Published online by Cambridge University Press: 01 July 1996
A yearlong nightmare for the European Monetary System (EMS) began in September 1992. Amid name–calling, finger–pointing, and hand–wringing, the British pound and the Italian lira dropped out of the Exchange Rate Mechanism (ERM). In succeeding months, virtually every other ERM currency came under attack.1 Three of them—the Spanish peseta, the Portuguese escudo, and the Irish punt—devalued within the system. Three others—the French franc, the Belgian franc, and the Danish krone—avoided devaluation, but only at the price of recurrent and costly rounds of intervention by multiple central banks. Finally, in August 1993, the defenders of the parities surrendered. The twelve EMS countries agreed to expand the fluctuation margins from 2.25 per cent on either side of parity (6 per cent for Spain, Portugal and the UK) to 15 per cent on either side of parity. The wider margins eliminated the potential for speculative attacks, but left the system only the thinnest veneer of exchange rate coordination. This article seeks not to assess the causes of the crisis but rather to explain why the EMS governments did not defuse it with a realignment—the mechanism built into the ERM for precisely such occasions.
1 The only exceptions were the Deutschmark and the Dutch guilder, which form the hard kernel of the ERM, and the Greek drachma, which was not part of the system.
2 That most of the currencies returned within months to their pre–widening, narrow bands vis–á–vis the Deutschmark is important and suggests numerous additional questions. Governments did not take advantage of the wider bands to reduce interest rates precipitously; on the contrary, they continued cautiously to follow German interest rate reductions.
4 Barry Eichengreen and Charles Wyplosz, ‘The Unstable EMS’, paper prepared for a Brookings Panel on Economic Activity, March 1993, pp. 19–26.
6 For a more extensive and formal explanation of the logic, see Eichengreen and Wyplosz, ‘Unstable EMS’, pp. 27–9.
7 David R. Cameron, ‘British Exit, German Voice, French Loyalty: Defection, Domination, and Cooperation in the 1992–93 ERM Crisis’, typescript, Yale University, n.d.
8 Cameron, ‘British Exit’; David Andrews, ‘Scapegoating, Exit Costs, and Credibility: The Politics of Exchange Rate Regimes’, paper presented at the Annual Meeting of the American Political Science Association, Washington, DC, 2–5 September 1993.
9 See Melitz, Jacques, ‘Monetary Discipline and Cooperation in the European Monetary System: A Synthesis’, in Giavazzi, Francesco, Micossi, Stefano and Miller, Marcus (eds.), The European Monetary System (New York, 1988), p. 58.Google Scholar I am not aware of any cross–national empirical tests of this generalization.
12 Higher inflation elsewhere, in an adjustable–rate system like the ERM in which realignments were not entirely compensating for accumulated inflation differentials, meant that foreign prices rose faster than French prices. Hence the increasing price competitiveness of French output.
24 See Keohane, Robert O., ‘The Demand for International Regimes’, in Krasner, Stephen D. (ed.), International Regimes (Ithaca, NY, 1983), pp. 155–7Google Scholar.
25 See Wayne Sandholtz, ‘Membership Matters: Limits of the Functional Approach to European Institutions’, Journal of Common Market Studies, forthcoming; also Martin, Lisa L., ‘International and Domestic Institutions in the EMU Process’, Economics and Politics, 5 3), p. 126Google Scholar.
26 I will explain the procedures defined by the Treaty on European Union, despite well–founded doubts that the timetable remains valid after the EMS crisis. My argument will be that the treaty provisions influenced the decision–making of national governments in 1991 and 1992, when the treaty created a set of expectations concerning the course of monetary integration. For my purposes, it is irrelevant that later events altered those expectations.
27 The treaty allows that the criteria are not necessarily strict cut–offs, that member states can take into consideration whether a state is making notable progress toward satisfying the criteria. Member states can also include in their assessments aspects of a country's economic performance that are not covered by the criteria.
33 Eichengreen and Wyplosz, ‘Unstable EMS’, p. 27.
45 For a discussion of the nature and depth of French and German commitment to EMU, see Sandholtz, Wayne, ‘Choosing Union: Monetary Politics and Maastricht’, International Organization, 41 (1993)Google Scholar.
47 David Andrews discusses the implications for exchange rate commitments of differing levels of public support for European integration in ‘Scapegoating’ (see no. 8); Jeffry Frieden analyzes how French and Italian governments linked EMS exchange rate commitments to the larger process of European integration, to which both French and Italian publics were highly favourable, in ‘Making Commitments: France and Italy in the European Monetary System, 1979–1985’, in Eichengreen, Barry and Frieden, Jeffry (eds.), The Political Economy of European Monetary Unification (Boulder, CO, 1994)Google Scholar.