The UK’s £1.7 billion surcharge is the big thing in UE/UK news right now. It’s in the interests of Cameron and Osborne to present this surcharge as a serious problem for two reasons. Firstly, because it presents the EU in a negative light forcing us to part with pounds at a time when we need them all, and secondly because it’s an opportunity to spin themselves as heroes, even if only in that they publicly resist it. Although they managed to totally **** that up. ALittleEcon describes the situation here.
The question is why should we be worried about this? Well, as far as I can tell even if paying the surcharge causes a problem for us, which is questionable, the problem is not at all what we are supposed to think it is.
We are supposed to imagine that we can only pay this bill if we give something else up. We need to give up a hospital or something. What actually happens when the government pays this bill? Someone at the Bank of England opens a spread sheet, finds the row that represents the EU’s bank account, and increments it by 1.7 billion. That’s it. They don’t have to raid any savings, or some budget. They don’t have to find a pile of cash somewhere. There is no bank account they withdraw from. They just press some keys and that’s that. No budgetary effects at all. If they then choose to subtract the same amount from somewhere else that’s purely up to them. Incidentally, the talk about the interest that might or might not be incurred is ridiculous. The government can pay that bill any time they want regardless of how big it is, so if they could only be forced to pay late fees if they choose to put off paying it, but there is no intrinsic reason for them to wait. Again, they don’t have to get the money from anywhere.
The EU can then do two things with the pounds in that account. They can buy things from the UK or they can trade it on the currency exchange market. If they buy things from us then, obviously, the pounds go right into one of our bank accounts. That would have some effect on prices. What effect? No-one has of yet provided a model to figure that out so there is no way to know. Anybody buying anything has a similar effect but we rarely stress about that.
The only clear effect of our government issuing the pounds needed to pay the surcharge is it’s effect on the exchange rate. You have to accept that the law of supply and demand holds, which is shaky but, assuming it does, if we increase the supply of pounds by some factor then it’s value should drop by the same factor. If we double the number of pounds in circulation then we would halve it’s value. In theory… which they call a law. So the magnitude of the effect is equal to the magnitude of the change of supply… right? We know the change is £1.7 billion, but what’s the total supply of pounds? If you go to the Bank of England website they have data on this. I think it’s at about £1.5 trillion. That puts this theoretical total effect on exchange rates in the range of about 0.1% over some period of time. To put this in perspective the Pound:Euro exchange rate has moved around over a range of 10% over the last couple of years. We’d have to issue 100 times this surcharge just to get back to 2012 rates.
Would this flicker in exchange rates be bad? Who knows. It would (again assuming theory holds) make imports more expensive and exports more profitable. Is this enough to warrant offsetting the pounds placed in the EU’s bank account by taking the same number away from some other public services? Given that our public services are being strangled to death through lack of investment I imagine that the theoretical exchange rate blip is a better choice.