Black Wednesday Was White Only in Britain

Britain was not alone in leaving the European Exchange Rate Mechanism in 1992. But it was alone in its strong economic performance post-Black Wednesday. In a radical reversal of conventional wisdom about the EMU debacle, a distinguished US economist finds, in a paper publishd by CEPR, that in the other five countries which were expelled from, or left, the EeRM at the same time, economic growth was largely eaten up by inflation and real growth was no higher than that achieved by those who stayed in. Professor Robert J Gordon (Northwestern University, Illinois and CEPR), says that the frequently-made comparison between Britain and France is misleading, as the UK was the only country in the group of eleven ‘stayers’ and ‘leavers’ where unemployment was lower in 1996 than in 1991.

The ‘stayers’ studied by Gordon are Austria, Belgium, France, the Netherlands and Switzerland. The ‘leavers’ are Britain, Finland, Italy, Portugal, Spain and Sweden.

The performance of what Gordon calls ‘the star performer’ among the leavers was entirely untypical of the group as a whole. He points to the country’s flexible labour force as one reason why, but also shows that the pound sterling had not become as overvalued against the Deutschemark as other ‘leaver’ currencies in the period before 1992. They had all suffered a considerable rise in the real effective exchange rate. After 1992, these five showed little difference in their economic performance from the ‘stayers’ – except in respect of inflation where outcomes were worse, often much worse. The rise in inflation occurred because of the effective devaluations. The writer shows that labour costs did not increase notably. That had its effect on real domestic demand, which declined over the period 1992-96 in Italy and Sweden and barely grew in Spain. That helped depress growth rates. These results owed much to the decision by the governments involved to apply the full rigour of the Maastricht criteria, which meant that any benefits of devaluation were counterbalanced by fiscal tightening.

It might be thought that Britain succeeded because the government was not bound by the Maastricht criteria. But Gordon has written that the exceptional performance of the UK in reducing unemployment and achieving real growth was not achieved by expansionary fiscal policy – “indeed the UK tightened its fiscal policy (measured by the shrinkage in its fiscal deficit as a percent of GDP) by about the same amount as the other five leaver countries, and by about the same amount as for the European Community as a whole.”

Gordon admits that the aftermath of the ERM collapse does not provide a clean experiment: “…the leaver economies might have experienced a more buoyant increase in output, and less of an increase in unemployment, if they had not been forced by their adherence to the Maastricht criteria to put their fiscal houses in order.” Inflation ate away 80% of the modest growth that did occur.

So there is no real evidence that the experience of September 1992 showed that the conventional wisdom about devaluation had been overturned. In the writer’s words, there was no “macro-economic free lunch.”

Notes for Editors:
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Robert J Gordon is Professor of Economics at Northwestern University Illinois, and a Research Fellow in CEPR’s International Macroeconomics programme.