Gaining and Losing Erm Credibility: The Case of the United Kingdom

Abstract

The model of this paper highlights two aspects of credibility: signalling the type of government, which is assumed not to be known; and, for any type, the likelihood that if circumstances are sufficiently unfavourable a devaluation will be impossible to avoid, since not to do so would go against the government's interests. These two factors have opposite implications for the link between unemployment and interest differentials: high unemployment signals a tough government, but also makes it less likely that even a tough government will maintain an existing parity.