Mr Major’s Comments on the Exchange Rate Mechanism

Below is the text from John Major’s book “The Autobiography” regarding the Exchange Rate Mechanism (ERM), ISBN 0006530745, page 662.

JOHN MAJOR:

“The slowdown in the economy turned into a recession in the third quarter of 1990 - before we entered the ERM - a recession that deepened sharply until mid-1991 before languishing in the no-man’s land of negligible growth. There were those who criticised us, with hindsight, for joining the ERM. We joined at the wrong time, some said. Or at the wrong rate. Or we shouldn’t have joined at all. But few argued so at the time. The fact is that our monetary policy had lost credibility outside the ERM, and if we wished to lower interest rates - and keep them down - we had to be part of the Mechanism. Inside it, there was the chance that our monetary policy would be seen as credible again, and we could cut rates, as the ERM’s discipline would prevent a collapse in the exchange rate, hold inflation in a vice and force it down.

And so it did, and interest rates fell. It is not the case, as some have argued, that the British economy was only freed after Black Wednesday. During our membership of the ERM interest rates were continually falling - from 15 per cent on 4 October 1990, the day before entry, to 14 per cent upon entry: 13.5 per cent and then 13 per cent in February 1991; 12.5 per cent in March; 12 per cent in April; 11.5 per cent in May; 11 per cent in July; 10.5 per cent in September; and 10 per cent in May 1992. It was a period of waiting for inflation to drop and easing monetary conditions whenever we were able to do so.

Was our ERM membership a constraint on the speed at which we could cut interest rates? In the first year, I do not believe so: the Bank of England was still very anxious about the underlying inflationary pressure, and would certainly have resisted rapid cuts. To begin with, membership clearly made cuts easier, since it reinforced our anti-inflationary credibility. It was only in the final few months of our membership that the tensions between domestic monetary policy and exchange-rate management became acute.