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Black or White Wednesday? Samuel Brittan The Financial Times 08/10/04 Who now remembers the European Exchange Rate Mechanism or ERM? In fact the euro was preceded by the ERM which in its time excited even more political passion than the euro in recent years. The ERM, like so many European moves, was based on a Franco-German initiative and started, without of course the UK, in 1979. It had become by the mid-1980s a system of fixed but adjustable exchange rates with the D-mark as the anchor currency. After the inconclusive attempts to regulate the British economy by means of rival measures of the money supply, the idea gained force that the UK could borrow the credibility of the D-mark by joining the ERM, and trying to minimise realignments, as France had already done. Owing mainly to the opposition of Margaret Thatcher, advised by Sir Alan Walters, UK membership was delayed until 1990. It lasted almost exactly two years; the government, by then headed by John Major, beat an ignominious departure on "Black Wednesday" Sept. 26, 1992 and the Conservative reputation for competent economic management received a blow from which it has yet to recover. The mere mention of the ERM provokes a shudder among British politicians. Even those in all main parties most keen to join the euro are adamant that the formal requirement of a preliminary period inside the ERM, should not be implemented. What killed ERM membership was the way in which the Kohl Government carried out German unification after the fall of the Berlin Wall in 1989. But on the purely British economic side, does the ERM episode deserved the censure it has subsequently received? Sir Alan Budd who was then chief economic adviser to the government in his Wincott lecture delivered on Tuesday. begged to differ. He believes "the case can be made that it was an economic triumph and marked the turning point in our macro economic performance.” The contemporary belief that the DM2.95 rate was too high and and monetary policy too tight. Sir Alan asks: "Too tight for what?” Both the initial interest rate increases, leading up to membership, "and their maintenance were essential elements in the defeat of inflation." Inside the ERM underlying inflation fell from 9.5 per cent to 4 per cent. "Norman Lamont, in the role of Ulysses, was tied to the mast, his eyes stuffed with wax, so he was unable to hear the siren calls for reflation. Nevertheless, "had we retained membership, we would have experienced further increases in unemployment, and although inflation no doubt would have fallen further, the price would not have been worth paying." Thus both membership of the ERM and the subsequent departure were inadvertently beneficlal. Moreover, the ERM episode paved the way for the operational independence for the Bank of England granted by the incoming Labour government in 1997. For the Bank was not asked to succeed where politicians had failed. It was asked to maintained the rate of inflation at 2½ per cent that it inherited. "The MPC has done a brilliant job... but it was not required to perform miracles. In the 12 years since the departure from the ERM the economy has performed well. Inflation has fluctuated around a low level, unemployment has fallen to levels which would have been thought inconceivable and output fluctuations have been kept within a modest range. This better experience began with the adoption of inflation targets after 1992 and continued after the change of government and formal independence for the Bank. The puzzling feature of the last twelve years is not the stability of inflation at a low level, but the continued drop in unemployment to levels which ten or 15 years ago would have been accompanied by an inflationary explosion and a crisis fall in sterling. There are clearly supply side elements in the explanation. Some people would put the emphasis on the delayed effects of the Thatcher government’s onslaught on union power in the 1980s. Others would emphasise Gordon Brown’s "welfare to work measures”, such as compulsory training and pressure and incentives on the unemployed to take work. A politically neutral analyst might give credit to both. But I would suggest that there is a third element. The first six years of the Labour government were characterised by a consumer boom which so far at least has not exploded in the way such booms have in the past. A clue is to be found in the behaviour of consumer spending at current prices. This rose by an average of 5.5 pc per annum in 1997-2003 - only slightly more than the 5.2 pc achieved by nominal GNP. As a matter of arithmetic this meant that consumer prices were rising less quickly than prices in general. Thus modest nominal pay increases have provided workers with a rising standard of living, even without the credit explosion, and there has been less need for high unemployment to moderate the pressure of wage settlements. The British economy may have moved still further towards high value services and specialised goods which can trade on more favourable terms than the old predominantly manufacturing goods. Even if this hypothesis can survive further investigation, we still do not know whether this is a continuing trend or a once-for-all gain which will reduce the scope for a further British economic miracle. So far Gordon Brown’s luck has held.
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