The ERM Crisis: History: Long, vain quest for stability

FOR MOST of the 22 years since the abandonment of fixed exchange rates, Europe has searched in vain for the holy grail of stable currencies, to encourage trade and investment across its borders.

More than 20 years ago, Edward Heath, as Prime Minister, was forced to withdraw from the European currency 'snake' only weeks after entering. The snake slithered on ineffectively until 1978.

The exchange rate mechanism, which began operation in March 1979, was a more tightly drawn operation. Its rules set the terms under which central banks bought and sold currencies in the markets, to keep their values within defined bands. Realignments were allowed when market pressures became too great.

Hopes that the economies of Europe would move steadily closer were soon dashed, since their rates of inflation and growth continued to move out of step. This led to a large number of realignments.

So, as the chart shows, for eight years the ERM was a loose arrangement in which the German mark played the role of anchor, never devaluing. The system bent rather than broke under market pressure. But by the time the Delors report in 1989 proposed a move to monetary union, the ERM had subtly changed. It was seen as a precursor to a single currency, and it was hoped that realignments would soon be eliminated. For more than five years until October 1992, when Britain left after 23 months' membership, the new-style ERM appeared to be working.

Critics warned that a semi-fixed system that tied Europe to a German economy going through the trauma of reunification was the worst of both worlds. It had lost flexibility without gaining the certainty of a single currency. They have been proved right.

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