Elasticity Pessimism: Economic Consequences of Black Wednesday Sebastian Bustos and Martin Rotemberg∗ October 2018 Abstract We document the ramifications of a large devaluation episode: the U.K.’s “Black Wednes- day” in 1992. Relative to synthetic counterfactuals, U.K. export and import prices in pounds increased by roughly 20 percent, a similar magnitude to the nominal devaluation. Inflation de- clined after the devaluation, although the prices of fuels increased. Contrary to the conventional belief that the UK experienced an export led boom after the devaluation, we find no evidence that exports or nominal GDP increased. We also find no evidence of a “J-curve:” imports declined immediately after the devaluation, and stayed persistently below their counterfactual value. We test a wide variety of theories of elasticity pessimism, and find that none do well at explaining patterns in the data. ∗Bustos: Harvard University, 79 JFK Street, Cambridge, MA 02138;
[email protected]. Rotemberg: New York University, 19 West 4th St., New York NY 10012;
[email protected]. We are grateful to Alex Segura, who started the project with us, as well as Alberto Abadie, Jonathan Eaton, Raquel Fernandez, Gita Gopinath, Ri- cardo Hausmann, Jeff Frankel, Mark Gertler, Rachel Glennerster, Robert Lawrence, Virgiliu Midrigan, Lant Pritchett, Dani Rodrik, Julio Rotemberg, Larry Summers and Rodrigo Wagner for helpful comments. On September 16, 1992, the British Pound devalued in nominal terms by around 20 percent after speculators successfully pushed the U.K. out of the European Exchange Rate Mechanism.1 The conventional wisdom is that the devaluation caused a “boom,” since it was followed by increased growth.2 However, we show that the economies of similar countries who did not devalue experienced similar growth rates.