Monday, July 27, 2009

the European monetary system

a significant development in international monetary arrangements began in march 1979 with the inauguration of the European monetary system (EMS). This system was an outgrowth of the joint float( sometimes called the "European Snake" because of the wavelike movements of the six currencies as a unit against other currencies) that had begun in 1972. the first key feature of the EMS of the European Community members was the creation of a new monetary unit, the European currency unit or ecu, in terms of which central rates for the countries‘ currencies were defined. The value of the ecu was a weighted average of EMS member currencies and the ecu was used as the unit of account for recording transactions among EMS central banks.
A second key feature of the original EMS was that each currency was generally to be kept within 2.25 percent of the centeral rates against the other participating currencies, and a mechanism was put in place requiring central bank action as exchange rates approached the limits of divergence permitted from centeral rates. there were also provisions for periodic realignments of centeral rates. Third, the EMS participating currencies were to move as a unit in floating fashion against other currencies, including the U.S. dollar. this set of exchange rate rules was known as the exchange rate mechanism (ERM) of the EMS. Finally, the European Monetary Cooperation Fund (EMCF), a "banker’s bank" similar to the IMF, was established for receiving deposits of reserves from the EMS members and making loans to members with BOP difficulties.
the European monetary system was conceived as a means of promoting greater exchange rate stability within Europe and, because of this stability and certainty, for generating more stable and soundly based economic growth. Because greater stability in exchange rates requires some degree of harmonization in macroeconomic policies, the EMS also promoted convergence of policies and inflation rates.

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