EUROPEAN MONETARY

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

Features of the European monetary system

The exchange-rate mechanism and the

European currency unit

An assessment 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.

It is 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.

Settingup 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…………….!!!!!