The Exchange Rate Mechanism Explained

Many people in the UK will remember the ERM or Exchange Rate Mechanism, but for those new to the subject and economic terms, it might be a confusing idea.

This system did not last long, as the UK only entered it actually in 1990, at a particular exchange rate which happened to be against the German deutschmark at the time.

What that meant was that to then maintain that exchange rate there needed to be a link between inflation levels in both economies, as expected by the purchasing power parity theory explained in a different article.

Otherwise Sterling would either deteriorate or do better, and these changes are not allowed under the ERM mechanism.

The system did not work, at least for the British currency, and as a result the pound sterling was only in the ERM for a couple of years, leaving as it did in 1992.

Since that time to the current date, the sterling currency has simply floated against the other currencies out there.

Whether the UK will eventually join the Euro and replace the oldest currency that is still around will be something that remains to be seen, however it does not appear that Britain will be set to adopt the Euro anytime soon.

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