Conflicting needs

But all this being said, the ERM did prolong the British slump, as it prevented UK rates from being cut to the levels justified by the UK economy. It was a nasty taste of a one-size-fits-all interest rate policy, as it was actually a German interest rate policy, set for Germany by the Bundesbank, which was the anchor currency of the whole system.

The mainstream view today is that fixing exchange rates as we did in the ERM is bound to fail

That tells us that the ERM may have worked better, if the interest rates had been set not by Germany for Germany, but by Europe for Europe (as they are in the euro).

At the time of the September 1992 crisis, most of Europe − including Britain, France, Italy and to some extent Spain − wanted lower rates. But it was the Bundesbank who effectively decided what rates were.

Nevertheless, even if rates had been set on a pan-European basis, the ERM would undoubtedly have had some problems at some stage.

There are times when the economic policy needs of one country, conflict with the needs of the other countries.

What does it mean for the euro?

For what it is worth, the mainstream view today is that fixing exchange rates as we did in the ERM is bound to fail. Any strain in the system caused by conflicting policy needs will be exploited by speculators, who will destroy the currency parities. In effect, that means for most large mid-sized countries (such as Britain, Argentina, Turkey, France or Brazil) there is a simple choice − a freely floating currency, or a shared currency like the euro.

Personally, I don't think the ERM experience tells us very much about how successful the euro will be. The euro has benefits in terms of convenience and transaction costs that the ERM never had; and the euro can't be ripped asunder by currency speculation. But the euro can involve totally inappropriate economic policies being imposed on countries.

It is no wonder that while pro- and anti-euro campaigners agree the ERM was a mistake, they do not agree on which route we should now follow.

(Source: http://news.bbc.co.uk/2/hi/ business/2259648.stm)