Discretionary Exchange Rate Regimes: Lessons from the European Monetary System, 1979-1988

This article focuses on EMU’s predecessor, the European Monetary System (EMS), and how this looser monetary arrangement was more conducive towards facilitating macroeconomic adjustment via realignments among EU’s diverse member states, paying particular attention to France and Germany. We argue that in the EMS, devaluations did indeed help more than revaluations did hurt. Assuming that the political-economic heterogeneity of the Eurozone will not vanish in the foreseeable future, the move to a more flexible exchange rate regime might therefore be economically advantageous. However, a purely economic view ignores the huge political costs of negotiable realignments, costs that the EMS members aimed at overcoming when they negotiated the euro. This trade-off between economic and political expediency between the two exchange rate regimes seems to have been a decisive factor in the reasoning behind the change from EMS to EMU.