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 is known as convergence. 

Strong central bank: A strong central bank, called the European Central Bank

(ECB) was established in Frankfurt, Germany, in accordance with the Treaty.

The bank is modeled after the U.S. Federal Reserve System. This independent central bank dominates the countries' central banks, which continue to regulate banks resident within their borders; all financial market intervention and the issuance of euros will remain the sole responsibility of the ECB. The single most important mandate of the ECB is to promote price stability within the European Union.  As part of its development of cross-boarder monetary policy, the ECB has formed TARGET is the mechanism by which the ECB will settle all cross border payments in the conduct of EU banking business and regulation. It will be the ECB to quickly and costlessly conduct monetary policy and other intrabanking system capital movements.