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Vol. 75, No. 5
Posted 1993-09-01

The Vulnerability of Pegged Exchange Rates: The British Pound in the ERM

by Mathias Zurlinden

Between September 1992 and August 1993, the European Monetary System (EMS) endured its most serious crisis since it began in 1979. Cross-pegging their exchange rates in the framework of the Exchange Rate Mechanism (ERM), member countries were confronted with a string of speculative currency attacks. As described by Mathias Zurlinden, the near-collapse of the ERM provides a useful example of a speculative attack under conditions of easy access to foreign exchange reserves and free capital mobility. Concentrating on the British experience in the ERM during the crisis, Zurlinden finds that a necessary condition for a speculative attack is the markets' expectation that the central bank will shift policy as a result of the attack. He concludes that an unwavering commitment to a fixed exchange rate is critical to maintaining an effective exchange regime.

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