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. The European Economic and Monetary Union (EMU), an institution of the European Union (EU), which established a common currency called the euro replaced the EMS.

BREAKING DOWN 'European Monetary System - EMS'

The European Monetary System (EMS) was developed as an attempt to stabilize inflation and stop large exchange rate fluctuations between European countries. In June 1998, the European Central Bank (ECB) 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 1972 Bretton Woods Agreement, meant to help foster economic and political unity in Europe and pave the way for a future common currency, the euro. The Bretton Woods Agreement, formed in the aftermath of WWII, established, among other European unity advances, an adjustable fixed foreign exchange rate 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 European Economic Community (EEC) to stabilize foreign exchange and prevent large fluctuations in inflation among member countries. 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 and adjustments that raised the value of stronger currencies and lowered those of weaker ones. However, after 1986, changes in national interest rates were specifically used to keep all the currencies stable.

The early 90s saw a new crisis for the EMS. Differing economic and political conditions of member countries, notably the reunification of Germany, led to Britain permanently withdrawing from the EMS in 1992. Britain's withdrawal reflected and foreshadowed their 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 form greater economic alliances continued. In 1993, most EEC members signed the Maastricht Treaty, establishing the European Union (EU). In 1994 the EU created the European Monetary Institute to transition to the European Central Bank (ECB), which came into being 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 common euro 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 to promote economic growth and prepare for the implementation of the euro.

The European Economic and Monetary Union (EMU) was 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, in 2002. The EU was considered a significant step towards European political unity. 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, significant 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 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 the prevailing 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 regarding true European fiscal and political unity.

More recently, though, as of late January 2018, despite resistance from noted EU members like Germany, Greece was in talks with the IMF regarding debt relief totaling 6.7bn euro ($8.2bn). The Eurogroup head, Mario Centeno, is quoted as saying that a cash injection was "critical to ensuring Greece's full market access," in an article from the BBC. Greece has, thus far, implemented 92 of 100 measures required by lenders. 

RELATED TERMS
  1. European Central Bank - ECB

    The central bank responsible for the monetary system of the European ...
  2. Euro

    The euro is the official currency of 19 members of the European ...
  3. European Currency Unit - ECU

    The European Currency Unit (ECU) was the precursor to the Euro, ...
  4. Maastricht Treaty

    The Maastricht Treaty was a treaty that is responsible for the ...
  5. Article 50

    Article 50 is the clause of the European Union treaty that outlines ...
  6. European Banking Authority (EBA)

    The European Banking Authority (EBA) is a regulatory body that ...
Related Articles
  1. 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.
  2. Insights

    Understanding the Downfall of Greece's Economy

    Greece has defaulted on its debt. Such an unprecedented event has left many wondering how Greece’s situation ever got so messy.
  3. 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.
  4. 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.
  5. Insights

    Is A Greek Euro Exit Finally About To Happen?

    The Eurozone crisis involving Greece has been a nagging thorn in the side of the European Union ever since the financial collapse of 2008–2009.
  6. Investing

    Will Spain Exit the Euro?

    With a "no" vote in last Sunday’s referendum on whether the Greek people would accept imposed austerity measures, chances of a Greek exit from the euro have substantially increased. Will Spain ...
  7. Insights

    Eurozone Gains Momentum--But Can It Last?

    Eurozone economic growth has picked up, most notably in France and Italy, but can it last, particularly as Greece continues its standoff with creditors?
  8. Investing

    Buying Euros as a Long-Term Investment: Risks and Rewards

    Learn about the potential risks and rewards of long term investing in the euro and the current status of the European Union's financial markets.
  9. Insights

    What Should Everyone Know About Greece’s Debt

    We weigh in on the top four things everyone should know about Greece's debt.
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. Read Answer >>
  2. How does inflation affect the exchange rate between two nations?

    Countries attempt to balance interest rates and inflation, but the interrelationship between the two is complex and can influence ... Read Answer >>
  3. Under what circumstances will a government change its monetary policy?

    Learn about the kind of variables, including political and theoretical factors, that can bring about change in a government's ... Read Answer >>
  4. The Difference Between the International Monetary Fund and the World Bank

    Learn about the International Monetary Fund and the World Bank and how they are differentiated by their respective functions ... Read Answer >>
  5. How do externalities affect equilibrium and create market failure?

    Learn about the responsibilities of the International Monetary Fund and its functions regarding the international monetary ... Read Answer >>
Hot Definitions
  1. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  2. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  3. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  4. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  5. Monte Carlo Simulation

    Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted ...
  6. Price Elasticity of Demand

    Price elasticity of demand is a measure of the change in the quantity demanded or purchased of a product in relation to its ...
Trading Center