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- Path: sparky!uunet!mcsun!uknet!edcastle!fofp
- From: fofp@castle.ed.ac.uk (M Holmes)
- Newsgroups: sci.econ
- Subject: Re: how does European Exchange Rate Mechanism work (UK vs. Germany)?
- Message-ID: <28075@castle.ed.ac.uk>
- Date: 12 Nov 92 18:53:47 GMT
- References: <1992Nov11.153842.11930@vision.ummed.edu>
- Organization: Edinburgh University
- Lines: 56
-
- lml@vision.ummed.edu (Lawrence Mark Lifshitz) writes:
-
- >I am trying to clear up a lack of understanding in how parts
- >of the European Rate Mechanism (?) currency exchange rates
- >work. Last month there was this big hullabaloo about how
- >the UK was outside of its exchange rate bounds with Germany.
- >The UK ended up pulling out of the system because it's bank
- >couldn't maintain the rate within the specified range.
-
- >Question: why did the UK have to take the onus for the
- >problem and not Germany?
-
- They both did. The German central bank bought Sterling for Deutschmarks
- to help out as they were supposed to. It's now up to the UK to refund
- the money spent.
-
- >I don't mean from an economic
- >stance, eg, the UK mismanaged their economy so the exchange
- >rate couldn't be maintained. I mean how do the powers
- >that be (whoever they are) decide that the UK is the one
- >which is in violation of the ERM rules? After all, it
- >takes two to define an exchange rate. Why wasn't Germany
- >worried about violating the ERM rules?
-
- Technically the exchange rate of all the currencies is against the ECU
- which is a weighted basket of the 12 euro currencies. Since the German
- Mark is the strongest currency, the formula in effect means that this is
- the one that comparisons are made against. The rules of the ERM specify
- that currencies must be within a specific range as compared to the
- currently strongest currency.
-
- Unfortunately, when Major and Lamont blew it, much of the macroeconomic
- policy depended on the ERM. UK policy was in effect to try to hold the
- line with the Pound overvalued against the DM. The idea was that keeping
- interest rates at the level necessary to do this would keep monetary
- policy tight.
-
- It worked quite well for two years in terms of the aim: to get inflation
- down. It came down from almost 11% (mainly caused by an asset boom in
- property prices feeding through) to just under 4%.
-
- Other problems, like the puncturing of the property boom, required that
- interest rates be lowered for political reasons. In the end, they
- lowered them too far and currency traders correctly guessed that the
- government wouldn't have the guts to defend Sterling with significantly
- higher interest rates. A tactic which the Swedes proved was effective.
-
- Our government caved in after about four hours. Which is admittedly,
- something of a record holdout for them nevertheless. They now have
- caving in to pressure down to such a fine art that by the time the
- newspapers get out, the government has usually changed its mind about
- something.
-
- FoFP
-
- "No, I've changed my mind....." - Spitting Image caricature of John Major
-