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EUROPEAN

MONETARY SYSTEM
OVERVIEW OF THE
PRESENTATION
The
background to the European
monetary system

Featuresof the European


monetary system

The exchange-rate mechanism


and the European currency unit

Anassessment of the European


monetary system

Conclusion
BACKGROUND……!!!
 The Snake(1972)

Outcomes of Werner report on economic and


monetary union 1972.

It is sometimes referred as mini Bretton Woods.

EMS owes much of its origin to the snake.

Itwas made up of six original EEC


members(Belgium, France, Italy, Luxembourg,
Netherlands, and West Germany ). Later UK and
Denmark joined the system and Norway became
an associate member.
CONTD…..
Through this agreement the member
currencies could vary by a maximum of
+/-1.125%.

Against other currencies they could


float by +/- 2.25(as permitted by the
Smithsonian agreement).

The smaller margin of the fluctuation


gave rise to the term ‘Snake in a tunnel’
which subsequently became the snake.

Snake system failed to produce the


necessary results ( coordination of
economic policies and convergence of
economic performance).
THE EUROPEAN
MONETARY SYSTEM
On 17th June 1978(Bremen conference) six of
the European community countries committed
themselves to set up European monetary
system to replace the snake.

Itaimed to provide “Zone of currency


stability” bringing back into the fold the
countries which had left the snake.

Objective of this initiative was to make the


countries less dependent on unpredictable
dollar and to provide a stable framework for
the conduct of European trade.
THE EUROPEAN
MONETARY SYSTEM

It commenced operation on 13th March 1979.

European Monetary System (EMS) was an


arrangement 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.
EUROPEAN MONETARY
SYSTEM
There are four main features of this system
some of which were built upon the
arrangements of the snake, they are:

 An Exchange Rate Mechanism (ERM)

The ECU(European currency unit)

 An extension of European credit facilities

 The European Monetary Cooperation Fund


EXCHANGE RATE
MECHANISM
It consists of two parts:

1. A grid of bilateral exchange rate bands


between each of the member currencies which
defines obligatory intervention.

2. An individual band of fluctuation for each


currency against the ECU which if breached by a
certain threshold will lead to the expectation that
the authorities of that currency will take policy
measures designed to bring it back within its ECU
threshold.
BILATERAL EXCHANGE RATE
PARITIES

This aspect of ERM consists of a grid of


central exchange rate between each pair
of currencies in the ERM.

Each currency can fluctuate a maximum


of +/- 2.25% of its bilateral central
rate against another member currency of
the ERM.

Italy was allowed to join with a larger


band of fluctuation of +/-6%(in January
1990 it narrowed its band of fluctuation to
+/- 2.25%).
BILATERAL EXCHANGE RATE
PARITIES

Obligatory Intervention
Authorities of each currency are obliged
to intervene or take economic policy
measures to keep the currencies within
limit.

Any changes in the grid of central rates


require mutual agreement between the
countries.
THE EUROPEAN CURRENCY
UNIT

ECU is a key component of ERM .


It is a weighted basket of various EEC
currencies.
It acts as an ‘indicator’ of divergence.

Once a currency crosses its divergence


threshold against the ECU the alarm bell
is triggered and the authorities of that
currency are expected to take measures
to bring its currency back into line.
Unlike reaching a bilateral exchange
rate limit triggering the ECU alarm bell
does not lead to obligatory intervention.
THE EUROPEAN MONETARY
COOPERATION

Each member of EMS deposits 20% of


its gold and dollar reserves with the
European monetary cooperation
fund(EMCF) in exchange for the
equivalent value in ECUs.

Each member have access to credit


facilities enabling deficit countries to
defend their exchange rate parities and
manage transitory BOP problems.
THE EUROPEAN MONETARY
COOPERATION

The credit facilities available are


 Very short term financing(VSTF)
 Short term monetary support(STMS)
 Medium term financial assistance
(MTFA)

The European investment bank(EIB) was


given the authority to make loans
available to the members of EMS at
favourable interest rates.
THE EUROPEAN MONETARY
FUND
Under the agreement setting of the EMS it
was planned to replace the EMCF which
had been set up under the snake with a
new European monetary fund in 1981.

Itis empowered to receive monetary


reserves from the central banks of the EEC
member state and issue ECUs against these
deposits.

It runs the ECU credit system and oversee


the ERM.

Setting up of the EMF was delayed due to


the controversies surrounding its powers
and roles.
AN ASSESSMENT OF THE
EMS
The European Monetary System was no
longer a functional arrangement after
May 1998 as the member countries fixed
their mutual exchange rates when
participating in the euro.

Unlike its predecessor ‘the snake’ ,no


countries left EMS and was relatively
successful.

The economic growth was generally


lower for the ERM countries compared
with the non-ERM countries.
ECONOMIC PERFORMANCE OF
ERM AND NON-ERM COUNTRIES

ERM Countries 1979 1990

Belgium 2.2 3.5


Italy 6.0 2.0
West Germany 3.5 4.5

Non-ERM 1979 1990


Countries
Austria 4.7 4.6
Japan 5.3 5.6
United Kingdom 2.8 0.6
SOURCE : WORLD ECONOMIC
OUTLOOK
ERM 2
ERM 2 was launched on 1 January 1999.

 In ERM 2 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.

The EMS-2 is sometimes described as


"waiting room" for joining the Economic
and Monetary Union of the European
Union.
CONCLUSION

The EMS confirmed the importance of the


collective discipline framework which it
helped to establish.

By obliging the countries, which were


party to it, to comply with an explicit
exchange rate discipline, it made a decisive
contribution in the fight against inflation.

The lesson gained by the EMS was that


monetary organisation was useful, but
needed better mechanisms.
Thank you for your
time…………….!!!!!