The UK entered the European Exchange Rate Mechanism (ERM) in October 1990 at 2.95 Deutsche mark per pound and agreed to keep the pound within a range of ±6% against other member currencies of the ERM. Under the ERM, if the exchange rate ever neared the bottom of its permitted range, 2.778 Deutsche mark per pound, the UK government would be obliged to intervene. In 1991-92, the UK economy was
suffering from a severe recession. During the fall of 1992, the British pound was under speculative attack as foreign exchange market participants believed that the pound was over-valued against the Deutsche mark and other major currencies within the European Monetary System. After raising its key interest rate to 15% and Page 4 of 4?

spending as much as £27 billion in reserves to prop up the British pound in vain, the UK government decided to exit the ERM on September 16, 1992 and allowed the pound to float. The pound quickly depreciated more than 10% against the Deutsche mark. Describe the advantages and disadvantages of the UK's entry into and exit from the ERM.