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262 Unemployment and Monetary Policy in the European Union
have increased net exports, especially to Germany, which in turn would have
helped Germany by increasing the resources available for East Germany and by
holding down inflation.
There is some evidence that the Bundesbank actually favored this approach,
to relieve both French unemployment and the pressure on the Bank to ease their
monetary policy faster than they (rightly or wrongly) deemed best for Germany.
But France’s view was that devaluation must be avoided regardless of domestic
costs because: i) it meant abandoning the EMS and European unity; ii) it might
result in loss of credibility—that is, that it might result in French interest rates
having to command a positive spread over German rates, thus reducing or even
eliminating the possibility of bringing French rates below the German ones; and
probably by far most important, iii) it would have meant a loss of face, inconsistent
with French pride. It therefore held on to the “Franc Fort” policy.
Given that decision, there was no way to avoid huge unemployment, except
by adopting a fiscal policy of government deficit as large as that of Germany and
even higher, to compensate for the lack of the exogenous stimulus; but such an
alternative was not even entertained.
4.6.2 August 1993 and Thereafter
With this dismal picture in mind, by August 1993 a group of MIT economists,
including myself, reached the conclusion published in the Financial Times, that
the time had come for France to put unemployment above other considerations
and cut interest rates. As this view spread in the market, speculation (led by
French, not Anglo-Saxon, interest) forced abandonment of parity.
The scenario we foresaw was 1) a sharp cut of the interest rate, 2) followed by
appreciable devaluation—most likely through a period of floating—and possibly
a joint one by the one-German EMS. What actually happened was quite different.
The EMS was saved by broadening the band to 15 percent, which would
have made it possible for the non-German EMS to cut interest rates without abandoning
the EMS. But the amazing and unexpected thing was that, despite the
wider band, exchange rates in the following days, weeks and months were kept
in the old narrow band by a policy led by France of holding on blindly and at
any cost to the “Franc Fort” policy and hence to the Bundesbank high interest
rates. This policy proved to be suicidal. It cost France an increase in unemployment
from a very high 8.9 percent in 1990 to 11.6 percent in 1993 and 12.6
percent in 1994. The cost was similar for the European Union as a whole. It transformed
the EMS and the march toward Maastricht into an instrument of torture.
The reason why participation in the EMS has been so disastrously costly can
be readily understood. It results fundamentally from the decision to maintain
rigidly fixed exchanges, at first as a member obligation, and after August 1993,