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= European Monetary System (EMS) =

The European Monetary System (EMS) was initiated in 1979, by an arrangement of the Member States of the European Economic Community (EEC) to foster closer monetary policy co-operation between the Central Banks to manage intra-community exchange rates and finance exchange market interventions. The EMS was setup basically to adjust exchange rate, (both the nominal and the real exchange rate) in order to establish closer monetary cooperation. The aim was to foster closer monetary cooperation and lead to a zone of monetary stability which was commencement in 1979 and worked until 1992; after that, the European monetary policy replaced the EMS. This policy existed from 1 March 1979 up to the point where exchange rates for Euro area countries were fixed at the turn of the year 1999. It was established in 1979 under the Roy Jenkins, President of the European Commission where most of the nations of the European Economic Community (EEC) linked their currencies to prevent large fluctuations relative to one another.

EMS was succeed by the Economic and Monetary Union of the European Union (EMU) which was established in 1992, EMU represented a major step in the integration of EU economics and founded a common currency called Euro. Since 1979, the European Monetary System considered as the benefits conferred by a system of managed currencies by exchange rates which was based on stable but adaptable exchange rate. The main objective of the EMS was Exchange Rate Mechanism (ERM) to reduce exchange rate variability and achieve monetary stability in Europe and the European Currency Unit (ECU) was introduced in that time as a weight basket of all EEC currencies. The official EMS entered into force March 13, 1979 with the participation of eight Member States (France, Denmark, Belgium, Luxembourg, Ireland, Netherlands, Germany and Italy).

Historical Timeline
The origin of the EMS started with former European Community (EC), now European Union (EU) (which was also former European Economic Community) with the plan and initiatives of the leader of the European Community. In the end of 1960, in the Hague (in the Netherlands), the Head of the Member States (known as European Council today) of the EC agreed to move along the road to a full economic union. In 1969, the Heads of the State or Government of the Community had decided to create an Economic and Monetary Union to complete into 1980. In response upon on the request, a group of experts, led by the Prime Minister and Minister of Finance of Luxembourg, Pierre Werner, elaborated the first plan in 1970. The Werner committee was established prior of the Werner report which was published on 8 October 1970 and it was the main successor of the EMS. On the basis of Werner report, the EEC moved to a single economy into three stage, with a fixed exchange rate but no single currency. On October 1972, EEC's Paris summit agreed with the Werner plan and EEC currencies were linked through "the Snake". The Community adopted a resolution for instituting the European Monetary System on 5 December 1978 in Brussels by with the central idea of French President Valéry Giscard d'Estaing and German Chancellor Helmut Schmidt at European Council meeting. The main policies were to follow independent budgetary, monetary policies and the exchange rate. The well-structured form of EMS was welcome for the monetary and exchange policy at the outcome with the participation of the Member States. In 1988, a committee set up under Commission President Jacques Delors to make a new hard EMS provides favorable starting conditions for the transition to Economic and Monetary Union (EMU). The Delors plan recommends a three-stage process leading to a single European currency under the control of a European Central Bank.

Overview
After the demise of the Bretton Woods system in 1971, most of the leaders of EC countries agreed in 1972 to maintain stable exchange rates by preventing exchange rate fluctuations of more than +/-2.25% (called European "currency snake") with Italy exceptionally benefited from a wider +/-6% margin, these permissible was so-called ‘fluctuation bandwidths’. In this time, the EMS was a formal objective of stabilizing the currency rates and also maintain the competitiveness of its Member Countries, their plan was to achieve real and nominal exchange rates. The EMS consists of two main elements: one was about an agreement on a Community exchange-rate regime, another was about the decision to create a European Monetary Cooperation Fund (EMCF). Moreover, the Members of the EEC countries participated in Exchange Rate Mechanism (ERM) because all of them were belonged to the EMS policy, although the Member States could opt out of the ERM if they had a valid reason. In March 1979, all idea were replaced by the European Monetary System, and the European Currency Unit (ECU) was defined at the end.

The EMU has four basic functional arrangements are:

1.The ECU: With this arrangement, Member currencies agreed to keep their foreign exchange rates within agreed bands with a narrow band of +/− 2.25% and a wide band of +/− 6%.

