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The Aftermath of the 1992 ERM Breakup: Was There a Macroeconomic Free Lunch?

In: Currency Crises

  • Robert J. Gordon

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.

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This chapter was published in:
  • Paul Krugman, 2000. "Currency Crises," NBER Books, National Bureau of Economic Research, Inc, number krug00-1, October.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 8694.
    Handle: RePEc:nbr:nberch:8694
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    1. Jeffrey A. Frankel and Andrew K. Rose., 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," Center for International and Development Economics Research (CIDER) Working Papers C95-052, University of California at Berkeley.
    2. Wyplosz, Charles, 1997. "EMU: Why and How It Might Happen," CEPR Discussion Papers 1685, C.E.P.R. Discussion Papers.
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