5.2.0.     The EMS and the Ecu

LEGAL BASIS

Resolution of the Brussels European Council of December 1978.

OBJECTIVES

-     Stabilising exchange rates.
-     Reducing inflation.
-     Preparing, through cooperation, for European monetary unification.

ACHIEVEMENTS

1.     Establishment

-     The European Monetary System was decided by a European Council resolution of 5 December 1978.
-     It was set up on 13 March 1979 under an agreement concluded the same day between the central banks of the then Member States of the Community.

2.     EMS elements and mechanisms

a.     The ECU
-     This was the central element. A composite currency (basket of currencies), it was made up of specific amounts of each of the participating currencies. These amounts were calculated by multiplying the weight assigned to each currency by that currency's exchange rate vis-à-vis the ECU. The weight of each currency was determined according to a country's share of collective GNP and its share of intra-Community trade. The ECU had thus a definite value in terms of each of its component currencies: this value was equal to the number of units (or fractions) by which that currency was represented in the ECU, plus the amounts of the other ECU components, converted into that currency at the central exchange rate (ECU central rate) or daily rate (market ECU).

-     It was also an accounting currency, acting in particular to specify the Community budget.

-     But it was not normally a means of payment: it was not legal tender.

b.     The central rates and the monetary stabilization mechanism

-     The central rates. From a currency's rate in terms of ECU could be derived its rate in each of the other participating currencies (cross-rates): these were the bilateral central rates. They may be the subject of jointly agreed adjustments (devaluation or revaluation).

-     The maximum fluctuation margins. The central rates were a basis for the main constraint of the EMS: the setting of a percentage beyond which a currency might not fluctuate in respect of its central rate with another currency, whether above or below that rate. This was an obligation for the Member States participating. Originally set at 2.25%, this percentage was subsequently modified.

-     The intervention mechanism. Whenever the maximum percentage was reached, the two central banks concerned were required to intervene to prevent it being exceeded. Such intervention took the form of purchases of the currency in question in the event of a fall vis-à-vis the central rate, of sales in the event of a rise.

-     Preventive action. Even before the authorised maximum percentage of fluctuation was reached, the country issuing the currency had to act. Once the exchange rate exceeded 75% of the maximum percentage ("divergence indicator"), the currency was deemed 'divergent' and the country had to take remedial action: raising of interest rates, tightening of budgetary policy, support of the exchange rate, in the event of a downward divergence; opposite measures in the event of a rise.

c.     The mechanisms for financing monetary interventions
The European Monetary Cooperation Fund (EMCF) managed the EMS short-term credit facility, the aim of which was to finance operations in support of a currency participating in the system.

3.     Evolution of the EMS

a.     The 1980s
-     When the EMS was set up in 1979, all the Member States of the Community excepting the United Kingdom entered the EMS, with the currencies having a fluctuation margin vis-à-vis their central rates of 2.25%, except for the Italian lira which had a margin of 6%.

-     Greece, which entered the Community in 1981, did not join the Exchange Rate Mechanism (ERM).

-     The Iberian Peninsula countries, which joined the Community in 1986, did not enter the ERM immediately: Spain entered in 1989 and Portugal in 1992, with a fluctuation margin widened to 6%.

-     At their Nyborg meeting of 17 September 1987 the Finance Ministers ratified a decision taken by the Governors Committee in Basel and took various measures to strengthen the EMS:

• a better coordination of preventative action ('inter-marginal' interventions: before the limits of the fluctuation margins were reached),
• an increase in short-term financing and use of interest rate variations to maintain the stability of exchange rates,
• a more flexible procedure for realignment of parities (without the intervention of the Ministers).

b.     The 1992-93 crisis
The EMS was severely disrupted by the violent storm that hit the European currency markets in September and October 1992, following the difficulties over ratifying the Maastricht Treaty in Denmark and France. The British pound and the Italian lira left the ERM in September 1992, and in November of the same year the Spanish peseta and the Portuguese escudo were devalued by 6% against the other currencies. In January 1993 the Irish pound was devalued by 10%; in May the peseta and the escudo were again devalued. Finally, in August 1993, the Finance Ministers took the decision to raise the fluctuation margins to 15%.

c.     1993-1999
These years saw a distinct return to normal. In 1996 all the participating currencies (including the lira, now reincorporated in the ERM, and the Austrian and Finnish currencies which entered in 1995 and 1996) had moved back within the original margin of fluctuation (2.25%).

4.     Assessment of the EMS

a.     The primary goal of the EMS, namely to create a zone of internal and external monetary stability, based upon the Exchange Rate Mechanism, was achieved. The participating countries were spared the instability that characterised the international monetary system during the 1980s. The 1992-93 crisis was finally overcome and after nearly twenty years of effort, stability prevailed.

b.     Monetary discipline led to economic convergence with reduction of inflation rates and alignment of interest rates.

c.     Private use of the ECU (as opposed to its 'official' use between EMS central banks) grew considerably. The ECU was increasingly used in international bond issues by Community institutions, Member State governments and companies. It became a major international financial instrument, overtaking most of its component currencies. There was also a growth of ECU bank deposits, and an inter-bank market with clearing facilities emerged. In these various ways the EMS and the ECU powerfully paved the way for the introduction of the single currency. The euro became the official unit of currency in 11 Member States on 1 January 1999.

5.     The new exchange-rate mechanism (EMS II)

The Amsterdam European Council meeting in June 1997 adopted the fundamental principles and elements of a new exchange-rate mechanism which regulates the relationships between the single currency and the currencies of those Member States of the European Union not participating in monetary union. The system was put in place on 1 January 1999, the starting date of the third stage of EMU. Unlike the EMS, under which all the currencies established central parities between themselves (central rates) and fluctuation margins around themselves, the parities and margins of the new exchange-rate mechanism are now fixed exclusively in respect of the euro. However, the central parities will be agreed and monitored multilaterally.

ROLE OF THE EUROPEAN PARLIAMENT

• The EP regularly called for the EMS to be strengthened through close coordination of monetary policies. It also demanded wider use of the ECU whose systematic use in all intra-Community payment transactions should contribute both to the economic and financial integration of the Community and to the raising of a European awareness among its people (see in particular its Resolutions of 20 November 1987 and 24 October 1991).
• Following the 1992 crisis, Parliament declared itself against competitive devaluations and in favour of lifting the legal barriers to use of the ECU in commercial transactions (Resolutions of 16 September and 27 October 1993). It called for a currency's entry into the EMS or its withdrawal from the system to be decided at Community level, with a key role for the European Monetary Institute, on the basis of objective economic data (Resolution of 6 May 1994).
• Finally, the EP called for a new exchange-rate mechanism that was simple, transparent and flexible, in order to regulate relations between Member States participating in monetary union and non-participating Member States (Resolutions of 13 November 1995 and 18 June 1996).

20/10/2000