Loading the player...

What is the '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 Union

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

    The successor to the European Monetary System (EMS), the combination ...
  3. European Central Bank - ECB

    The central bank responsible for the monetary system of the European ...
  4. European Union - EU

    A group of European countries that participates in the world ...
  5. Euro

    The official currency of the European Union's (EU) member states. ...
  6. European Sovereign Debt Crisis

    During the European debt crisis several countries in the eurozone ...
Related Articles
  1. Insights

    What Are The Advantages Of Not Adopting The Euro?

    European Union countries that do not use the euro have a few advantages over eurozone countries. Investopedia explores how.
  2. Insights

    Why These European Countries Don't Use The Euro

    The euro is a common currency of the European Union. Yet, many EU countries don’t use the euro. Investopedia explores why.
  3. Trading

    The Euro: What Every Forex Trader Needs To Know

    Find out the reports and events that determine the euro's worth, and how we can predict movements in its valuation.
  4. Trading

    Behind The Euro: History And Future

    The euro was designed to create economic parity among eurozone nations. Discover where it's going and where it's been.
  5. Investing

    How Would The Euro Trade If If A Grexit Occurs?

    In the event of a Grexit, the euro could head towards parity with the USD.
  6. Trading

    Why the Euro Failed to Become the World's Reserve Currency

    Examine the current state of the U.S. dollar as the world's reserve currency; learn the major reasons why the euro has failed to replace it in that capacity.
  7. Investing

    What is the European Union?

    The European Union is a group of European countries that participate as one unit in the global economy, and who mostly operate under one currency.
  8. Trading

    A Primer On Currency Regimes

    Currency regimes are dynamic and complex, reflecting the ever-changing landscape of their respective nations' monetary and fiscal policies.
  9. Insights

    5 Times the European Central Bank Got It Right This Century

    Find out how the ECB made the right moves in pulling the eurozone through many difficult periods despite skepticism the euro would stand the test of time.
  10. Investing

    Could 2016 Be the Year the EU Collapses?

    The EU is facing its strongest test since the potential "Grexit." Are pressures now severe enough to break it up?
RELATED FAQS
  1. When and why did the euro make its debut as a currency?

    On January 1, 1999, the European Union introduced its new currency, the euro. Originally, the euro was an overarching currency ... Read Answer >>
  2. In what ways does Bayesian probability support the probability default model when ...

    Learn what happened in the European debt crisis. It became a heated argument between the hawks and doves who argued the merits ... Read Answer >>
  3. Why doesn't England use the euro?

    Understand why the United Kingdom has opted to not join the eurozone in adopting the euro over the pound sterling as its ... Read Answer >>
  4. How does inflation affect the exchange rate between two nations?

    Understand how inflation can affect foreign exchange rates of a currency and how it is just one of many economic factors ... Read Answer >>
  5. What is the purpose of the International Monetary Fund?

    Read about the stated goals of the International Monetary Fund, which acts as an economic adviser and lender of last resort ... Read Answer >>
  6. How do changes in national interest rates affect a currency's value and exchange ...

    Understand the role that changes in interest rates can play in determining the value and foreign exchange rate of a country's ... Read Answer >>
Hot Definitions
  1. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  2. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  3. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  4. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  5. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  6. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
Trading Center