The document summarizes the monetary history of Europe from pre-17th century to the present. It describes how currencies originally used metals but bills of exchange later emerged. Public banks were established in the 17th-18th centuries in Amsterdam and London. The 19th century saw continued use of bills of exchange and the designation of certain currencies as legal tender within countries. The gold standard period from the late 19th century was unstable. Post-WWI and WWII attempts to restore monetary order included the Bretton Woods system and the European Monetary System (EMS), which evolved from a symmetrical system to one centered around the German Deutsche Mark.

1. The European
Monetary
System
European Economic
Issues
Reading: Abdul Rishad

2. A Brief Monetary History of Europe Pre 17th C.
• Money –originally based on metals
• Costly and dangerous to engage in long
distant trade.
• Problems with quantity and divisibility
• Even then no guarantee that value is ‘true’
• Emergence of bills of exchange
• Essentially guaranteeing that goods to the
value of x could be purchased in A

3. 17th & 18th Century
• Amsterdam set up Public bank to weigh
coins and therefore warranty deposits
– Which could be transferred between merchants
– AND which could be lent onwards
• 1694 Bank of England established
– to facilitate the King - with the right to issue
promissory notes to others on the King’s
behalf.
– Complemented by private banks (former
goldsmiths) issuing ‘notes’
• Paris - Banque Royal and the Mississippi
Company

4. A Brief Monetary History of Europe 19th C.
• Bills of exchange still backed by (some?)
metal
• Uncertainty as to true value
• Trade between cities as difficult as between
nations
• Sorted in UK by 1844 designation that
notes of the ‘Official Bank’ – Bank of
England - were legal tender and guaranteed
• But internationally problem remained

5. A Brief Monetary History of Europe
• Currencies issued by governments of
different ‘perceived’ stability
• No agreement on how currency should be
backed – gold or silver –often both
circulating simultaneously and fluctuating
in relative value
• Trade involved frequent movements of
commodity gold or silver

6. A Brief Monetary History of Europe
• ‘Golden age’ of Gold Standard
• UK: 1821-1914
• Paris Conference 1867
• Latin European Monetary Union-1865-1926,
F,B,I, Switz, & 1867 Gr & Bul.
• Scandinavian monetary union 1873-1924
Dn, Sw & Nor
• Essentially a quasi-monetary union or set
of unions
• www.euromove.org.uk/publications/europe
anhistories/chron2

7. A Brief Monetary History of Europe
• ‘Not so ‘Golden’ Really
• Frequent revaluations, devaluations and
currency crises
• Need strict monetary discipline, particularly
on growth of monetary supply for this to
work. Did not exist.
• 1914 UK came off the Gold Standard at
outbreak of war.

8. A Brief Monetary History of Europe
• After WWI attempt to return to Gold Standard
• But huge interwar debts had devalued currencies
• But UK returned to Gold at Pre-war rate
• French expected Germans to pay France’s war
debts
• Germans could not raise enough taxes, printed
money at home, causing hyper-inflation
• Result was interwar chaos

9. A Brief Monetary History of Europe
• After WWII international attempt to restore
monetary order – Breton Woods system
• A Gold Standard based on the dollar. Worked well
for a time.
• Currencies allowed to fluctuate by 1% around
parity
• Some devaluations and revaluations but
reasonably well behaved until Vietnam War.
• US paid for deficits by printing more dollars
• Eventually foreign governments lost faith and
system started to collapse.

10. A Brief Monetary History of Europe
• Agreed to widen the band vis-a- vis the dollar
from 1% to 2.25.
• But if DM 2.25 above & FF 2.25 below then 4.5%
difference
• And if FF 2.25 above & DMF 2.25 below then total
fluctuations of DM/FF is 2 x 4.5% = 9% difference.
• Response: Werner Report in 1970 forerunner of
EMS
• The (original) six Member States set up a ‘snake
in the tunnel’ mechanism to narrow the
fluctuation margins between the Community
currencies (the snake) in relation to fluctuations
against the US dollar (the tunnel).

