Freedom from the ERM is slightly illusory. The experience of the UK shows that having escaped the ERM, the Treasury is shadowing the DM 2.50 exchange rate, though without admitting it. The reluctance to cut interest rates below 6 per cent despite the weakness of the recovery lends support to this view.
The secret shadowing (or 'dirty floating') arises from the need that any government has in the present- day globalised financial markets to establish and maintain credibility. Credibility requires a discernible anchor in economic policy. Up to now, the mark has provided that. France and other countries with wider bands will soon discover that, after the first dose of realignment, life will go back to shadowing some anchor currency.
The main problem, however, that the ERM faces has been the perverse behaviour of the anchor currency country. The Bretton Woods system was destroyed when the anchor currency country - the US - behaved in a fiscally irresponsible fashion and tried to shift the burden of the Vietnam operation on the world by exporting inflation. In the ERM case, Germany behaved in a fiscally irresponsible way by refusing to face up to the cost of unification. Its independent central bank therefore decided to shift the cost of German unification by exporting deflation.
There is little hope that in the near future the mark can maintain its anchor position without inflicting even greater damage on the German economy and inviting further social unrest in what is already a troubled country. The Bundesbank remains the last old-fashioned monetarist central bank. It does not see what Nigel Lawson saw as far back as 1985: that once financial markets are deregulated, broad money supply figures lose their usefulness as a way of controlling the economy. Its autonomy insulates the Bundesbank from unpalatable truths. Perhaps the financial markets will bring home these truths in the near future.
The need will remain, in a system of fluctuating currencies, in a region of free capital and labour mobility, to arrive at some limits at which short-run fluctuations can be contained though the freedom to adjust is not lost. Dirty floating was widely practised in the Seventies, which brought about the European Monetary System as a response.
Once the shock of the current crisis has passed there will no doubt recommence a search for new anchors to regulate monetary and exchange rates. The need at the moment is to search for any arrangement that puts full employment and economic growth back at the top of the agenda. This, however, cannot be done at the level of the EC alone. Unemployment is a problem for all the OECD countries, as President Clinton emphasised on the eve of the G7 conference. The answer is to look for a revamped version of the Bretton Woods system, which for 25 years served to create a golden age of full employment. This task is most urgent.
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