Introduction

This study examines the functioning of the Exchange-Rate Mechanism (ERM) of the European Monetary System (EMS) over its eight-year history (March 1979–June 1987). It concentrates on the role of intervention in foreign-exchange markets and domestic monetary instruments in maintaining ERM cohesion; the analysis of individual countries' behaviour is complemented by that of their interactions, with a view to describing the rules and patterns of monetary coordination implicit in the system's exchange-rate constraint.

In order to highlight the ‘rules of the game’, and the different positions and policy approaches of the system's members, we have focused on four countries: Germany, as the monetary ‘leader’; Belgium, as a small country basically behaving as an exchange-rate pegger; and France and Italy, two large countries with heterogeneous economic structures and economic performances that have diverged (albeit decreasingly so) from that of the leading country through most of the EMS's life.

The study is organised as follows. Section 2 examines the intervention rules and intervention patterns within the ERM; Section 3 presents evidence on the behaviour of the four sample countries, notably as regards the different ways they have combined intervention, exchangerate and interest-rate flexibility in their policy approach; Section 4 offers more detailed discussion of various institutional aspects of monetary management and monetary coordination within the system and presents preliminary evidence on the sterilisation techniques used to ‘decouple’ interventions from domestic monetary conditions; and finally, Section 5 presents the results of econometric estimates of individual countries' sterilisation policies, as well as of certain aspects of monetary policy interaction within the ERM. The main findings and open issues are summed up in the concluding Section 6.