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The Aftermath of the 1992 ERM Break-up: Was There a Macroeconomic Free Lunch?

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  • Gordon, Robert J
Abstract
This paper examines the macroeconomic aftermath of the 1992 breakdown of the European Exchange Rate Mechanism (ERM). The economic performance of six "leaver" nations is compared with five "stayer" nations that maintained a roughly fixed parity with the Deutsche Mark. Recent writing about post-1992, which I call the "conventional wisdom," reports that a surprising miracle occurred - the leaver nations are alleged to have enjoyed a burst of real growth and a decline in unemployment, all without any evidence of extra inflation. The results in this paper turn the conventional wisdom on its head. While the leaver nations experienced an acceleration of nominal GDP growth relative to the stayers, fully 80 percent of this spilled over into extra inflation, leaving only 20 percent remaining for extra real GDP growth. Virtually 100 percent of the nominal exchange rate depreciation passed through into higher import prices, and extra inflation would have been even more pronounced if it were not for quiescent wage rates, which the paper attributes to high unemployment. The absence of any significant stimulus to real output growth is attributed to fiscal tightening under pressure from the Maastricht criteria, which offset nearly all of the stimulus coming from the improved current account of the leaver nations.

Suggested Citation

  • Gordon, Robert J, 1999. "The Aftermath of the 1992 ERM Break-up: Was There a Macroeconomic Free Lunch?," CEPR Discussion Papers 2073, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2073
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    Cited by:

    1. Eichenbaum, Martin & Rebelo, Sérgio & Burstein, Ariel Tomas, 2002. "Why Are Rates of Inflation So Low After large Devaluations," CEPR Discussion Papers 3178, C.E.P.R. Discussion Papers.
    2. repec:onb:oenbwp:y::i:68:b:1 is not listed on IDEAS
    3. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2003. "Why is Inflation so Low after Large Devaluations?," CERS-IE WORKING PAPERS 0308, Institute of Economics, Centre for Economic and Regional Studies.
    4. Barry Eichengreen, 2000. "Solving the Currency Conundrum," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 29(3), pages 315-339, November.
    5. Kim, Yoonbai & Ying, Yung-Hsiang, 2007. "An empirical assessment of currency devaluation in East Asian countries," Journal of International Money and Finance, Elsevier, vol. 26(2), pages 265-283, March.
    6. W. Wascher & Palle S. Andersen, 1999. "Sacrifice ratios and the conduct of monetary policy in conditions of low inflation," BIS Working Papers 82, Bank for International Settlements.

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    More about this item

    Keywords

    economic Performance; exchange rate mechanism; Exchange Rates;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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