2. An Exchange Rate Mechanism (ERM)

3. An extension of European credit facilities

4. The issue of a new reserve asset, to create European Monetary Cooperation Fund: created in October 1972 and allocates ECU to members' central banks in exchange for gold and US dollar deposits.

The EMS in many ways was very similar to the Bretton Woods system in its policies and constituency. The similarities of the role of European Monetary System was based on Deutsche Mark and that of the Bretton Woods system was based on U. S. Dollar. The European monetary system of the exchange-rate regime constituted a kind of Bretton Woods par value system on a European scale. Although no currency was designated as an anchor, the Deutsche Mark and German Bundesbank emerged as the center of the EMS. Germany emerged as the dominant player within the EMS, setting its monetary policy largely autonomously while other ERM members had attempted to converge on the German standard of Deutsche Mark which makes EMS highly asymmetrical. The plan for German money supply played a role because the lagged value of French money supply were jointly insignificant. That was the that German monetary policy transmitted into European Monetary System area, because of its relative strength and the low-inflation policies of the bank, all other currencies were forced to follow its lead if they wanted to stay inside the system. The convergence was in German standard rather than the symmetry policy responded policy of it. Eventually, this situation led to dissatisfaction in most countries, and was one of the primary forces behind the drive to a monetary union. The Deutsche Bundesbank determines the European monetary policy, fixed the reference level of the interest rates and the exchange rate in regard to the dollar; although in the first ten months of 1979, the Deutsche Mark continued to rise both against the dollar within the snake.

Basically, there were two phases of the European Monetary System.

(a) The flexible system of EMS (1979-1986) : In this period, various adjustment of parity were taken place and Member countries of the former EEC, enjoyed a certain degree of autonomy in monetary policy by the given restriction on capital movements. Exchange rate were possible through certain adjustment also.

(B) The rigid system of EMS (1987-1992) : In this period, it was decided not to conduct readjustment despite significant changes in the real exchange rates of some countries. There was gradually shrink of monetary policy and readjustment were substantially absent.

1992 crisis
The early period of year 1990 saw a new crisis of the European Monetary System. There were several steps where EMS faced the crisis in period of EMS. After establishment of the European Single Market in 1986 where main theme was to remove the control on capital movements. The crisis started when the adjustment of the exchange rate was became problematic because of control the capital movements. Periodic adjustments raised the values of strong currencies and lowered those of weaker ones, so in 1986 changes of national interest rates were used to keep the currencies within a narrow range. In the early 1990, the European Monetary System was strained by the differing economic policies and conditions of its members, especially the newly reunified Germany, and Britain (which had initially declined to join and did so in 1990) permanently withdrew from the system in September 1992. The opt out of Danish referendum from EMU in 1992 and exchange rate of the currencies of weaker countries of EMS also stimulated the crisis. Speculative attacks on the French Franc during the following year led to the so-called Brussels Compromise in August 1993 which established a new fluctuation band of +15% on each side for all the participating currencies. On August 1993, the ERM fluctuation bands were broadened from +/-2.25% to +/- 15% against central parity. The Bundesbank reduced the official interest rates and UK and Italy were affected by large capital outflows. Both Italy and UK between 1987 and 1992 were affected by a significant appreciation of the real exchange rate and then hit by the crisis; after the crisis, they planned to withdraw from ERM. In September 1992 and then again in August 1993, however, the European Monetary System was hit by a major several crisis. The outcome as follows :

• On 13 September 1992 Italy decided to devalue Italian Lira by 7% (other currencies revalue of 3.5%: Lira devalues 3.5%)

• On 16 September 1992 UK withdrew from ERM.

• On 17 September 1992 Italy withdrew from ERM.

