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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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