Introduction:

On 9 May 1950, the Schuman Declaration proposed the establishment of a European Coal and Steel Community  (ECSC) - ( Treaty of Paris of 18 April 1951).This put in place a common market in coal and steel between the six founding countries (Belgium, the Federal Republic of Germany, France, Italy, Luxembourg and the Netherlands).So 9 May is celebrated as the EU's birthday.

The Six then decided, on 25 March 1957 with the Treaty of Rome, to build a European Economic Community (EEC) based on a wider common market covering a whole range of goods and services.Customs duties between the six countries were completely abolished on 1 July 1968 and common policies, notably on trade and agriculture, were also put in place during the 1960s.

In 1971, the United States decided to abolish the fixed link between the dollar and the official price of gold, which had ensured global monetary stability after World War Two.This put an end to the system of fixed exchange rates.

European Monetary System (EMS)

  • After the collapse of Bretton Woods system in 1971, most of the EEC countries agreed in 1972 to maintain stable exchange rates by preventing exchange fluctuations of more than 2.25% (the European "currency snake").
  • In March 1979, this system began operating under the Jenkins European Commission where most nations of the European Economic Community (EEC) linked their currencies to prevent large fluctuations relative to one another by holding exchange rates within specified limits.
  • The goal was to foster monetary stability in the European Community.

Main Features of European Monetary System (EMS):

  1. Reference currency called the ECU: this was a ‘basket’ made up of the currencies of all the member states.
  2. An exchange rate mechanism: each currency had an exchange rate linked to the ECU; bilateral exchange rates were allowed to fluctuate within a band of 2.25 %.
  3. A credit mechanism: each country transferred 20 % of its currency and gold reserves to a joint fund. 

European Currency Unit (ECU)

  1. The quantity of each country's currency in the ECU reflected the country’s relative economic strength in the European Community.
  2. The ECU functioned as a unit of account, a means of settlement and a reserve asset for the members of the EMS.

European Union (EU)

  1. By 1986, nine countries joined the EMS – Denmark, Ireland, UK, Greece, Portugal, Spain, Austria, Finland and Sweden.
  2. 7th Feb. 1992, it was renamed as European Union (EU).
  3. The EU currently has 25 member states.

European Monetary System (EMS)

  • Periodic adjustments raised the values of strong currencies and lowered those of weaker ones, but after 1986 changes in national interest rates were used to keep the currencies within a narrow range.
  • In the early 1990s, the European Monetary System was strained by the differing economic policies and conditions of its members, especially the newly reunified Germany, and Britain (which had initially declined to join and only did so in 1990) permanently withdrew from the system in September 1992. 
  • Speculative attacks on the French Franc during the following year led to the so-called Brussels Compromise in August 1993 which established a new fluctuation band of +15%.
  • To prevent wide currency fluctuations among EU currencies and to eliminate competitive devaluations, EU governments had decided to relaunch the drive to full monetary union and to introduce a single currency.

From the EMS to EMU

  • At the European Council in Madrid in June 1989, EU leaders adopted a three-stage plan for economic and monetary union.
  • This plan became part of the Maastricht Treaty on European Union adopted by the European Council in December 1991.

The first stage (1 July 1990) :
  1. Completely free movement of capital within the EU (abolition of exchange controls).
  2. Increasing the amount of resources devoted to removing inequalities between European regions (Structural Funds).
  3. Economic convergence, through multilateral surveillance of member states’ economic policies.
The second stage (1 January 1994):

It provided for:
  1. Establishing the European Monetary Institute (EMI) in Frankfurt; the EMI was made up of the governors of the central banks of the EU countries.
  2. Independence of national central banks.
  3. Rules to curb national budget deficits.
The third stage (1 January 1999):
  1. The EMS  was no longer a functional arrangement in May 1998.
  2. In June 1998, the European Central Bank was established.
  3. From this point onwards, the European Central Bank took over from the EMI and became responsible for monetary policy, which is defined and implemented in euro.