The European Monetary System : The Experience, 1979-82

Peter Nyberg, Horst Ungerer, and Owen Evens

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1983
• eBook ISBN: 9781557750631

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Contents

Prefatory Note

I. Introduction and Background

History and Objectives

Main Features of the EMS

II. The Performance of the System

General

Exchange Rate Developments

Variability of Exchange Rates

The Problem of Convergence

The EMS Concept of Convergence

Price Developments

Monetary Developments

Factors Influencing the Performance of the System

III. The Evolution of the System

Operational Aspects

Exchange Rate and Intervention Mechanism

Divergence Indicator

Settlement of Intervention Debts

Role of the ECU

Credit Facilities

Proposals for Institutional Changes

IV. The European Monetary System and the International Monetary Fund

Surveillance over Exchange Rate Policies

Conditionality in Çredit Operations

Creation of International Liquidity

APPENDICES

I. Statistical Tables

II. Bibliography

STATISTICAL TABLES

1. EMS: Periods of Strain

2. EMS: Bilateral Central Rates

3. EMS Realignments: Percentage Changes in Bilateral Central Rates

4. EMS: ECU Central Rates

5. EMS: Interest Differentials for Three-Month Deposits, 1979–82

6. EMS: Economic Measures in Connection with Realignments

7. Variability of Nominal Effective Exchange Rates, 1974–82

8. Variability of Nominal Exchange Rates Against EMS Currencies, 1974–82

9. Variability of Nominal Exchange Rates Against Non-EMS Currencies, 1974–82

10. Variability of Bilateral Real Exchange Rates Against EMS Currencies, 1974–82

11. Variability of Bilateral Real Exchange Rates Against Non-EMS Currencies, 1974–82

12. Consumer Price Indices, 1974–82

13. GDP Deflators, 1974–81

14. Short–Term Interest Rates, 1974–81

15. Long–Term Interest Rates, 1974–81

16. Matrix of Correlation Coefficients Between Long-Term Interest Rates, March 1976–March 1979 and April 1979–March 1982

17. Matrix of Correlation Coefficients Between Short-Term Interest Rates, March 1976–March 1979 and April 1979–March 1982

18. Rate of Growth of Narrow Money, 1974–81

19. Rate of Growth of Broad Money, 1974–81

20. Rate of Growth of Domestic Credit, 1974–81

21. Real Narrow Money Stock, 1974–81

22. Real Broad Money Stock, 1974–81

23. Real Domestic Credit, 1974–81

24. Central Government Budget Deficit as a Ratio to Nominal GDP, 1974–81

25. Budget Deficits and Changes in Money Supply, 1974–81

26. Balance of Payments Current Account, 1974–81

27. The Creation of ECUs by Swap Operations, April 1979–December 1982

28. Real Rates of Growth of Gross Domestic Product, 1974–81

29. Gross Fixed Capital Formation, 1974–81

BIBLIOGRAPHY

CHARTS

Chapter

II. 1. Exchange Rate of the ECU Against the U.S. Dollar

2. Positions Within the EMS Band

3. Movement of EMS Currency Exchange Rates Against the ECU

4. Variability of Nominal Effective Exchange Rates, 1974–82

5. Consumer Prices

6. Changes in Interest Rates and Prices.

7. Monetary Expansion Before and After the Introduction of the EMS

Exchange Rate Developments

A number of distinct periods of strain within the EMS can be distinguished (Table 1). During some of these, the authorities attempted to resist changes in central rates by substantial intervention in the exchange market, or by measures of short-term monetary policy directly motivated by exchange rate considerations. Within months of each of these episodes, and in the absence of more far-reaching measures aimed at the correction of the underlying causes of imbalances, confidence in the will and capacity of the authorities to continue to resist the adjustment of central rates diminished, thus amplifying pressure on the exchange rates. In each case, the renewed pressures ended with an adjustment of central rates.

Other periods of strain appear to have followed different patterns. In the case of the devaluation of the Danish krone in November 1979, the authorities acted quickly, without a lengthy period of intervention. On two other occasions, both centered around a weak deutsche mark (October 1980 and February 1981), market pressures were successfully resisted. The ability of the authorities to resist market forces was a reflection of the substantial foreign exchange resources available and, in the second instance, of the forceful measures of monetary policy taken in February 1981. Ultimately, market sentiment reversed itself when it was seen that the Federal Republic of Germany continued to have a better price performance than its partners in the EMS and that an improvement in its current account could be expected.

These experiences appear to be very much in line with those of other countries outside the system: intervention against market pressure serves to buy time, but in the absence of policy measures aimed directly and with sufficient strength at the underlying causes of weakness, exchange rate changes become inevitable in the course of time.

It was early recognized that differences in the relationships between the participating currencies and the U.S. dollar could give rise to tensions within the EMS.¹¹ When the U.S. dollar is relatively weak, mobile international capital seeks alternative locations, and particularly tends to move to the deutsche mark and vice versa. With the United Kingdom not actively participating in the EMS, currencies other than the deutsche mark play only a limited role as alternative reserve and investment currencies. Consequently, there is a tendency for the deutsche mark to be strong against other European currencies when the U.S. dollar is weak, whether or not underlying economic developments dictate this.

After a short period of strength at the start of the EMS in March 1979, the U.S. dollar remained relatively weak with respect to most EMS currencies from the middle of 1979 to the beginning of 1980 (Chart 1). On September 24, 1979, the first realignment¹² under the EMS occurred with the deutsche mark being revalued by 5 percent against the Danish krone and 2 percent against other EMS currencies. The second realignment occurred on November 30, 1979 when the Danish krone was again devalued by 5 percent against all other currencies.

Chart 1. Exchange Rate of the ECU Against the U.S. Dollar¹

(In U.S. dollars per ECU)

Source: Fund staff calculations.

¹ The lower line excludes the pound sterling component. Calculated from midweek London noon quotations.

From early 1980 to early 1981, the U.S. dollar strengthened on average with respect to EMS currencies; there were, however, substantial short-term fluctuations. Early in 1981, an easing of U.S. interest rates and the tightening of monetary policy in the Federal Republic of Germany caused the joint float to firm temporarily relative to the U.S. dollar. An acceleration in inflation and increasing current account difficulties put pressure on the Italian lira within the EMS, triggering substantial intervention by the authorities in February and early March, and leading ultimately to the third realignment, on March 23, 1981, when the lira was devalued by 6 percent relative to the other EMS currencies. The joint float depreciated relative to the U.S. dollar from mid-April until August 1981, with the deutsche mark at the top of the band and the French franc at the bottom after its sharp fall following the Presidential elections of May 1981.

From mid-August 1981 to December 1981, the situation reversed with the EMS currencies on average appreciating relative to the U.S. dollar. There was renewed confidence in the deutsche mark as the German current account performance improved and inflation moderated. At the same time, doubts about the stability of the French franc and uncertainties about the policy stance of the new French administration increased. Worsening inflation and a widening trade deficit put renewed pressure on the Italian lira. These tensions led to the fourth realignment, on October 5, 1981, with the deutsche mark and Netherlands guilder revaluing by 5.5 percent, and the French franc and Italian lira devaluing by 3 percent against the Belgian franc, the Luxembourg franc, the Danish krone, and the Irish pound, whose central rates remained unchanged.¹³

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Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Prefatory Note
• I. Introduction and Background
• II. The Performance of the System
• III. The Evolution of the System
• IV. The European Monetary System and the International Monetary Fund
• Appendices
• Footnotes