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Indian Economy




                    Notes            The November 1967 Devaluation
                                     1967 was a year of world economic crisis – the largest since 1949. Cost pressures were
                                     rising and translating into persistent inflation in many nations. In 1966 and into 1967,
                                     Britain ran very large balance of payments deficits and there was a substantial associated
                                     loss of reserves and reduced confidence in the sterling.
                                     Policy contraction including a wage and prices freeze in mid-1966 led to a decline in
                                     imports and an improving current account position. There was a slight slowdown overall
                                     and unemployment edged up. The trade surplus renewed confidence in the sterling. Further,
                                     sterling was strengthened because interest rates were eased in the US and Europe,
                                     encouraging net capital inflows into Britain in search of higher yields. Britain used the
                                     windfall of funds to repay various international debts, including reducing its outstanding
                                     IMF liabilities under previous stand-by arrangements.

                                     The calm was short-lived. The first disruption came on June 5, 1967, when the – Six-Day
                                     War – between the Arab States (United Arab Republic, Jordan and Syria) and Israel broke
                                     out after Israeli military aggression (air strikes into Egypt).

                                     The War impeded British exports, increased the cost of oil and saw a sell-off of sterling.
                                     Secondly, the US increased interested rates to quell a credit boom and this boosted the
                                     value of the dollar. Third, Europe entered recession which further damaged UK exports
                                     and the current account went into deficit. The loss of export revenue also led to rising
                                     British unemployment and plunged Britain into a policy quandary.
                                     The sterling was under pressure from the increasing external deficit and net capital outflow,
                                     which would normally have led to some domestic policy contraction. But with a recession
                                     looming the Government needed to bolster domestic demand. This is a situation that
                                     would repeat itself in 1975 and 1976. The British government opted to avoid the politically
                                     costly rise in unemployment and there was a monetary easing combined with some fiscal
                                     policy expansion, which pushed the deficit up. There was considerable debate as to whether
                                     the British government was committed to maintaining sterling stability given these
                                     expansionary domestic policy interventions.
                                     Additionally, despite initial wage restraint in 1967 following the completion of the 1965-66
                                     wage freezes, wages growth was rapid in the latter part of 1967 and outstripped productivity
                                     growth thereby undermining Britain’s international competitiveness. Further industrial
                                     unrest on the wharves in the latter part of 1967 constrained Britain’s exports and the
                                     current account deficit rose.

                                     The British government had to face the reality that to defend the mounting pressure on the
                                     sterling it would have to invoke a harsh recession and drive unemployment up significantly.
                                     The stop-go growth pattern had come firmly up against the political constraints. It also
                                     knew that earlier efforts in the 1960s to deal with a weak balance of payments situation
                                     had resulted in lost national income but didn’t really solve the underlying problem.
                                     The problem became rather obvious – the exchange rates was overvalued and try as they
                                     might to preserve that value for reasons of national prestige the reality was that it had to
                                     be devalued.
                                     On November 18, 1967 the British government devalued the sterling by 14.3 per cent
                                     against the US dollar.
                                     Questions
                                     1.   Give your view point on the case study.

                                     2.   How the condition of the British Government can be improved?
                                   Source: http://bilbo.economicoutlook.net/blog/?p=24469



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