The relationship between the single currency and the other currencies in the Union:

Is there EMS after EMU?

Ciro Schioppa


The debate on Economic and Monetary Union (EMU) has so far concentrated on general aspects of the adoption of a single currency, such as the function of the European Monetary System (EMS) in the transition to Stage III, the costs and benefits of EMU, the role of convergence criteria (Gros and Thygesen, 1992). With the dates for a possible move to Stage III now in the offing, it is increasingly necessary to deal with the actual implementation of EMU and face issues pertaining to the internal logic of the Maastricht Treaty, rather than its strategic and economic logic.

One of the issues to be solved concerns the type of exchange-rate arrangement, if any, that should link the single currency, the ECU, to the currencies of countries that do not enter Stage III from the start. What are the Treaty prescriptions on this important aspect of intra-EU relationships? What indications can be derived from the whole fabric of the Treaty and from its historic precedents? The importance of these questions is apparent if we consider the historical role played by exchange rate co-operation in advancing the EMU process (Papadia and Saccomanni, 1994). In addition to being important from a qualitative point of view, the issue is likely to be quantitatively significant: some "old" member countries might be unable, or unwilling, to participate in Stage III from the start, while future "new" members might adopt the single currency only several years after joining the Union.

The aim of this paper is to ascertain what the general logic and the letter of the Treaty say and what is suggested by the history of EMU as regards the adoption of a co-operative arrangement as a framework for managing, in the EMS tradition, the relationship between the ECU and the OCUs (Other Currencies of the Union). Thus, Section 2 reviews the complex procedure established by the Treaty regarding the decision to move to Stage III with the aim of determining when the problem will arise, as well as which categories of countries are likely to be involved. Section 3 seeks to ascertain whether the Treaty points to possible solutions, while Section 4 analyses the factors which have a bearing on the relationship between the ECU and the OCUs.


The debate on whether EMU should be achieved only after a gradual process of convergence rather than by way of a sudden and instantaneous transition goes back to the first efforts of European monetary co-operation (Kenen, 1992). However, both for practical and political reasons, the instantaneous transition option was never considered to be realistic (Bini Smaghi et al, 1992). Thus, the Treaty on European Union is based on the principle that EMU can only be achieved by way of a gradual process (Stages I and II), during which each participating country endeavours to converge individually - both from an economic and an institutional point of view - towards the common standards indicated by the Treaty.

Embedded in the gradual approach to EMU is the idea that not all the countries which have ratified the Treaty will necessarily participate in Stage III at the same time: owing to insufficient economic or institutional convergence, one or more countries may be unable to participate in Stage III of EMU when it starts. In the jargon of the Treaty, these countries are termed "countries with a derogation" (Art. 109k).

The designation of the countries with a derogation is part of a complex procedure prescribed by the Treaty for making the final decision to move to Stage III. The procedure involves two logically distinct, albeit intertwined, decisions about: i) the timing of and the participation in the move to Stage III; ii) the conversion rates at which the participating currencies are irrevocably locked and the ECU becomes a currency in its own right. Since both decisions are important for the analysis of the relationship between the ECU and the OCUs, it is worth briefly describing the procedure established by the Treaty.

As regards the timing of and the participation in the move to Stage III, the Treaty states that, in the event of a decision being made before the end of 1997, the Council of Ministers shall assess, on the basis of two independent reports by the European Monetary Institute (EMI) and the Commission, whether a majority of the Member States fulfil the necessary conditions for the adoption of a single currency (Art. 109j).

This assessment will be based not only on the four economic convergence criteria which have attracted the attention of commentators and critics of the Treaty, but also on the institutional convergence in the field of central bank independence provided for in Arts. 107 and 108. Based on the Council's recommendations and the opinion of the European Parliament, the Council - meeting in the composition of the Heads of States and Government and acting by a qualified majority - shall decide whether a majority of the Member States is ready to start Stage III and whether it is appropriate for the Community to enter Stage III, and set the date for the beginning of the third stage.

