The Credibility of the United Kingdom's Commitment to the Erm: Intentions Versus Actions
The paper presents estimates of a model of the credibility of the U.K. commitment to its central parity against the deutsche mark during the period of U.K. ERM membership (1990-92). The measure of credibility used is the long-term interest differential with Germany. Credibility is decomposed into two aspects: an assessment of whether the government was truly committed to the ERM, and the probability that even a committed government would be able to continue to bear the unemployment costs. Doubts about the first aspect—which could lead to a self-fulfilling crisis—are shown to have declined steadily during the period of ERM membership, while the second aspect is estimated to have become increasingly important, due to rising unemployment.
IMF Working Papers