European Monetary System (EMS) was an arrangement between several European nations that aimed to prevent wide swings in the prices of its members’ currencies in relation to one another. Economists call the price of one nation’s currency, expressed in terms of another’s, an exchange rate. Exchange rates vary, depending on the supply of, and demand for, various currencies, as well as interest rates from country to country. What is now the European Union (EU) established the EMS in 1979 to stabilize exchange rates—and thus encourage trade and investment—among its members. The EU is a group of European countries that promotes political and economic cooperation among its members.
Until 1999, the EMS linked the currencies of its members according to an arrangement called the Exchange Rate Mechanism (ERM), which used a method called the target and band system. Under this system, the ERM established target exchange rates for each currency. Each currency could vary only within a specific range, known as a band, above and below the target value. If a currency moved too far from its target price, the member nations had to intervene, by buying the currency or adjusting interest rates, until the rate returned to the specified band. The ERM was based on a specially created unit of value called the European Currency Unit (ECU). The currency of each nation had a target value in relation to the ECU and to other nations’ currencies.
In 1999, a new currency unit, the euro, replaced the ECU. This event marked the final stage of a process known as Economic and Monetary Union (EMU). Eleven members of the EU froze their exchange rates by fixing them in terms of the euro. These nations were Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. A 12th member, Greece, joined the group in 2001. In 2002, euro notes and coins replaced the currencies of the 12 nations. By 2023, 20 EU nations had adopted the euro.
See also Euro; European Economic and Monetary Union; European Union (EU); Exchange rate.
