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7.2.2.  European Monetary System

    Convinced of the advantages of a monetary organisation of the Community, the European Council, in July 1978, laid the groundwork for the introduction of an improved monetary system. Following its guidelines, the Council adopted, in December 1978, a Regulation [Regulation 3181/78 repealed by Regulation 640/2006] relating to the European monetary system (EMS). Whereas at world level, since 1971, a country's monetary authorities were no longer obliged to intervene to influence the exchange rate of their currency, the EMS exchange rate mechanism introduced, for member currencies, an obligation to limit fluctuations between the latter to certain fluctuation margins.

    In its initial stage the EMS was in reality an improved, more flexible and sounder ''monetary snake''. The maximum margin tolerated between two currencies in the system remained 2.25%, just as in the snake (6% for the weaker currencies), but a currency's exchange rate fluctuations were no longer calculated, as in the snake, in relation to each of the other currencies in the system, but in relation to the European currency unit. The ecu (English initials of the European Currency Unit, calling to mind, in French, the old gold coin used for centuries) was based on an assortment, or "basket", of different national currencies, the initial composition of which was determined on the basis of objective criteria relating to the economic importance of each Member State, in particular its gross national product, its intra-Community trade and its contribution to the short-term financial assistance mechanism.

    In addition to its general functions as a unit of account, in particular for expressing the amounts in the general budget of the Communities and the common prices for agricultural products, the ecu was the central element of the European Monetary System. Thus, the ecu was used as the common denominator in the exchange rate grid for Community currencies, as the basis for establishing the indicator of divergence between Community currencies, as the denominator for intervention operations and as a means of settling credit or debit balances between the central banks.

    In the first few years, there were many currency realignments in the European Monetary System (EMS). But by the time of the negotiations on the Maastricht Treaty in 1990-91, it had 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. Over the years, however, the EMS became a genuine mark zone, in which discipline was notably guaranteed by the German Central Bank, the famous Bundesbank. This discipline gave good results until the end of the '80s, but, since 1990, two important phenomena started eroding this discipline within the EMS: the complete liberalisation of capital movements within the Community, which reinforced the speculative capacity of financial intermediaries; and the cost of German reunification, which had resulted in an increasing budgetary deficit in Germany. No system of monetary cooperation can function, however, when the State, which issues the reference currency, cannot guarantee its stability. Just as the inflation drift in the United States put an end to the Bretton Woods system, so the German interest rate drift caused the rupture of the EMS. The lesson gained by the EMS was that monetary organisation was useful, but needed better mechanisms. These were outlined in the Maastricht Treaty.

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    Your roadmap in the maze of the European Union.

    Based on the book of Nicholas Moussis:
    Access to European Union law, economics, policies
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