Saturday 21 Jul 2018 | 04:36 | SYDNEY
Saturday 21 Jul 2018 | 04:36 | SYDNEY

Snakes and ladders: A euro pre-history


Mark Thirlwell

27 May 2010 08:47

The tension between economic and political factors in the story of the euro, which I talked about in my first post in this series, can be traced all the way back to the decision to adopt the 1970 Werner Report and its recommendations that Western Europe should aim for monetary union via the route of a progressive hardening of exchange rate commitments. 

This took the form of the 1972 Basle Agreement which produced the European 'snake'. The snake sought to limit the exchange rate movements of member states to a band of ±1% and was supported by a couple of financing facilities and by the 'European Monetary Cooperation Fund.'

The snake failed: in the 1970s the world economy was hit by a series of major shocks, including the 1973 oil price spike and the 1974 commodity boom. European policymakers responded to these shocks quite differently. As a result, the snake saw a series of currency crises and between 1972 and 1978 the UK, France, and Italy (among others) were all forced out of the arrangement, sometimes repeatedly. 

This did not mark the end of the search for intra-European currency stability. 

Instead, the snake was replaced by the launch of the European Monetary System (EMS) in 1979, with the European Exchange Rate Mechanism (ERM) introducing a system of fixed-but-adjustable exchange rate pegs based on central parities against the European currency unit (ecu) and subject to both a ±2.25% fluctuation band (in some cases ±6%) and the option to adjust the central parity itself. 

For the first years of its operation, the flexibility of this system permitted its survival. But from around 1987 onward the ERM morphed into a more rigid system of fixed exchange rates, and for more than five years there were no changes in parities. 

Yet again, the scheme ultimately failed to cope with a series of severe shocks (this time a global recession, German economic and monetary unification, and a pan-European liberalisation of capital controls), and the ERM was blown apart by a series of exchange rate crises over 1992-93: Sweden, Italy and the UK were all forced to abandon their pegs while the remaining member economies ended up having to adopt much wider fluctuation bands (±15%), signaling a major retreat from the quest for exchange rate stability.

Once more, this did not mean the abandonment of the project, and the retreat from fixed rates was temporary. By 1989, the European Council had adopted the Delors Plan for European Economic and Monetary Union at the Madrid Summit and a tweaked version of the Plan was part of the 1991 Maastricht Treaty.

The 1992 ERM crisis destroyed the part of the Plan that relied on the EMS fixed exchange rate system, but the plans to create a European Central Bank and a euro area went ahead, with the euro introduced on 1 January 1999 and with the euro replacing national currencies on 1 January 2002.

I'll pursue the euro story to the present day in my final post in this series.

Photo by Flickr user mafalda.foto, used under a Creative Commons license.