European Monetary System

There are three stages of monetary cooperation in the European Union.

Stage I

European Monetary System (EMS) was an arrangement established in 1979 under the Jenkins European Commission where most nations of the European Economic Community (EEC) linked their currencies to prevent large fluctuations relative to one another.

After the collapse of the Bretton Woods system in 1971, most of the EEC countries agreed in 1972 to maintain stable exchange rates by preventing exchange fluctuations of more than 2.25% (the European "currency snake"). In March 1979, this system was replaced by the European Monetary System, and the European Currency Unit (ECU) was defined.

The basic elements of the arrangement were:
#The ECU: A basket of currencies, preventing movements above 2.25% (6% for Italy) around parity in bilateral exchange rates with other member countries.
#An Exchange Rate Mechanism (ERM)
#An extension of European credit facilities.
#The European Monetary Cooperation Fund: created in October 1972 and allocates ECUs to members' central banks in exchange for gold and US dollar deposits.

Although no currency was designated as an anchor, the Deutschmark and German Bundesbank were unquestionably the centre of the EMS. Because of its relative strength, and the low-inflation policies of the bank, all other currencies were forced to follow its lead. This situation led to dissatisfaction in most countries, and was one of the primary forces behind the drive to a monetary union (ultimately the euro).

Periodic adjustments raised the values of strong currencies and lowered those of weaker ones, but after 1986 changes in national interest rates were used to keep the currencies within a narrow range. In the early 1990s the European Monetary System was strained by the differing economic policies and conditions of its members, especially the newly reunified Germany, and Britain (who had initially declined to join and only did so in the late 1980s) permanently withdrew from the system. This led to the so-called Brussels Compromise in August 1993 which established a new fluctuation band of +15%.

Stage II

The European Monetary System was no longer a functional arrangement in May 1998 as the member countries fixed their mutual exchange rates when participating in the euro. Its successor however, the ERM-II, was launched on 1 January 1999. In ERM-II the ECU basket is being discarded and the new single currency euro has become an anchor for the other currencies participating in the ERM 2. Participation in the ERM 2 is voluntary and the fluctuation bands remain the same as in the original ERM, i.e. +15 percent, once again with the possibility of individually setting a narrower band with respect to the euro. Denmark and Greece became new members

Stage III

The EMS-2 is sometimes described as "waiting room" for joining the Economic and Monetary Union of the European Union. In the EMU (stage III) the actual currencies in the participating member states are replaced by euro banknotes and coins.

References

Ludlow, Peter. The making of the European monetary system. A case study of the politics of the European community. London: Butterworth, 1982