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

  • 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6964.

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Date of creation: Feb 1999
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Publication status: published as The Aftermath of the 1992 ERM Breakup: Was There a Macroeconomic Free Lunch? , Robert J. Gordon. in Currency Crises , Krugman. 2000
Handle: RePEc:nbr:nberwo:6964
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  1. Gordon, Robert J, 1996. "The Time-varying NAIRU and its Implications for Economic Policy," CEPR Discussion Papers 1492, C.E.P.R. Discussion Papers.
  2. 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.
  3. Charles Wyplosz, 1997. "EMU: Why and How It Might Happen," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 3-21, Fall.
  4. Alesina, Alberto Francesco & Perotti, Roberto & Tavares, Jose, 1998. "The Political Economy of Fiscal Adjustments," Scholarly Articles 12553724, Harvard University Department of Economics.
  5. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1), pages 51-144.
  6. Sergio Rebelo, 1997. "What Happens When Countries Peg Their Exchange Rates? (The Real Side of Monetary Reforms)," NBER Working Papers 6168, National Bureau of Economic Research, Inc.
  7. Andrew K. Rose & Lars E.O. Svensson, 1993. "European Exchange Rate Credibility Before the Fall," NBER Working Papers 4495, National Bureau of Economic Research, Inc.
  8. Sergio, R., 1997. "What Happens When Countries Peg Their Exchange Rates? (The Real Side of Monetary Reforms," RCER Working Papers 441, University of Rochester - Center for Economic Research (RCER).
  9. Assar Lindbeck, 1997. "The Swedish Experiment," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1273-1319, September.
  10. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  11. Maurice Obstfeld, 1995. "Intenational Currency Experience: New Lessons and Lessons Relearned," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(1, 25th A), pages 119-220.
  12. Alberto Alesina & Roberto Perotti & José Tavares, 1998. "The Political Economy of Fiscal Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 197-266.
  13. McKinnon, Ronald I, 1997. "EMU as a Device for Collective Fiscal Retrenchment," American Economic Review, American Economic Association, vol. 87(2), pages 227-29, May.
  14. Menon, Jayant, 1995. " Exchange Rate Pass-Through," Journal of Economic Surveys, Wiley Blackwell, vol. 9(2), pages 197-231, June.
  15. Kenen,Peter B., 1995. "Economic and Monetary Union in Europe," Cambridge Books, Cambridge University Press, number 9780521558839, Junio.
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