In the absence of a decision by end-1997, the Council must indicate, by the first of July 1998, which countries are ready to participate in Stage III from January 1st 1999. Art. 109k(1) states that the designation of the countries with a derogation is complementary to this decision. Immediately after the decision on the date of the move to Stage III, the European Central Bank (ECB) and the European System of Central Banks come into life (Art. 109l(1)).

As for the second decision, the Treaty indicates that the Council, meeting in the composition of the Heads of States and Government, is the body which is ultimately responsible for the adoption of the conversion rates (Art. 109l(4)). The Council is to act upon a proposal from the Commission after consulting the European Central Bank. It is only with the irrevocable fixing of parities that the ESCB assumes responsibility for the conduct of the single monetary policy: from that moment, the problem of the relationship between the single currency and any non-participating currency arises.

The problem also arises for the currencies of a second category of countries, those with a so-called opt-out clause (the United Kingdom and Denmark (1) ), which may decide not to participate in Stage III of EMU. The protocol containing the UK opt-out clause differs from the Danish one in terms of detail and length, but, in practice, both protocols imply that convergence is only one of the criteria relevant for the move to Stage III, as the willingness of the two countries must also be taken into account. Thus, the problem of the possible links between the single currency and the other currencies is likely to involve the currencies of these two countries as well.

A final group of countries may be involved in the problem, namely those that will join the European Union after the locking of parities. A number of central and eastern European countries are eager to become full members of the EU and some of them have already applied. As a result of the practical and political complexity of these negotiations, many will probably arrive at a positive conclusion only after the beginning of Stage III. Moreover, becoming a member of the EU involves much broader considerations than merely the adoption of the single currency; thus, it cannot be excluded that a country will want to join the EU while delaying the adoption of the single currency. Finally, it is possible that at least some of the future new members of the EU will not have achieved the required degree of economic and institutional convergence by the time they join. Be that as it may, it is likely that some future member countries will join the EU while retaining their national currencies for a period of years rather than months; in this interim period, the derogation regime envisaged by Art. 109(k) should be applied to them as well.


In the previous section, it has been shown that the question of the relationship between the ECU and the other EU currencies arises with the locking of parities and that the problem involves countries with a derogation, opting-out countries, and countries joining the EU after the locking of parities. It is of course difficult to predict now which countries will be in each category. Nonetheless, it is important to ascertain what the Treaty says about this important issue.

The Treaty does not establish a complete set of rules, but it does give some indications. Firstly, Art. 109(m) states:

  1. Until the beginning of the third stage, each Member State shall treat its exchange rate policy as a matter of common interest. In so doing, Member States shall take account of the experience acquired in co-operation within the framework of the European Monetary System (EMS) and in developing the ECU, and shall respect existing powers in this field.
  2. From the beginning of the third stage and for long as a Member State has a derogation, paragraph 1 shall apply by analogy to the exchange rate policy of that Member State.

The first paragraph of Art. 109(m) is applicable during Stage II to all member countries, whereas the second paragraph is applicable during Stage III to countries with a derogation, be they "old" or "new" members of the EU. This means that it should apply to both Denmark, under par. 2 of relevant protocol, and the UK, since par. 3 of the UK protocol states that Art. 109(m) shall apply to the United Kingdom as if it had a derogation (2).

However, the content of Article 109(m) is open to interpretation. For instance, Kenen argues that the Treaty does not impose reciprocal obligations on the ECB with regard to the management of the exchange rate between the ECU and the non-participants' currencies (Kenen, 1995). This is certainly true, but it does not imply that the Article is an empty box. In this respect, three main observations apply.

First, the Article establishes a continuum between the experience of the EMS up to the end of Stage II (par. 1) and the duties of countries with a derogation regarding their exchange rate policy in Stage III (par. 2). Thus, the fact that the first paragraph of Art. 109(m) is applicable by analogy to Stage III is not a sign of a lack of precision in the Treaty; on the contrary, it should be considered as a positive Treaty prescription of how the exchange rate policy of the countries with a derogation should evolve as a result of the adoption of the single currency. In this light, it is fair to say that Art. 109(m) sets the EMS as the model to which the exchange rate policy of non-participating countries should broadly conform.