11. Snake in the tunnel: Commitment to keeping
European rates within narrower band
compared with Breton Woods System
O
Exchangerate
No
intervention
Central bank
buys domestic
currency
No
intervention
Central bank
sells domestic
currency
No
intervention
Time
+4.50%
-4.50%
+2.25%
- 2.25%

12. A Brief Monetary History of Europe
• 1973 – First Oil Crisis
• Snake outside the ‘tunnel’ link with dollar
broken
• Governments responded by trying to
reflate economies spending and issuing
(‘forging’) money
• –expansionary fiscal and monetary policy
• Differences across countries meant
exchange rates unsustainable
• Collapsed, and then revived in 1979

13. The EMS-1: Key Features
• A parity grid:
– bilateral central parities
– associated margins of fluctuations.
• Mutual unlimited support:
– exchange market interventions
– short-term loans.
• Realignments:
– tolerated, if not encouraged
– require unanimity agreement.
• The E.C.U.:
– not a currency, just a unit of account
– took some life on private markets.

14. The ECU
A basket of all EU currencies.
Source: Baldwin & Wyplosz 2003

15. The EMS: Interpretation and Assessment
• Improving on the Snake to stabilise intra-
European exchange rates:
– mutual support
– realignment unanimity rule.
• Respecting the EU equalitarian approach:
– no centre currency
– bilateral interventions by strong and weak
currency central banks.
• No role for the US dollar: Europe on its own.

16. The EMS: Past and Present
• The EMS was originally conceived as the
solution to the end of the Bretton Woods
System.
• Over the years, its nature changed and it
became a kind of DM area, with the
Bundesbank very much in command.
• This, and the speculative crisis of 1993, made
the monetary union option attractive.
• Now the EMS is mostly the entry point for
future monetary union members.

17. Four Incarnations of the EMS
• 1979-82: EMS-1 with narrow bands of
fluctuation (2.25%) and symmetric.
• 1982-93: EMS-1 centered on the DM,
shunning realignments.
• 1993-99: EMS-1 with wide bands (15%).
• 1999- : EMS-2, assymmetric, on the way to
euro area.

18. History of the ERM
Mar Sept Nov Mar Oct Feb June Mar July Apr Aug Jan Jun Jan
'79 '79 '79 '81 '81 '82 '82 '83 '85 '86 '86 '87 '89 '90
Belgian franc En21/4% –8.5 +1.5 +2.0 +1.0 +2.0
Danish krone En21/4% –2.9 –4.8 –3.0 +2.5 +2.0 +1.0
German mark En21/4% +2.0 +5.5 +4.25 +5.5 +2.0 +3.0 +3.0
French franc En21/4% –3.0 –5.75 –2.5 +2.0 –3.0
Irish punt En21/4% –3.5 +2.0 –8.0
Italian lira En6% –6.0 –3.0 –2.75 –2.5 –6.0 B21/4%
Dutch guilder En21/4% +5.5 +4.25 +3.5 +2.0 +3.0 +3.0
UK pound – – – – – – – – – – – – – –
Spanish peseta – – – – – – – – – – – – –En6%
Oct Apr Sept Sept Nov Jan May Aug Jan Mar Oct Nov Mar Jan Jan
'90 '92 '92 '92 '92 '93 '93 '93 '95 '95 '96 '96 '98 '99 '01
Belgian franc B15% S
Danish krone B15% B21/4%
German mark B15% S
French franc B15% S
Irish punt –10.0 B15% +3.0 S
Italian lira –7.0 Ex – – – – – – – En15% S
Dutch guilder B15% S
UK pound –En6% Ex – – – – – – – – – – –
Spanish peseta –5.0 –6.0 –8.0 B15% –7.0 S
Portuguese escudo – En6% –6.0 –6.5 B15% –3.5 S
Austrian schilling – – – – – – – – En15% S
Finnish markka – – – – – – – – – – En15% S
Greek drachma – – – – – – – – – – – – En15% S
– =% devaluation; + =% revaluation. B% = new band; En% = entry band; Ex = exit; S = join single currency
– =% devaluation; +=% revaluation. B% = newband; En% =entry band; Ex =exit; S= joinsingle currency
Source: Sloman (2006)

19. Evolution: From Symmetry to DM Zone
• First a flexible arrangement:
– different inflation rates: long run monetary
policy independence
– frequent realignments.

20. Evolution: From Symmetry to DM Zone
Inflation
Source: Baldwin & Wyplosz 2003

21. The EMS: Interpretation and Assessment
• Can EMS have monetary policy independence ?
• The Impossible trinity:
– widespread capital controls to preserve at least the
ability to have different inflation rates.
• But Single Market Act ruled out
Fixed
Exchange
Rate
Monetary union
Free
float
EMS
Full Capital
Mobility
Monetary
Independence
Source: Baldwin & Wyplosz 2003

22. Evolution: From Symmetry to DM Zone
• But: realignments:
– barely compensated accumulated inflation
differences
– were easy to guess by markets
– put weak currency/high inflation countries on
the spot:
Continuing current account deficits
Speculative attacks.
• The symmetry was broken de facto.
• The Bundesbank became the example to follow.