Background
European currency exchange rate stability has been one of the most important objectives of European policy makers at least since the Second World War. EMS provided a favorable starting condition for the transaction to Economic and Monetary Union. Between late 1982 and 1987, the different positions on the money stability, the Dutch guilde r remained quite stable in regard to the Mark, the Italian lira exhibits a sharp downward trend throughout the whole EMS period; finally the French franc, the Belgian franc, the Danish krona and the Irish pound switched from a trend of successive devaluations to stability. The Council of the European Union Ministers finalized in designing the EMS was the creation of a new monetary unit, the European Currency Unit (ECU). ECU was a composite of monetary unit of account which was based on a basket of all EEC countries on specified amounts of each Community currency in the ECU was fixed, the weights of the various currencies change over time, as intra-European exchange rates fluctuated.

Two primary factors account for this:

• The history of exchange rate instability leading to social and economic instability, for example during the hyper inflation after the First World War in Germany or the competitive devaluations of the 1930s.

• The inter-dependence and "openness" of European economies.

Stage I
Closer economic policy coordination and the liberalization of capital movements.

Stage II
The European Monetary System was no longer a functional arrangement in May 1998 as the Member countries fixed their mutual exchange rates when participating in the Euro. Its successor however, the ERM-II, was launched on 1 January 1999. The establishment of the European Monetary Institute (EMI). Member States are required to work to fulfill the five convergence criteria on inflation, interest rates, government deficit and debt, and exchange rate stability. In ERM-II the ECU basket was discarded and the new single currency euro has become an anchor for the other currencies participated in the ERM-II. Participation in the ERM-II is voluntary and the fluctuation bands remain the same as in the original ERM, i.e. +15 percent, once again with the possibility of individually setting a narrower band with respect to the euro. Denmark and Greece became new members.

Stage III
The ERM-II is sometimes described as "waiting room" for joining the Economic and Monetary Union of the European Union. The third and final stage dominated by the introduction of the Euro (currencies of the most countries of the European union, basically the Eurozone countries are using Euro). The Madrid European Summit on 15 and 16 December 1995 set the start date for stage 3 as 1 January 1999, fixed the final euro conversion rates of the participated monetary units, and the finished date in 2002 with the introduction of euro notes and coins. In the EMU (stage III) the actual currencies in the participating member states are replaced by euro banknotes and coins and entered into the Eurozone.

Criticism
In the assessment of the credibility of the European Monetary System, Michael J Artis, (1987) criticized that the EMS had low credible during the first eight years in the EMS history, the system demonstrated its resilience and had worked relatively not so smoothly. He also remarked that EMS was supposed to have contributed to improving the stability of the intra-EMS bilateral exchange rates but the improvement was less marked for effective rates and stability of the EMS had weakened with the passage of time.

Another criticism by Paul De Grauwe (1987) about the credibility and limited criteria of the EMS policy. On 1979, when EMS entered into force, GDP growth rate, investment growth rate, stability of exchange rate and interest rates declined dramatically. In 1980, there was a rise of unemployment after the EMS system. Both the average EMS the unemployment rate and the inflation differential had a significant effect on EMS credibility. He divided the shortcomings into several sections. The macroeconomic performance of the small EMS countries experienced larger declines in investment, whereas before the EMS they had experienced relatively faster growth rates.

About Exchange rate stability was quite powerless which was not much succeed in long term changes and real exchange rates. Whereas, real exchange rates are more important for investment, output, export and import decisions. It was only succeed in reducing short-term changes in bilateral exchange rates and nominal exchange rates. Indeed, inflation rates continued to differ widely within EMS. For example, Inflation rates of the nine members of the European Community vary 3 percent in Germany and 13 percent in only Italy.

Finally, the interest rates for both nominal and real interest rates increased substantially after 1979 and EMS provided a little benefit to its member in terms of monetary and financial stability. Furthermore, the degree of cooperation was too small to have significant benefits. The smaller EMS economics such as Belgium, Denmark and Ireland possess short term credibility but lack of long term credibility, on the other hand the highest long run credible found for Germany and the Netherlands, which both had low inflation record.

Additionally, Axel A. Weber (1991) also refers that the EMS was a de facto Deutsche Mark zone. Moreover, it was often called “tie one hands” because the policy adopted a fixed exchange rate which had short-run effects. The Bundesbank independently choose its monetary policy whilst all remaining EMS member countries by tied their hands on monetary policy and simply target their exchange rates to the German mark.