Definition of European Monetary System

The Birth of a European Currency: The Euro

The 15 members of the European Union are also members of the European Monetary System (EMS). This group has tried to form an island of fixed exchange rates among themselves in a sea of major floating currencies. Members of the EMS rely heavily on trade with each other, so they perceive that the day-to-day benefits of fixed exchange rates between them are great.

Nevertheless the EMS has undergone a number of major changes since its inception in 1979, including major crises and reorganizations in 1992 and 1993 and conversion of 11 members to the euro on January 1, 1999 (Greece joined in 2001). In December 1991, the members of the European Union met a Maastricht, the Netherlands, and finalized a treaty that changed Europe’s currency future.

Timetable

The Maastricht treaty specified a timetable and a plan to replace all individual ECU currencies with a single currency, call euro. Other steps were adopted that would lead to a full European Economic and Monetary Union (EMU).

Convergence Criteria

To prepare for the EMU, the Maastricht Treaty called for the integration and coordination of the member countries’ monetary and fiscal policies. The EMU would be implemented by a process called convergence.

Before becoming a full member of the EMU, each member country was originally expected to meet the following convergence criteria:

1. Nominal inflation should be no more than 1.5 percent above the average for the three members of the EU with the lowest inflation rates during the previous year.

2. Long-term interest rates should be no more than 2 percent above the average for the three members with the lowest inflation rates.

3. The fiscal deficit should be no more than 3 percent of gross domestic product.

4. Government debt should be no more than 60 percent of gross domestic product.