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European Exchange Rate Mechanism

From Academic Kids

The European exchange rate mechanism (or ERM) was a system introduced by the European Community in March 1979, as part of the European Monetary System (EMS), 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 in January 1999.

The ERM is based on the concept of fixed currency exchange rate margins, but with exchange rates variable with those margins. Before the introduction of the Euro, exchange rates were based on the ECU, the European unit of account, whose value was determined as a weighted average of the participating currencies.

A grid (known as the Parity 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% either side of the bilateral rates (with the exception of the Italian lira, which was allowed a margin of 6%). Determined intervention and loan arrangements protected the participating currencies from greater exchange rates fluctuations.

Ireland's participation in ERM resulted in the Irish Pound breaking parity with the Pound Sterling in 1979, becoming an entirely separate currency, the Irish Punt.

In 1990, the United Kingdom participated but was forced to exit the programme after the Pound Sterling came under major pressure from currency speculators led by George Soros. September 16, 1992, was subsequently dubbed "Black Wednesday".

In 1993, the margin had to be expanded to 15% to accommodate monetary problems with the Italian lira and the Pound Sterling.

On December 31, 1998, the ECU exchanges rates of the Eurozone countries were frozen and the value of the Euro, which then superseded the ECU on a 1:1 basis, was thus established.

In 1999, ERM II replaced the original ERM. The Greek and Danish currencies were part of the system, but as Greece joined the euro in 2001, the Danish krone was left as the only participant member. Currencies in ERM II are allowed to float within a range of ±15% with respect to a central rate against the euro. In the case of the krone, the Danish central bank keeps the exchange rate within the narrower range of ± 2.25% against the central rate of EUR 1 = DKK 7.460 38.

As of 1 May 2004, the ten National Central Banks (NCBs) of the new member countries became party to the ERM II Central Bank Agreement. The national currencies themselves will become part of the ERM II at different dates, as mutually agreed.

The Estonian kroon, Lithuanian litas, and Slovenian tolar were included in the ERM II on June 28, 2004, the Cyprus pound, the Latvian lats and the Maltese lira on May 2, 2005. More national currencies will follow.

EU countries that have not adopted the euro must participate for at least two years in the ERM II before joining the Eurozone.

Exchange Rate Bands

Currency Code Central Rate Band
Cyprus Pound CYP 0.585 274 15%
Danish Krone DKK 7.460 38   2.25%
Estonian Kroon EEK 15.646 6     15%
Lithuanian Litas LTL 3.452 80   15%
Latvian Lat LVL 0.702 804 15%
Maltese Lira MTL 0.429 300 15%
Slovenian Tolar SIT 239.640       15%

External links

European Central Bank (http://www.ecb.int/) press releases:

Articles

fr:Mécanisme de taux de change européen sl:ERM-2

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