The Politics of Forex

The exchange-rate politics differed considerably in Britain, France, and Italy in the 1990s. The Thatcher government in Britain abandoned its focus on domestic monetary developments by joining the exchange-rate mechanism (ERM) of the European Monetary System (EMS) in 1990. But less than two years later, the government reverted to form by withdrawing from the ERM, allowing sterling to float, and focusing on keeping inflation low rather than on stabilizing the exchange rate.

French governments gave greater attention to exchange-rate stability than to growth and competitiveness, reversing the priorities of the 1970s and 1980s. The French raised interest rates to defend the franc's ERM parity and cut the budget deficit during a period of slow economic growth, which provoked sharp domestic political conflict but did allow the country to meet the Maastricht Treaty's criteria for participation in monetary union in 1999.

Italian governments also were committed to participating in the single currency but pursued a quite different set of economic policies to achieve this goal. They initially strengthened their commitment to European monetary institutions by refusing to devalue, eliminating capital controls, and narrowing the lira's fluctuation band in the early 1990s. But they withdrew the lira from the ERM in 1992 in the face of large-scale foreign exchange market speculation and allowed the currency to depreciate sharply until 1995.

Thereafter, they rejoined the ERM and quickly reduced a very large budget deficit to join the single currency. The evidence presented in this article supports the institutionalist explanation rather than the openness explanation for exchange-rate politics. Variation in bank-industry ties was associated with differences in groups' preferences and governments' policy choices, although in some cases the relationship was weaker in the 1990s than in earlier decades.

Increased openness to trade and investment with Europe did not lead to changes in groups' preferences or government policy choices in Britain, although largely unchanged levels of openness accompanied a reversal of French policy priorities and overall continuity in Italian policy.

The next part of this article which will be a part two, details the effects of exchange-rate changes, German unification, and the drive toward monetary union on exchange-rate policy coordination in Europe in the 1990s, focusing on the events surrounding the heavy speculation against ERM parities in 1992-1993. There can be different identifications to describe exchange-rate politics and policy choices in each country, paying particular attention to the reactions of bankers, industrialists, and officials to exchange-rate instability and real appreciation.