The European Monetary System (EMS) was a multilateral adjustable exchange rate agreement in which most of the nations of the
European Economic Community (EEC) linked their currencies to prevent large fluctuations in relative value. It was initiated in 1979 under then President of the European Commission
Roy Jenkins
Roy Harris Jenkins, Baron Jenkins of Hillhead, (11 November 1920 – 5 January 2003) was a British politician who served as President of the European Commission from 1977 to 1981. At various times a Member of Parliament (MP) for the Lab ...
as an agreement among the Member States of the EEC to foster monetary policy co-operation among their Central Banks for the purpose of managing inter-community exchange rates and financing exchange market interventions.
The EMS functioned by adjusting nominal and real exchange rates, thus establishing closer monetary cooperation and creating a zone of monetary stability.
As part of the EMS, the EEC established the first European Exchange Rate Mechanism (ERM) which calculated exchange rates for each currency
and a
European Currency Unit (ECU): an accounting currency unit that was a weighted average of the currencies of the 12 participating states.
The ERM let exchange rates to fluctuate within fixed margins, allowing for some variation while limiting economic risks and maintaining liquidity.
The European Monetary System lasted from 1979 to 1999, when it was succeeded by the
Economic and Monetary Union (EMU) and exchange rates for Eurozone countries were fixed against the new currency
the Euro.
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The ERM was replaced at the same time with the current
Exchange Rate Mechanism (ERM II).
History
Background, 1960 to 1971
The origins of the EMS can be traced back to the end of 1960 when the Heads of the member states of the EEC, known as the
European Council
The European Council (informally EUCO) is a collegiate body that defines the overall political direction and priorities of the European Union. It is composed of the heads of state or government of the EU member states, the President of the E ...
today, met in
the Hague
The Hague ( ; nl, Den Haag or ) is a city and municipality of the Netherlands, situated on the west coast facing the North Sea. The Hague is the country's administrative centre and its seat of government, and while the official capital of ...
and agreed to begin moving toward the goal of a single European economy. In 1969, the European Council decided to create an economic and monetary union to be implemented by 1980.
1972: the Werner Report is published and EEC countries peg their currencies
A group of experts, led by the Prime Minister and Minister of Finance of Luxembourg,
Pierre Werner
Pierre Werner (29 December 1913 – 24 June 2002) was a Luxembourgian politician in the Christian Social People's Party (CSV) who was the 18th Prime Minister from 1959 to 1974 and from 1979 to 1984.
Training and early activities
Pierre Werne ...
, met and produced the
Werner Report, which was published on 8 October 1970 and outlined the structure and function of the EMS. On the basis of the Werner Report, the EEC began moving to a single economy in three stages. The final stage economy was to have a fixed exchange rate but no single currency. After the abandonment of the
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. The Bretto ...
in 1971, the EEC took action. In October 1972, the EEC's Paris summit adopted the recommendations of the Werner Report and, as a result, the EEC currencies were adjustably pegged to one another in a scheme known as the
snake in the tunnel
The snake in the tunnel was a system of European monetary cooperation in the 1970s which aimed at limiting fluctuations between different European currencies. It was the first attempt at European monetary cooperation. It attempted to create a sing ...
.
The currency snake established a single currency fluctuation band of +/-2.25%, however Italy left the snake already in 1973.
The EMS is created
At a meeting of the EEC in Brussels on 5 December 1978, French President
Valéry Giscard d'Estaing
Valéry René Marie Georges Giscard d'Estaing (, , ; 2 February 19262 December 2020), also known as Giscard or VGE, was a French politician who served as President of France from 1974 to 1981.
After serving as Minister of Finance under prime ...
and German Chancellor
Helmut Schmidt
Helmut Heinrich Waldemar Schmidt (; 23 December 1918 – 10 November 2015) was a German politician and member of the Social Democratic Party of Germany (SPD), who served as the chancellor of West Germany from 1974 to 1982.
Before becoming Cha ...
successfully championed the EMS, which was implemented via resolution at the meeting.
The EMS officially entered into force on March 13, 1979 with the participation of eight Member States (
France
France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of Overseas France, overseas regions and territories in the Americas and the Atlantic Ocean, Atlantic, Pacific Ocean, Pac ...
,
Denmark
)
, song = ( en, "King Christian stood by the lofty mast")
, song_type = National and royal anthem
, image_map = EU-Denmark.svg
, map_caption =
, subdivision_type = Sovereign state
, subdivision_name = Danish Realm, Kingdom of Denmark
...
,
Belgium
Belgium, ; french: Belgique ; german: Belgien officially the Kingdom of Belgium, is a country in Northwestern Europe. The country is bordered by the Netherlands to the north, Germany to the east, Luxembourg to the southeast, France to th ...
,
Luxembourg
Luxembourg ( ; lb, Lëtzebuerg ; french: link=no, Luxembourg; german: link=no, Luxemburg), officially the Grand Duchy of Luxembourg, ; french: link=no, Grand-Duché de Luxembourg ; german: link=no, Großherzogtum Luxemburg is a small lan ...
