European Monetary System

Question

Discuss the workings and arrangements of European Monetary System (EMS).

Answer 1

EMS was launched in the year 1979 for:

a) Establish the zone of monetary stability in the Europe, 

b) Coordinate exchange rate policies against non-EMS currencies, and 

c) Pave the way for eventual European monetary union. 

Main instruments of EMS are and Exchange Rate Mechanism (ERM) European Currency Unit (ECU). Just like SDR, ECU is also a basket currency formed as a weighted average of currencies of various EU member countries. ECU works as accounting unit of EMS and performs an important role during the working of ERM. ERM is the process through which member of the EMS countries manages their exchange rates. ERM is based on the parity grid system, along with parity grids firstly computed by defining the par values of EMS currencies in terms of ECU. In case, a country’s ECU market exchanges the rate diverges from central rate through as much as the utmost allowable deviation, country has to adjust its policies in order to maintain the par values relation to the other currencies.