In 1990, Britain joined the ERM. If the German Bundesbank increased interest rates, assuming Britain maintains its exchange rate peg, the likely impact on the British economy would be a(n):

Question

Quizplus · Accepted Answer

If the German Bundesbank increased interest rates, it would likely lead to an increase in demand for the deutsche mark, causing a decrease in demand for British pound. This would put downward pressure on the value of the pound, making it more expensive for British businesses to import goods and causing a rise in inflation. To prevent inflation from rising above the agreed-upon level, the Bank of England would have to increase interest rates as well. However, higher interest rates would lead to a decrease in consumer and business spending, slowing economic growth and potentially leading to a recession.

In 1990, Britain Joined the ERM