Sterling Effective Exchange Rate 1975-2001

Cambridge 2000 memos

February 2002

It is a common complaint of British manufacturers and trade unionists that Sterling is "overvalued". There is never any evidence or criteria given for this statement, but the media are lazy and let it pass. After all we all know the Euro is "weak". And Europe is the UK's largest trading partner. Below is a chart of the "effective exchange rate" of Sterling and four other currencies over the period 1975-2001. Obviously the exact period you choose to examine determines to some extent how you would interpret the data, but 27 years is a reasonable time span and it is also corresponds to the data which is publicly available on the Bank of England website.

Interestingly enough, the only currency amongst the five which was lower at the end of 2001 than at the beginning of 1975 is Sterling. Is this an "overvalued" currency? If so, under what criteria? What is the "correct" value?

The chart makes it clear that the removal of Sterling from the Exchange Rate Mechanism (ERM) in 1992 really was a "competitive devaluation". This kind of devaluation is what many people would like to see repeated for (what they perceive as) their own short-term advantage.

Note: The "effective exchange rate" shown here is a trade-weighted average, with the scale of all currencies being set so the average 1990 value is 100, and with the weight being defined using trade data for 21 countries from the period 1989-1991. This is not a theoretically perfect definition, but to a first approximation, over the time scale being considered, it is good enough. For more information see the following pages from the Bank of England website (clicking on the links opens a new browser window)

Cambridge 2000 memos