23. The DM Zone
• What shadowing the Bundesbank required:
– giving up much what was left of monetary
policy indepedence
– aiming at a low German-style inflation rate
– avoiding realignments to gain credibility.

24. History of the ERM
Mar Sept Nov Mar Oct Feb June Mar July Apr Aug Jan Jun Jan
'79 '79 '79 '81 '81 '82 '82 '83 '85 '86 '86 '87 '89 '90
Belgian franc En21/4% –8.5 +1.5 +2.0 +1.0 +2.0
Danish krone En21/4% –2.9 –4.8 –3.0 +2.5 +2.0 +1.0
German mark En21/4% +2.0 +5.5 +4.25 +5.5 +2.0 +3.0 +3.0
French franc En21/4% –3.0 –5.75 –2.5 +2.0 –3.0
Irish punt En21/4% –3.5 +2.0 –8.0
Italian lira En6% –6.0 –3.0 –2.75 –2.5 –6.0 B21/4%
Dutch guilder En21/4% +5.5 +4.25 +3.5 +2.0 +3.0 +3.0
UK pound – – – – – – – – – – – – – –
Spanish peseta – – – – – – – – – – – – –En6%
Oct Apr Sept Sept Nov Jan May Aug Jan Mar Oct Nov Mar Jan Jan
'90 '92 '92 '92 '92 '93 '93 '93 '95 '95 '96 '96 '98 '99 '01
Belgian franc B15% S
Danish krone B15% B21/4%
German mark B15% S
French franc B15% S
Irish punt –10.0 B15% +3.0 S
Italian lira –7.0 Ex – – – – – – – En15% S
Dutch guilder B15% S
UK pound –En6% Ex – – – – – – – – – – –
Spanish peseta –5.0 –6.0 –8.0 B15% –7.0 S
Portuguese escudo – En6% –6.0 –6.5 B15% –3.5 S
Austrian schilling – – – – – – – – En15% S
Finnish markka – – – – – – – – – – En15% S
Greek drachma – – – – – – – – – – – – En15% S
– =% devaluation; + =% revaluation. B% = new band; En% = entry band; Ex = exit; S = join single currency
Mar Sept Nov Mar Oct Feb June Mar July Apr Aug Jan Jun Jan
'79 '79 '79 '81 '81 '82 '82 '83 '85 '86 '86 '87 '89 '90
Belgian franc En21/4% –8.5 +1.5 +2.0 +1.0 +2.0
Danish krone En21/4% –2.9 –4.8 –3.0 +2.5 +2.0 +1.0
German mark En21/4% +2.0 +5.5 +4.25 +5.5 +2.0 +3.0 +3.0
French franc En21/4% –3.0 –5.75 –2.5 +2.0 –3.0
Irish punt En21/4% –3.5 +2.0 –8.0
Italian lira En6% –6.0 –3.0 –2.75 –2.5 –6.0 B21/4%
Dutch guilder En21/4% +5.5 +4.25 +3.5 +2.0 +3.0 +3.0
UK pound – – – – – – – – – – – – – –
Spanish peseta – – – – – – – – – – – – –En6%
Oct Apr Sept Sept Nov Jan May Aug Jan Mar Oct Nov Mar Jan Jan
'90 '92 '92 '92 '92 '93 '93 '93 '95 '95 '96 '96 '98 '99 '01
Belgian franc B15% S
Danish krone B15% B21/4%
German mark B15% S
French franc B15% S
Irish punt –10.0 B15% +3.0 S
Italian lira –7.0 Ex – – – – – – – En15% S
Dutch guilder B15% S
UK pound –En6% Ex – – – – – – – – – – –
Spanish peseta –5.0 –6.0 –8.0 B15% –7.0 S
Portuguese escudo – En6% –6.0 –6.5 B15% –3.5 S
Austrian schilling – – – – – – – – En15% S
Finnish markka – – – – – – – – – – En15% S
Greek drachma – – – – – – – – – – – – En15% S
– =% devaluation; + =% revaluation. B% = new band; En% = entry band; Ex = exit; S = join single currency
– =% devaluation; + =% revaluation. B% = new band;
En% = entry band; Ex = exit; S = join single currency
Source: Sloman (2006)

25. Breakdown of the DM zone
• Bad design:
– full capital mobility established in 1990 as
part of the Single Act: EMS in
contradiction with impossible trinity
unless all monetary indepdence
relinquished.
• Bad luck:
– German unification: a big shock that called
for very tight monetary policy
– the Danish referendum on the Maastricht
Treaty.
• A wave of speculative attacks in 1992-3:
– the Bundesbank sets limits to unlimited
support.

