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FOREX (Foreign Exchange Market ) - Essay Example

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The country’s economic welfare deteriorated soon before and after joining the ERM. Interest rates, inflation, and economic growth were critical to control as far as UK’s was concerned. Even after experiencing a boom in late 1980s, a…
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FOREX (Foreign Exchange Market )
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ERM and the UK 1992 Crisis UK’s entry into the ERM was short-lived. The country’s economic welfare deteriorated soon before and after joining the ERM. Interest rates, inflation, and economic growth were critical to control as far as UK’s was concerned. Even after experiencing a boom in late 1980s, a looming recession was inevitable. This recession became a recipe for the 1992 UK crisis. Before joining the ERM, UK should have considered domestic interest rates and their relationship to inflationary pressures in the economy. In essence, preventing the ERM would have required UK to reduce inflation and stabilize economic growth before joining the ERM.
#2
When UK joined the ERM, her DM rate stood at 2.95, slightly above the minimum requirement for the euro zone (Friedman and Woodford 182). In a bid to migrate the ERM loss, UK should have tried not to overvalue the pound. The overvaluation caused ripples in economic markets, allowing speculators to make profits at the expense of economic failure.
A graph of UK’s Inflation-Economic Growth Levels between 1982 and 1992

Source: Bank of England (http://www.bankofengland.co.uk/Pages/home.aspx)
Drawing from the above diagram, UK government could have migrated losses by avoiding buying of pounds using foreign exchange reserves. As the diagram suggests, 1990 and 1992 exhibits inhibited economic growth and significantly high inflation. Artificial overvaluation of the pound under such circumstances proved catastrophic to the UK.
#3
A Graph of UK’s Base Rates between 1985 and1993
Source: Bank of England (http://www.bankofengland.co.uk/Pages/home.aspx)
By 1992, UK base rates were on a decline trend as the above diagram suggests. However, the actual scenario on the ground was different. UK had revised interest rates upwards, an aspect that further accelerated economic failure. In response, UK left ERM, cut interest rates, and embarked on economic growth stimulation through inflation reduction, housing market corrections, and employment creation.
Works Cited
Friedman, Benjamin, and Woodford Michael. Handbook of Monetary Economics. Amsterdam: Elsevier, 2010. Print. Read More
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