European Exchange Rate Mechanism

Andorra

Bulgaria

Croatia

Czech
Rep.

Denmark

Eurozone

Hungary

Kosovo

Lithuania

Monaco

Monten.

Poland

Romania

San Marino

Sweden

United
Kingdom

Vatican

  eurozone

  ERM II

  other EU members

  monetary agreement

  unilaterally adopted

The European Exchange Rate Mechanism (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 on 1 January 1999.

After the adoption of the euro, policy changed to linking currencies of countries outside the eurozone to the euro (having the common currency as a central point). 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 This mechanism is known as ERM II and has superseded ERM.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 are just two countries in the ERM II, the Danish krone and the Lithuanian litas.

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 (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% on either side of the bilateral rates (with the exception of the Italian lira, the Spanish peseta, the Portuguese escudo and the pound sterling, which were allowed to fluctuate by ±6%).^[1] Determined intervention and loan arrangements protected the participating currencies from greater exchange rate fluctuations.

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.^[2]

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".^[3]

Some commentators, following Norman Tebbit, took to referring to ERM as an "Eternal Recession Mechanism",^[4] 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^[5][6][7] 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,^[8] 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.^[9]

Increase of margins

In August 1993, the margin had to be 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 (ECU)^[10] 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 7.460 38.

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.

Current status of the ERM II

On 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 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.^[11] The currencies of the three largest countries which joined the European Union on 1 May 2004 (the Polish złoty, the Czech koruna, and the Hungarian forint), the two countries which joined on 1 January 2007 (the Bulgarian lev, and the Romanian leu) as well as the currency of Croatia, which joined the EU on 1 July 2013, (the Croatian kuna) are required to follow in accordance with the terms of the applicable treaties of accession.

Other countries to have since joined the eurozone, and hence left ERM II, include Slovenia (1 January 2007), Cyprus (1 January 2008), Malta (1 January 2008), Slovakia (1 January 2009), Estonia (1 January 2011) and Latvia (1 January 2014).

The Hungarian Ministry of Finance said that Hungary originally wanted to adopt the euro in 2010,^[12] but this has been delayed. In 2011, experts said that the earliest date when Hungary will adopt the euro is 2015;^[13] however, the earliest possible date is now 2016. Bulgaria wanted to apply for ERM II membership as soon as possible after the EU entry. In November 2009, Bulgaria confirmed that it planned to apply for joining ERM II in early 2010, but was forced to delay its application for at least one year after updated figures put the budget deficit for 2009 at 3.7% of GDP, outside the Maastricht criteria.^[14] Romania initially planned to join ERM in 2010–2012,^[15] but after the onset of the euro crisis, postponed this indefinitely, citing concerns about its workforce productivity.^[16]

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.^[17]

The Swiss Franc had always floated independently until its currency appreciation became unsustainable during the eurozone debt crisis, at which point it made a compromise to keep the exchange rate at a minimum of 1.20 francs to the euro, which does not constitute a peg.^[18] Switzerland is not officially a member of ERM II as it is not an EU member and expresses no ambitions to become one.

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 Lithuania is pegged tightly to the central rate, and the currency of Denmark deviates very little (usually less than 1%) from it.

Date of entry[19]	Country	Currency	€1=[19]	Band		Notes
				Nominal	Actual
1 January 1999	Denmark	Krone	7.46038	2.25%	<1%	The Danish krone entered the ERM II in 1999, when the euro was created. See Denmark and the euro for more information.
28 June 2004	Lithuania	Litas	3.45280	15%	0%	The Lithuanian litas was pegged to the US dollar until 2 February 2002, when it switched to a euro peg.

Historical reference

The former members of ERM II are the Greek drachma, Slovenian tolar, Cypriot pound, Estonian kroon, Maltese lira, Slovak koruna and Latvian lats.

Period	Country	Currency	€1=	Band		Notes
				Nominal	Actual
31 Dec 1998 — 16 Jan 2000	Greece	Drachma	353.109[20]	15%	[citation needed]
17 Jan 2000 — 31 Dec 2000			340.750[21]		[citation needed]
28 Jun 2004 — 31 Dec 2006	Slovenia	Tolar	239.640[22]	15%	0.16%[23]
2 May 2005 — 7 Dec 2007	Cyprus	Pound	0.585274	15%	2.1%[23]
7 Dec 2007 — 31 Dec 2007					0%
2 May 2005 — 31 Dec 2007	Malta	Lira	0.429300	15%	0%	The Maltese lira has been pegged to the euro since joining ERM II. Only two exceptions exist: 2005-05-02 (ECB rate: 1 EUR = 0.4288 MTL) and 2005-08-15 (ECB rate: 1 EUR = 0.4292 MTL).[23]
28 Nov 2005 — 16 Mar 2007	Slovakia	Koruna	38.4550[24][25][26]	15%	12%[23]
17 Mar 2007 — 27 May 2008			35.4424[27][28]		12%[23]
28 May 2008 — 31 Dec 2008			30.1260[29]		1.9%[23]
28 Jun 2004 — 31 Dec 2010	Estonia	Kroon	15.6466	15%	0%	The Estonian kroon had been pegged to the German mark since its re-introduction on 20 June 1992, and then to the euro. It was fixed on 13 July 2010.
2 May 2005 — 31 Dec 2013	Latvia	Lats	0.702804	15%	1%	Latvia had a fixed exchange rate system arrangement whose anchor switched from the SDR to the euro on 1 January 2005.

See also

• List of acronyms: European sovereign-debt crisis

References

External links

• European Central Bank press releases:

Articles

• Guardian Unlimited | Special reports | Pound drops out of ERM – 17 September 1992