26. History of the ERM
Mar Sept Nov Mar Oct Feb June Mar July Apr Aug Jan Jun Jan
'79 '79 '79 '81 '81 '82 '82 '83 '85 '86 '86 '87 '89 '90
Belgian franc En21/4% –8.5 +1.5 +2.0 +1.0 +2.0
Danish krone En21/4% –2.9 –4.8 –3.0 +2.5 +2.0 +1.0
German mark En21/4% +2.0 +5.5 +4.25 +5.5 +2.0 +3.0 +3.0
French franc En21/4% –3.0 –5.75 –2.5 +2.0 –3.0
Irish punt En21/4% –3.5 +2.0 –8.0
Italian lira En6% –6.0 –3.0 –2.75 –2.5 –6.0 B21/4%
Dutch guilder En21/4% +5.5 +4.25 +3.5 +2.0 +3.0 +3.0
UK pound – – – – – – – – – – – – – –
Spanish peseta – – – – – – – – – – – – –En6%
Oct Apr Sept Sept Nov Jan May Aug Jan Mar Oct Nov Mar Jan Jan
'90 '92 '92 '92 '92 '93 '93 '93 '95 '95 '96 '96 '98 '99 '01
Belgian franc B15% S
Danish krone B15% B21/4%
German mark B15% S
French franc B15% S
Irish punt –10.0 B15% +3.0 S
Italian lira –7.0 Ex – – – – – – – En15% S
Dutch guilder B15% S
UK pound –En6% Ex – – – – – – – – – – –
Spanish peseta –5.0 –6.0 –8.0 B15% –7.0 S
Portuguese escudo – En6% –6.0 –6.5 B15% –3.5 S
Austrian schilling – – – – – – – – En15% S
Finnish markka – – – – – – – – – – En15% S
Greek drachma – – – – – – – – – – – – En15% S
– =% devaluation; + =% revaluation. B% = new band; En% = entry band; Ex = exit; S = join single currency
Source: Sloman (2006)

27. Contradictory Lessons From 1993 (1)
• The two-corner view:
– even the cohesive EMS did not survive
– go to one of the two corners (pick one!).
• The EMS should be made even more cohesive:
– the monetary union is the way to go.
• The EMS was a bad idea:
– float is the future.
• Unlimited interventions cannot be unlimited:
– need more discipline and less support.

28. Contradictory Lessons From 1993 (2)
• The Bundesbank’s selection of countries to be
supported:
– left scars (e.g. Britain)
– raises question on who decides what.
• Speculative attacks can hit even robust systems
and properly valued currencies (suggesting self-
fulfilling crises).
• Both facts strengthen the two-corner view,
providing arguments for each corner.

29. The Wide-Band EMS
• Way out of crisis:
–wide band of fluctuation (15%)
–a soft EMS on the way to monetary union.

30. Four Incarnations of the EMS
Source: Baldwin & Wyplosz 2003

31. EMS-2
• EMS-1 ceased to exist on 1 January 1999
with the launch of the Euro.
• EMS-2 was created to:
– host currencies of existing EU members
who cannot/don’t want to join euro area:
Denmark and the UK have a derogation,
but Denmark has adopted the new ERM
Sweden has no derogation but has
declined to adopt the new ERM
– host currencies of new EU members
before they are admitted into euro area:
potentially ten new members.

32. How Does EMS-2 Differ From EMS-1?
ECB explicitly allowed
to suspend intervention
Automatic unlimited
interventions
‘Normal’ (±2.25%) and
‘standard’ (±15%) bands
Margin explicitly set
Asymmetric, all parities
defined vis a vis euro
Symmetric, no anchor
currency
EMS-2EMS-1

33. A Revival of The EMS?
• In principle, ERM membership is compulsory
for the all new members.
• They must stay at least two years in the ERM
before joining the euro area.
• They must also eliminate all capital controls.
• The impossible trinity says that they will have
to fully give up monetary policy.
• The risk of self-fulfilling crises says that may
not be enough to avoid trouble.