in question were now in good order, the tradeoff between fiscal and monetary policy raises issues for which there are still no ready-made solutions. Let us take the hypothetical case of a falling stock market in the United States that pulls the dollar down. The recent trend would then be reversed into an appreciation of the euro. That would be liable to check the recovery of manufacturing in the euro area. What should the EU finance ministers do? One possibility would be to go for an overall tightening of fiscal policy in order to pave the way for lower interest rates and a weaker euro. As things stand, however, it is not clear how this could be done in practice. Once again we face the question of the restriction’s distribution among the participating countries. These three interrelated issues are all important. The solutions are hardly self-evident, partly because they involve the difficult balance between national concerns and matters that should be decided at union level. Conclusion The euro’s introduction in eleven countries in our part of the world is the biggest economic policy change in Europe for decades.
Although the burden of servicing these debts is currently manageable because of the low level of mortgage interest rates, concerns about future servicing costs as interest rates normalise may lead the high stock of outstanding debt to weigh on these households’ spending. The possibility of unemployment may also encourage saving, though happily unemployment has so far risen by less than many observers, including the Monetary Policy Committee, feared. The relative robustness of employment, given the depth of the decline in output, owes something to the willingness of employees to accept low pay awards in the face of the downturn. Last year over a third of private sector pay settlements were pay freezes, and a recent survey of their business contacts carried out by the Bank’s regional Agents points to a similar outcome this year (Chart 2). Third, the Government allowed the fiscal deficit to rise in response to the downturn. That was helpful in cushioning the fall in demand. But the deficit now looks set to be around 12% of GDP this year, which is unsustainable in the medium term. That creates a difficult balancing act. Cutting spending and/or raising taxes is likely to result in lower domestic demand, though a failure to do so may lead long-term interest rates to rise, also hitting demand. The recent depreciation of sterling appears to owe something to heightened fears about the UK’s fiscal prospects.