The Lira and the Pound in the 1992 Currency Crisis: Fundamentals Or Speculation?

Abstract

The prevalent explanation of the Exchange Rate Mechanism (ERM) currency crisis of September, 1992 is that myopic speculation prevailed over the ''fundamentals.'' Our paper explores the reasons why the Italian lira and the U.K. pound were attacked and, subsequently, forced out of the ERM. The crisis was sparked by a common awareness that political unification and the commitment to monetary union had petered out in the summer of 1992, leaving the field open to speculators to pick countries with the weakest fundamentals (Italy) or with policy makers who feared jeopardizing an economic recovery by keeping the currency in the ERM (the U.K.).