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FEERs and the ERM∗

Published online by Cambridge University Press:  26 March 2020

John Williamson
John Williamson*
Affiliation:
The Institute for International Economics in Washington.
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Extract

A number of economists, including the author, were critical of the central rate that was chosen when sterling entered the ERM in October 1990, on the ground that it overvalued the pound. Specifically, the central rate against the other ERM currencies implied a higher value for the pound than that yielded by calculations of ‘fundamental equilibrium exchange rates’ (FEERs).

The present paper aims to explain the concept of the FEER, introduced by the author in Williamson (1983), and argues that it provides the right criterion for assessing whether a currency is correctly valued. It also sketches the evidence for believing the pound's ERM central rate to be above the FEER. A final section considers the policy implications of the finding that sterling is overvalued.

Type
Articles
Information
National Institute Economic Review , Volume 137 , August 1991 , pp. 45 - 50
Copyright
Copyright © 1991 National Institute of Economic and Social Research

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References

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In an interesting recent paper, Simon Wren-Lewis (1991) points out that this implies that the FEER is not independent of the path taken to achieve equilibrium. Slower adjustment by a deficit country will imply a larger transitional deficit, a larger debt that needs to be serviced, and hence a more competitive FEER.Google Scholar
See their publication The International Economics Analyst.Google Scholar
Thus the PPP exchange rate is £1 = DM 3.14 if £1 will buy the same bundle of goods in Britain as DM 3.14 buys in Germany. (This is the latest Goldman Sachs figure, from the June 1991 issue of The International Economics Analyst, table 1.)Google Scholar
This analysis was undertaken prior to German reunification being factored into the macroeconometric models.Google Scholar
Such interdependence arises if higher real wages, which are possible with a less competitive exchange rate, increase labour supply and thus diminish the NAIRU.Google Scholar