European Monetary System - EMS

Loading the player...

DEFINITION of 'European Monetary System - EMS'

The European Monetary System (EMS) is a 1979 arrangement between several European countries which links their currencies in an attempt to stabilize the exchange rate. This system was succeeded by the European Economic and Monetary Union (EMU), an institution of the European Union (EU), which established a common currency called the euro.

BREAKING DOWN 'European Monetary System - EMS'

The European Monetary System originated in an attempt to stabilize inflation and stop large exchange rate fluctuations between European countries. Then, in June 1998, the European Central Bank was established and, in January 1999, a unified currency, the euro, was born and came to be used by most EU member countries.

History of the European Monetary System

The European Monetary System (EMS) was founded in 1979 after the collapse of the Bretton Woods Agreement in 1972, to help foster economic and political unity in the European Union (EU) and pave the way for a future common currency, the euro. The Bretton Woods Agreement, formed in the wake of World War Two’s aftermath, established among other European unity advances an adjustable fixed foreign exchange rate in order to stabilize economies within Europe. Due to various economic and political pressures this agreement was abandoned in 1972.

The EMS established a new policy of linked currencies between most countries in the EU in order to stabilize foreign exchange and prevent large fluctuations in inflation among members. Another important tenet of the EMS was the formation of the European Currency Unit (ECU), a prelude to the euro. The ECU determined exchange rates among the participating countries’ currencies via officially sanctioned accounting methods. The early years of the EMS were marked by uneven currency values, with adjustments that raised the values of stronger currencies and lowered those of weaker ones. However, after 1986 changes in national interest rates were specifically used to keep all currencies more stable.

The early 90s saw a new crisis for the EMS. Differing economic and political conditions of member countries, particularly the reunification of Germany, led to Britain permanently withdrawing from the EMS in 1992. This reflected and foreshadowed Britain’s insistence on independence from continental Europe, later refusing to join the eurozone along with Sweden and Denmark.

Efforts to push on to a common currency and greater economic alliance continued. In 1994 the EU created the European Monetary Institute in order to transition to the European Central Bank (ECB), which was formed in 1998. The primary responsibility of the ECB was to institute a single monetary policy and interest rate – working with national central banks – including the euro common currency. Like a typical central bank, the ECB is responsible for controlling inflation; however, unlike most central banks it was not charged with boosting employment rates or functioning as a lender to governments during financial difficulty. At the end of 1998, most EU nations unanimously cut their interest rates in order to promote economic growth and prepare for the implementation of the euro.

The European Economic and Monetary Union (EMU) was then established, succeeding the EMS as the new name for the common monetary and economic policy of the EU. The euro was fully adopted and brought into circulation by EU member states, with Greece joining last, by 2002. This was considered a major step towards European political unity, and together participating nations acted to reduce debt, curb excessive public spending and attempt to tame inflation. As more countries subsequently joined the EU, many have adopted the euro.

The EMS/EMU and the European Sovereign Debt Crisis

With the global economic crisis of 2008-2009 and the ensuing economic aftermath, major problems in the foundational European Monetary System policy became evident. Certain member states; Greece in particular but also Ireland, Spain, Portugal and Cyprus, experienced high national deficits that went on to become the European sovereign debt crisis. Without national currencies these countries could not resort to devaluation, and were not allowed to spend in order to offset unemployment rates. From the beginning EMS policy intentionally prohibited bailouts to ailing economies in the eurozone. With vocal reluctance from EU members with stronger economies, the EMU finally established bailout measures to provide relief to struggling peripheral members.

In 2012 the European Stability Mechanism, a permanent fund to aid the struggling economies of EU member nations, was implemented across the EU. With new bailout measures and mandated austerity measures in the afflicted countries, several economies such as Ireland, Portugal and Spain have managed a tentative recovery. However Greece’s continuing economic recession, political strife and rampant unemployment rate continued in 2015. By June 2015 Greece defaulted on an International Monetary Fund loan and on July 5, 2015 the Greek people voted against further austerity measures imposed by the EU. The future of Greece’s participation in the eurozone remains uncertain, revealing the weaknesses of the original European Monetary System policy in terms of true European fiscal and political unity.

RELATED TERMS
  1. Currency

    Currency is a generally accepted form of money, including coins ...
  2. Inflation

    The rate at which the general level of prices for goods and services ...
  3. Currency Union

    When two or more groups (usually countries) share a common currency ...
  4. European Economic and Monetary ...

    The successor to the European Monetary System (EMS), the combination ...
  5. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  6. Maastricht Treaty

    A treaty that is responsible for the creation of the European ...
Related Articles
  1. Personal Finance

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.
  2. Forex Education

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  3. Forex

    How Global Stock Markets Affect The Euro

    Currency strategist Todd Gordon reviews key correlations between the euro and global stock markets, explaining how traders can profit from news from the euro zone and China.
  4. Forex Education

    Dual And Multiple Exchange Rates 101

    Why would a country choose to implement dual or multiple exchange rates? It's risky, but it can work.
  5. Investing News

    How Interest Rates Can Go Negative

    Central banks from Europe to Japan have implemented a negative interest rate policy (NIRP) in order to stimulate economic growth.
  6. Economics

    The Delicate Dance of Inflation and GDP

    Investors must understand inflation and gross domestic product, or GDP, well enough to make decisions without becoming buried in data.
  7. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  8. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
  9. Forex

    The Consumer Price Index

    Find out how this economic measure can help you make key financial decisions.
  10. Economics

    Understanding the History of Money

    Money has been a part of human history for at least 3,000 years, evolving from bartering to banknotes.
RELATED FAQS
  1. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  2. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  3. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  4. How do you make working capital adjustments in transfer pricing?

    Transfer pricing refers to prices that a multinational company or group charges a second party operating in a different tax ... Read Full Answer >>
  5. Marginal propensity to Consume (MPC) Vs. Save (MPS)

    Historically, because people in the United States have shown a higher propensity to consume, this is likely the more important ... Read Full Answer >>
  6. Do lower interest rates increase investment spending?

    Lower Interest rates encourage additional investment spending, which gives the economy a boost in times of slow economic ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center