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What is the European Monetary System (EMS)?


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In 1979 a few European nations linked their currencies together in an arrangement and system to stabilize exchange rates called the European Monetary System. This system endured until the EMU European Economic and Monetary Union succeeded it.

As an important institution within the European Union, the EMU established the euro. The origin of the EMS lay in an effort to reduce significant changes in exchange rates between the European nations and to reign in inflation. It led to the creation of the European Central Bank in June of 1998 and the euro in January of 1999.

After the failure of the defunct Bretton Woods Agreement in 1972, the Europeans wanted to create a new exchange rate system of their own to help encourage political and economic unity throughout the EU. They came up with the EMS in 1979 as a means of moving towards the common currency of the future.

The EMS eventually formed its successor the European Currency Unit. With the ECU, exchange rates could be formulated by methods that were official. In the first year of the EMS, currency values proved to be uneven. Adjustments had to be made to lower weaker currencies while increasing the stronger currency values. In 1986 they came up with a more stable system of altering national interest rates instead.

Crisis broke out in the EMS in the early years of the 1990s. Germany’s reunification created political and economic conditions that made the exchange rate bands less workable. Britain withdrew permanently from EMS in 1992. They became more independent from the central EU this way and banded together with Denmark and Sweden in refusing to become members of the eurozone.

This did not stop other nations within the EU from continuing to push for closer economic integration and a common currency. They formed the European Monetary Institute in 1994 to set up an orderly transition to the ECB that arose in 1998. The main tasks of the new ECB were to come up with one interest rate and monetary policy by laboring alongside the national central banks.

The ECB was not given the role originally of lending money to governments in financial crises or increasing employment rates like the majority of central banks. This would later cause delays and problems in bailing out struggling countries in the financial crisis that began in earnest in 2008.

The end of 1998 saw the majority of nations in the EU cut their interest rates at the same time to encourage economic growth while preparing to implement the Euro currency. This is when they established the EMU to succeed the EMS as the primary economic policy mechanism in the European Union. The adoption and subsequent circulation of the euro by the eurozone countries proved to be a significant step towards the aimed for European political unity. The EMU has helped member nations attempt to work toward lower inflation, less public spending, and lesser government debts.

Hidden weaknesses in the European Monetary System became obvious during the global financial crisis of 2008 and the following years. Member nations like Greece, Portugal, Spain, Ireland, and Cyprus ran up high deficits that later erupted in the European sovereign debt crisis.

Because these countries did not have national currencies to devalue, they could not increase their exports. The EMU forbade them from spending additional money and running higher deficits to help increase employment. EMS policies had expressly forbidden eurozone bailouts to any countries whose economies were in trouble.

After months of arguments from the larger economy members such as Germany and France, the EMU at last came up with bailout policies that allowed aid to be dispensed to peripheral members who were struggling. They set up the European Stability Mechanism as a permanent pool of money to help out economies of struggling EU member states in 2012. This allowed a few of the countries in trouble like Spain, Portugal, and Ireland to make some progress on recoveries.

The term 'European Monetary System (EMS)' is included in the Banking edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.