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Black or White Wednesday UK ERM membership in retrospect Samuel Brittan: Talk at Institute of Econ. Affairs, 16/09/02 The UK departure from the European Exchange Rate Mechanism 10 years ago was called Black Wednesday because of its effect on the fortunes of the Major Government which had staked so much on membership. It was called White Wednesday by those who hated an exchange rate objective and were delighted to break free. I wish I could be sure that that was the only reason and that their delight had nothing to with the word European in front of ERM. At the risk of boring you to tears I have to say that even in retrospect I regard the event as neither black nor white but, like so much in human affairs, as an indeterminate shade of grey. I would in fact agree with what Norman Lamont said a few years later: that joining the ERM was of great help in getting down the rate of inflation in the UK; and that leaving it was an important element in the recovery from recession. Could the process have been smoother and less traumatic with a different policy regime? The main policy development since 1992 has been the proliferation throughout the world of inflation targets as a way of allowing central banks to use their own discretion in terms of means and intermediate objectives, but holding them to account for the final result. I have always doubted whether these targets will turn out to be the last word; but in the past decade or so they have been more successful than many of us expected them to be. Could an inflation target regime have been introduced earlier on in the 1980s, when the main arguments about the ERM were taking place? We can rewrite history as much as we like. But, as far as I know, no high profile participant in the British policy debate urged inflation targets as an alternative to ERM membership. The first country to adopt them was New Zealand in 1990. They were adopted by the Major Government when it was trying to pick up the pieces in 1992; and since then they have spread like wildfire throughout the world in conjunction with operationally independent central banks. Nevertheless they hardly figured at all in the policy debates leading up to British ERM membership. Indeed, of all the people who have celebrated White Wednesday I doubt if one in a hundred remember or know what caused not merely several chancellors of the exchequer in succession, but many people in business, the City and academia to advocate us joining the ERM. The Thatcher Government, elected in 1979, was committed to a money supply policy for reducing inflation. But this ran into paradoxical difficulties from the very start. Between 1979 and 1981, judged by what was happening to the economy, to sterling and to inflation, the policy was, if anything, somewhat too tight. But the then official measure of money - the broad aggregate known as M3 was severely overshot. One or two people in this room were instrumental in bringing over Professor Jurg Niehans to examine the phenomenon. He argued that a much narrower definition of money was required. But no-one found a definition which did the job and carried street credibility. The last of the purely domestic monetary targets was known as M0 cash plus bankers' balances at Bank of England. Some Friedmanites mistakenly welcomed this as a move to Monetary-Base Control. But if you look both at what the Treasury did and said, it was nothing of the kind. Officials were attracted by M0 because they thought it had a rough, but very imperfect, relationship to economic conditions, to be precise to Nominal GDP. While all these arcane arguments were going on, some people were attracted by what became known as exchange rate monetarism. In British circumstances, this was to borrow the anti-inflationary credibility of the Bundesbank by an exchange rate link with the D-mark. The ERM was simply the mechanism by which the anchor was established. This was not just theory. Several countries - France and Austria for instance - managed to reduce their inflation rates by joining the ERM from the beginning in 1979 and making their realignments as small and as infrequent as possible. This was the background against which Nigel Lawson made his first bid to join the ERM in 1985, which was vetoed by Margaret Thatcher. There followed in 1987/1988 another attempt to shadow the D-mark without a formal arrangement. This too was brought to an end by the then Prime Minister. A third attempt by John Major who was then Chancellor, but soon to become PM, succeeded in 1990. No economic policymaker then thought of the ERM as a step to a European superstate. As there are some who regard currency mechanisms as matters of doctrinal purity, it is worth reminding ourselves that serious free market economists have long differed on these matters. The longest lasting fixed exchange rate system was known as the gold standard. When I first came into economic journalism, free market economists were split between those like Lionel Robbins who favoured sticking to a semi-fixed exchange rate under the Bretton Woods system and those like Milton Friedman who favoured floating exchange rates. My sympathies were all on the Friedman side. I even wrote a small book in 1970 advocating floating rates. Indeed I still believe that the rejection by the post-war Churchill government in 1952 of Operation Robot to float sterling represented the greatest missed opportunity in British economic policy since World War II. But unless we are just to parrot out slogans we need to be alive to changing circumstances. By 1990, when John Major took Britain into the ERM, something big had changed in the outside world. This was the fall of the Iron Curtain and the reunification of Germany. To offset the inflationary impact of the way in which this was carried out, the Bundesbank quite rightly raised interest rates in a way that did not suit many of the other ERM members. As the Jewish Day of Atonement has just come to an end I will put in my mea culpa here. I have no regrets about supporting the first two attempts at a D-Mark link. But I allowed the momentum of my own views to carry over into supporting the third and successful attempt in 1990 and not advocating departure or realignment in the following two years. They who are without sin will no doubt cast their stones at me at this point. FAST FORWARD Some people suppose that the debate on the euro is just a re-run of the ERM debate at a higher decibel volume. But it is really very different. The European Monetary Union - unlike Bretton Woods or the ERM - is not an exchange rate peg. It involves abolishing sterling altogether and relying for monetary stability on the recently established European Central Bank. I originally favoured joining the euro as the best way of establishing an operationally independent Bank of England. But now that it has been established in any case, the choice between the present MBC framework and relying on the ECB seems to me half a dozen of one and six of the other - a choice on which the Treasury is to elaborate on at massive length! On the purely economic question I now would side with the sceptics - for what some of you may regard as the strange reason that there is no real chance of establishing a strong European government; and therefore one size will not fit all. My main worry is that a No vote may encourage the sort of person who is opposed not merely to the European Union but to the European Charter of Human Rights - which long predates the EU and is now incorporated into UK law and is overseen by the Strasbourg Court. Fortunately, I do not expect to have to vote on the issue during the present parliament, as the chances of a referendum are now quite small.
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