Economists, of which I was one, from a range of economic policy persuasions supported the decision to enter the ERM in the autumn of 1990. A key argument underlying this view was the belief that ERM entry would act as a shock to wage-bargaining behaviour. Workers would realise very quickly that the rules of the game had changed, and that excessive wage increases would translate rapidly into unemployment increases. As a result, wage increases would be moderated, and inflation would fall.
In fact, the relationship between inflation and unemployment has been exactly the same post-ERM entry as it was both in the 1987-89 boom and in the 1980-82 recession. ERM has changed nothing.
In order to meet the Chancellor's target of 'Japanese' rates of inflation of around 2 per cent, unemployment in the UK will have to rise to around three and a half million and stay at that level for a number of years. This is not a price worth paying.
It is now imperative, in order to avoid Lord Rees-Mogg's scenario of prolonged recession, that UK interest rates are reduced sharply.
Economists who supported ERM entry at 2.95 marks should acknowledge their mistake in the light of the empirical evidence.
There would be some inflationary consequences of interest-rate reductions, but in the short term these would be beneficial. A few years of inflation at 7-8 per cent would help to erode in real terms the massive debts that have been built up as a result of the irresponsible Lawson boom years. Then, and only then, will the UK be capable of resuming balanced growth.
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