Britain's Return to Gold and Entry into the EMS: Expectations, Joining Conditions and Credibility

In this paper the surprising conclusion of Smith and Smith (1990) that the prospect of Britain's return to gold in 1925 had the effect of weakening sterling is subjected to critical analysis. It is shown that this conclusion is reversed when the trend in the UK money stock prior to joining the gold standard is treated as endogenous; and when non-stationary solutions are considered. It is further suggested that a more realistic interpretation of events must involve the use of a model with price inertia. The final section of the paper considers the major difference between the United Kingdom's return to gold and its entry into the EMS, namely, the current lack of credibility attached to an exchange rate peg for sterling.