,
Ireland
Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic Ocean, in Northwestern Europe, north-western Europe. It is separated from Great Britain to its east by the North Channel (Grea ...
,
Netherlands
)
, anthem = ( en, "William of Nassau")
, image_map =
, map_caption =
, subdivision_type = Sovereign state
, subdivision_name = Kingdom of the Netherlands
, established_title = Before independence
, established_date = Spanish Netherl ...
,
Germany
Germany,, officially the Federal Republic of Germany, is a country in Central Europe. It is the second most populous country in Europe after Russia, and the most populous member state of the European Union. Germany is situated betwe ...
and
Italy
Italy ( it, Italia ), officially the Italian Republic, ) or the Republic of Italy, is a country in Southern Europe. It is located in the middle of the Mediterranean Sea, and its territory largely coincides with the homonymous geographical re ...
).
Creation of the European Currency Unit
European currency exchange rate stability has been one of the most important objectives of European policymakers since the
Second World War. Between 1982 and 1987, European currencies displayed a range of stable and unstable behavior. For example, the
Dutch guilder
The guilder ( nl, gulden, ) or florin was the currency of the Netherlands from the 15th century until 2002, when it was replaced by the euro.
The Dutch name ''gulden'' was a Middle Dutch adjective meaning "golden", and reflects the fact that, wh ...
remained quite stable with respect to the Mark, the
Italian lira
The lira (; plural lire) was the currency of Italy between 1861 and 2002. It was first introduced by the Napoleonic Kingdom of Italy in 1807 at par with the French franc, and was subsequently adopted by the different states that would eventually f ...
exhibited a sharp downward trend throughout the life of the EMS, and the
French franc
The franc (, ; sign: F or Fr), also commonly distinguished as the (FF), was a currency of France. Between 1360 and 1641, it was the name of coins worth 1 livre tournois and it remained in common parlance as a term for this amount of money. It w ...
, the
Belgian franc
The Belgian franc ( nl, Belgische frank, french: Franc belge, german: Belgischer Franken) was the currency of the Kingdom of Belgium from 1832 until 2002 when the Euro was introduced. It was subdivided into 100 subunits, each known as a in Dutch ...
, the
Danish krone and the
Irish pound
The pound (Irish: ) was the currency of the Republic of Ireland until 2002. Its ISO 4217 code was IEP, and the symbol was £ (or IR£ for distinction). The Irish pound was replaced by the euro on 1 January 1999. Euro currency did not begin cir ...
all escaped trends of successive devaluations to emerge more stable.
At the same time that the EMS was created, the
Council of the European Union
The Council of the European Union, often referred to in the treaties and other official documents simply as the Council, and informally known as the Council of Ministers, is the third of the seven Institutions of the European Union (EU) as ...
Ministers created a new monetary unit, the European Currency Unit (ECU).
The ECU was the official monetary unit of the EMS, but it was purely a composite accounting unit, not a real currency. The ECU's value was based on the weighted average of a basket of 12 European currencies; the Belgian franc, German mark, Danish krone, Spanish peseta, French franc, British Pound, Greek drachma, Irish pound, Italian lira, Luxembourgish franc, Dutch guilder, and Portuguese escudo. The exchange rates for member nations' currencies were based on their value relative to the ECU.
German monetary policy dominates
The EMS was similar to the
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. The Bretto ...
, in that it pegged member currencies within a fluctuation band. Furthermore, the EMS came to be 'de facto' centered on the Deutschmark similarly to how the Bretton Woods system had been based on the US Dollar.
Although no currency was designated as an anchor, the Deutsche Mark and
German central bank emerged as the anchor of the EMS. Germany emerged as the dominant player within the EMS, setting its monetary policy largely autonomously while other ERM members attempted to converge on the German standard of the Deutsche Mark, causing a power imbalance within the EMS.
German monetary policy dictated the policy of the European Monetary System, because of its strong growth rate and the low-inflation policies of the German central bank.
Eventually, this situation led to dissatisfaction in most countries and was one of the primary forces behind the drive to a monetary union.
Changing operating principles and preparing for the Euro
The EMS went through two distinct phases. During the first period, from 1979 to 1986, the EMS allowed member countries a certain degree of autonomy in monetary policy by restricting the movement of capital. The second period, from 1987 to 1992, the EMS was more rigid. In 1988, a committee was set up under EEC President
Jacques Delors
Jacques Lucien Jean Delors (born 20 July 1925) is a French politician who served as the 8th President of the European Commission from 1985 to 1995. He served as Minister of Finance of France from 1981 to 1984. He was a Member of the European Par ...
to begin changing the EMS to provide favorable starting conditions for the transition to
Economic and Monetary Union
An economic and monetary union (EMU) is a type of trade bloc that features a combination of a common market, customs union, and monetary union. Established via a trade pact, an EMU constitutes the sixth of seven stages in the process of economic ...
(EMU).
The Delors plan was a three-stage process that lead to a single European currency under the control of a
European Central Bank
The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's Big Four (banking)#Intern ...
.
