European Monetary System - EMS


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.


Loading the player...

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.

  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. 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.
  2. 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.
  3. 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.
  4. 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.
  5. Economics

    Long-Term Investing Impact of the Paris Attacks

    We share some insights on how the recent terrorist attacks in Paris could impact the economy and markets going forward.
  6. Investing

    The Hunger Games Economy: 5 Unanswered Questions About Panem

    The Hunger Games's fictitious nation of Panem has technology, black markets, and government. But, we know precious little about Panem's economy and the reasons for its rampant inequality.
  7. Economics

    Understanding Donald Trump's Stance on China

    Find out why China bothers Donald Trump so much, and why the 2016 Republican presidential candidate argues for a return to protectionist trade policies.
  8. Economics

    Who Stands To Lose (And Gain) From The Paris Attacks

    For every major world event, there are those who stand to lose and those who stand to gain. A look at the short, medium, and long-term impacts of the Paris attacks.
  9. Investing News

    How the Paris Attacks Could Impact the Economy

    The horrific terror attacks in Paris will have a ripple effect on comsumer spending and tourism.
  10. Investing

    World Bank Data For Dummies

    Developing countries can't always afford to track the data crucial to setting the right economic policies and programs. That's where the World Bank steps in.
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. Who decides to print money in Russia?

    The Central Bank of the Russian Federation (CBRF), like its peers in most countries, is the governmental entity responsible ... Read Full Answer >>
  5. Who decides to print money in Canada?

    In Canada, new money comes from two places: the Bank of Canada (BOC) and chartered banks such as the Toronto Dominion Bank ... Read Full Answer >>
  6. Who decides when to print money in India?

    The Reserve Bank of India, or RBI, manages currency in India. The bank's additional responsibilities include regulating the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  2. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  3. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  4. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  5. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
  6. Indemnity

    Indemnity is compensation for damages or loss. Indemnity in the legal sense may also refer to an exemption from liability ...
Trading Center