The European Exchange Rate Mechanism was a system introduced by the European
Economic Community on 13 March 1979, as part of the European Monetary System, to
reduce exchange rate variability and achieve monetary stability in Europe, in
preparation for Economic and Monetary Union and the introduction of a single
currency, the euro, which took place on 1 January 1999.
After the adoption of the euro, policy changed to linking currencies of EU
countries outside the eurozone to the euro. The goal was to improve stability
of those currencies, as well as to gain an evaluation mechanism for potential
eurozone members. This mechanism is known as ERM II and has superseded ERM.
Currently there is just one currency in the ERM II, the Danish krone.
Intent and operation of the ERM The ERM is based on the concept of fixed
currency exchange rate margins, but with exchange rates variable within those
margins. This is also known as a semi-pegged system. Before the
introduction of the euro, exchange rates were based on the European Currency
Unit, the European unit of account, whose value was determined as a weighted
average of the participating currencies. A grid of bilateral rates was calculated
on the basis of these central rates expressed in ECUs, and currency
fluctuations had to be contained within a margin of 2.25% on either side of the
bilateral rates. Determined intervention and loan arrangements protected the
participating currencies from greater exchange rate fluctuations.
Historical exchange-rate regimes for EU members
The chart below provides a full summary of all applying exchange-rate regimes
for EU members, since the European Monetary System with its Exchange Rate
Mechanism and the related new common currency ECU was born on 13 March 1979.
The euro replaced the ECU 1:1 at the exchange rate markets, on 1 January
1999. During 1979-1999, the D-Mark functioned as a de facto anchor for the
ECU, meaning there was only a minor difference between pegging your currency
against ECU and pegging it against the D-mark.
Sources: EC convergence reports 1996-2014, Italian lira, Spanish peseta,
Portuguese escudo, Finish markka, Greek drachma, UK pound
The eurozone was born with its first 11 Member States on 1 January 1999. The
first enlargement of the eurozone, to Greece, took place on 1 January 2001,
one year before the euro had physically entered into circulation. The next
enlargements were to states which joined the EU in 2004, and then joined the
eurozone on 1 January in the mentioned year: Slovenia, Cyprus, Malta, Slovakia,
Estonia, Latvia, and Lithuania. All new EU members having joined the
bloc after the signing of the Maastricht treaty in 1992, are obliged to adopt the
euro under the terms of their accession treaties. However, the last of the five
economic convergence criteria which needs first to be complied with in order
to qualify for euro adoption, is the exchange rate stability criterion, which
requires having been an ERM-member for a minimum of two years without the
presence of "severe tensions" for the currency exchange rate.
= Irish pound breaks parity with pound sterling=
To participate in the ERM, Ireland had to break the Irish pound's parity with
the pound sterling in 1979, because the pound sterling, which was not an ERM
currency, appreciated against all ERM currencies shortly after the launch of
the ERM. The continued parity between the Irish pound and the pound sterling
would have taken the Irish pound outside its agreed band. To fulfil the ERM
conditions, the Irish government was required to break the parity of the
Irish pound with the pound sterling. = Pound sterling's forced withdrawal
from the ERM= The United Kingdom entered the ERM in
October 1990, but was forced to exit the programme within two years after the
pound sterling came under major pressure from currency speculators, including
George Soros. The ensuing crash of 16 September 1992 was subsequently dubbed
"Black Wednesday". There has been some revision of attitude towards this event
given the UK's strong economic performance after 1992, with some
commentators dubbing it "White Wednesday".
Some commentators, following Norman Tebbit, took to referring to ERM as an
"Eternal Recession Mechanism", after the UK fell into recession in 1990. The UK
spent over £6 billion trying to keep the currency within the narrow limits with
reports at the time widely noting that Soros's individual profit of £1 billion
equated to over £12 for each man, woman and child in Britain and dubbing Soros
as "the man who broke the Bank of England".
Britain's membership of the ERM was also blamed for the prolonging of the
recession at the time, and Britain's exit from the ERM was seen as an
economic failure which contributed significantly to the defeat of the
Conservative government of John Major at the general election in May 1997,
despite the strong economic recovery and significant fall in unemployment which
that government had overseen after Black Wednesday.
= Increase of margins= In August 1993, the margin was expanded
to 15% to accommodate speculation against the French franc and other
currencies. = Replacement with the euro and ERM II=
On 31 December 1998, the European Currency Unit exchange rates of the
eurozone countries were frozen and the value of the euro, which then superseded
the ECU at par, was thus established. In 1999, ERM II replaced the original
ERM. The Greek and Danish currencies were part of the new mechanism, but when
Greece joined the euro in 2001, the Danish krone was left at that time as
the only participant member. A currency in ERM II is allowed to float within a
range of ±15% with respect to a central rate against the euro. In the case of
the krone, Danmarks Nationalbank keeps the exchange rate within the narrower
range of ± 2.25% against the central rate of EUR 1 = DKK 7.46038.
EU countries that have not adopted the euro are expected to participate for at
least two years in the ERM II before joining the eurozone.
= New EU members= On 1 May 2004, the ten national central
banks of the new member countries became party to the ERM II Central Bank
Agreement. The national currencies themselves were to become part of the
ERM II at dates to be agreed. The Estonian kroon, Lithuanian litas,
and Slovenian tolar were included in the ERM II on 28 June 2004; the Cypriot
pound, the Latvian lats and the Maltese lira on 2 May 2005; the Slovak koruna on
28 November 2005. These states have all since joined the
eurozone, and hence left ERM II: Slovenia, Cyprus, Malta, Slovakia,
Estonia, Latvia, and Lithuania. = Current status=
As of 2015, only the Danish krone participates in ERM II. The currencies
of Sweden, the three largest countries which joined the European Union on 1 May
2004, the two countries which joined on 1 January 2007 as well Croatia, which
joined the EU on 1 July 2013, are required to join in accordance with the
terms of the applicable treaties of accession.
Sweden has chosen to stay out of the mechanism. This choice is currently
tolerated by the ECB, even though it warned in 2002 that such an option will
not be permitted for newer union members.
Exchange rate bands In theory, most of the currencies are
allowed to fluctuate as much as 15% from their assigned value. In practice,
however, the currency of Denmark deviates very little from it.
= Historical reference= The former members of ERM II are the
Greek drachma, Slovenian tolar, Cypriot pound, Estonian kroon, Maltese lira,
Slovak koruna, Lithuanian litas and Latvian lats.
See also List of acronyms: European
sovereign-debt crisis Notes and references
External links European Central Bank press releases:
= Articles= Guardian Unlimited | Special reports |
Pound drops out of ERM – 17 September 1992