1992 crisis
The year 1990 saw a crisis in the EMS. The
European single market had been created in 1986 with the main goal of removing control on capital movements. Periodic adjustments raised the value of strong currencies and lowered those of weaker ones, and national interest rates were changed to keep the currencies within a narrow range. In early 1990, the European Monetary System was strained by the differing economic policies and conditions of its members, especially the newly reunified Germany, and Britain, which had initially declined to join, subsequently joining in 1990. The opt-out of Denmark from the EMU in 1992 and exchange rate adjustments of the currencies from weaker countries by the EMS also contributed to the crisis.
Speculative attacks on the French franc during the following year led to the Brussels compromise in August 1993 which broadened the fluctuation band from +/-2.25% to +/-15% for all the participating currencies.
The German central bank reduced interest rates and the UK and Italy were affected by large capital outflows. In the aftermath of the crisis, Italy and the UK both withdrew from the ERM in September 1992.
According to
Barry Eichengreen
Barry Julian Eichengreen (born 1952) is an American economist and economic historian who holds the title of George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley, where he ha ...
, there were three primary reasons for the crisis:
# Inadequate harmonization of past policies: Italy, Spain and the UK had not brought their inflation rates down to the levels of other EMS members, which contributed to competitive imbalances
# Inadequate harmonization of future policies: rising unemployment (stemming in part from German unification) reduced the credibility of the governments with high unemployment rates and weak public support, which led markets to attack the currencies of those countries
# Speculative pressures: The Maastricht Treaty provided the conditions for self-fulfilling speculative attacks
Criticism
Michael J Artis (1987) assessed the credibility of the EMS, stating that the EMS had low credibility during the first eight years of its history. Artis also states that the system demonstrated its resilience despite working relatively non-smoothly. He also remarked that EMS was supposed to have improved the stability of the intra-EMS bilateral exchange rates but that the improvement was less marked for effective rates when compared to nominal rates and stability weakened with the passage of time.
Another criticism was laid by Paul De Grauwe (1987) about the credibility of the EMS policy. In 1979, when EMS entered into force, GDP growth rate, investment growth rate, the stability of exchange rate, and interest rates declined dramatically. In 1980, there was a rise in unemployment after EMS implementation. Both the average EMS the unemployment rate and the inflation differential had a significant effect on EMS credibility. Macroeconomically, small EMS countries experienced larger declines in investment, whereas before the EMS they had experienced relatively faster growth rates.
The EMS did not achieve long-term stability in real exchange rates. This is significant because real exchange rates are more important than nominal exchange rates when it comes to investment, output, export, and import decisions. The EMS only succeeded in reducing short-term changes in bilateral exchange rates and nominal exchange rates. Indeed, inflation rates continued to differ widely among EEC countries.
For example, Germany experienced an inflation rate of 3 percent while Italy's inflation rate reached 13 percent.
Both nominal and real interest rates increased substantially after 1979 and EMS provided little benefit to its members in terms of monetary and financial stability. Furthermore, there was not enough cooperation among the member states to fully realize the potential benefits of the EMS.
The smaller EMS economies such as Belgium, Denmark, and Ireland possessed short-term credibility but lack of long-term credibility. On the other hand, Germany and the Netherlands had the most long-term credibility, due to their low inflation records.
Additionally, Axel A. Weber (1991) claims that the EMS was a de facto Deutsche Mark zone. Moreover, it was often called “tying one's hands” because the policy adopted a fixed exchange rate which had short-run effects. The German central bank independently choose its monetary policy whilst all remaining EMS member countries' hands were tied on monetary policy and they were forced simply target their exchange rates to the German mark.
See also
*
Programme commun
The Programme commun (or 'Common Programme') was a reform programme, signed 27 June 1972 by the Socialist Party, the French Communist Party and the centrist Radical Movement of the Left, which provided a great upheaval in the economic, political ...
*
European Unit of account The European Unit of Account (EUA) was a unit of account most notably used in the European Communities from 1975 to 1979, when it was replaced at parity by the European Currency Unit, in turn replaced at parity in 1999 by the euro.
The EUA was intr ...
*
List of currencies in Europe
There are 29 currencies currently used in the 50 countries of Europe, all of which are members of the United Nations, except Vatican City, which is an observer with the United Nations General Assembly. All ''de facto'' present currencies in Eur ...
*
Eurosystem
The Eurosystem is the monetary authority of the eurozone, the collective of European Union member states that have adopted the euro as their sole official currency. The European Central Bank (ECB) has, under Article 16 of its Statute,
*
History of the Euro
History (derived ) is the systematic study and the documentation of the human activity. The time period of event before the invention of writing systems is considered prehistory. "History" is an umbrella term comprising past events as well ...
*
Fixed Exchange rate
A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another m ...
References
Further reading
* Kathleen R. McNamara. 1999. "
Consensus and Constraint: Ideas and Capital Mobility in European Monetary Integration." ''JCMS: Journal of Common Market Studies'' Volume 37, Issue 3, Pages 455–476.
* Story, Jonathan. "The launching of the EMS: An analysis of change in foreign economic policy." ''Political Studies'' 36.3 (1988): 397–412.
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Eurozone
European Union