Secondly, the fact that the Article does not impose the adoption of a new EMS does not exclude the possibility of its being established if necessary and appropriate. Evidently, it depends on circumstances and the reference to the experience acquired in co-operation within the framework of the EMS contained in paragraph 1 seems entirely consistent with its application by analogy in the future Stage III. The drafters of the Treaty were probably well aware that the EMS had evolved substantially over its life (Gros and Thygesen, 1992) and thought it inappropriate to impose the mechanical transposition of a model which could witness further evolution. The EMS crisis of 1992-93 and the ensuing widening of the fluctuation margins prove that the choice was the right one .

Thirdly, the reference contained in Art. 109(m) to the fact that each member state with a derogation should treat its exchange rate policy as a matter of common interest in the light of the experience of co-operation in the EMS must also mean something about the co-operative attitude of countries participating in Stage III. Since it takes two to tango, countries with a derogation could not co-operate if single-currency countries were unwilling to do so. Thus, it can be stated that Art. 109(m) sets a lower limit to the co-operative character of the regime which will link the ECU to the non-participating currencies. Probably, a sum of unilateral peggings would not comply with the prescriptions of Art. 109m(1).

The view that a revised EMS should be based on a high degree of co-operation is reinforced by a second set of provisions, those contained in Arts. 44 and 47 of the ECB Statute, which prescribe that the General Council of the ECB shall take over those tasks of the EMI which, because of the derogations of one or more Member States, still have to be performed in Stage III. The tasks include not only improving monetary policy co-ordination among the Member States, but also monitoring the functioning of the EMS and, presumably, performing the activities originally conducted by the European Monetary Cooperation Fund. It is important to note that the General Council will comprise the President and Vice President of the ECB and the Governors of all the EU national central banks, including those of the countries with a derogation.

A third set of relevant Treaty provisions are those contained in Art. 109k(2), which prescribe the repetition - at least once every two years, or at the request of a Member State with a derogation - of the procedure followed to determine the participation in Stage III (see Section 2). If the Council decides that a country with a derogation meets the convergence criteria indicated by Art. 109j(1), the derogation is abrogated and the country adopts the single currency. According to the relevant protocol, the convergence criteria include the observance of the normal fluctuation margins provided for by the Exchange Rate Mechanism (ERM) of the EMS, for at least two years, without devaluing its currency's bilateral central rate against the currency of any other Member State on its initiative for the same period. If a country with a derogation has to respect the ERM margins to qualify for Stage III, there must be an ERM in place and therefore these provisions confirm that an arrangement closely resembling the ERM of the EMS is necessary in Stage III.


In the previous section it was argued that the Treaty seems to require an EU-wide co-operative exchange-rate arrangement for two main reasons. First, to ensure a set of mutually consistent exchange-rate policies aimed at preventing beggar-my-neighbour policies which might jeopardise the integrity of the single market. Secondly, to conduct a periodical re-assessment of the economic convergence of latecomers. It is beyond the scope of this note to formulate a full proposal for an exchange-rate arrangement which could replace the EMS in Stage III. However, it is worth identifying the main factors which should be taken into account in designing such a system.

In principle, exchange-rate arrangements can be ranked in terms of the degree of co-operation and the symmetry of formal obligations for participating countries. From this perspective, two polar cases limit the range of alternatives available for managing the relationship between the ECU and the OCUs.

At one extreme, there is a unilateral pegging system. In this arrangement, each individual OCU would adopt a parity with the ECU, which would play the role of nominal anchor and would also constitute the main currency of denomination of official reserves and of the intervention instruments for keeping the rate within pre-announced fluctuation bands. Presumably, the degree of co-operation required by such an arrangement would be low and limited to information commitments. In fact, non-participating countries would feel free to change their parity without consulting the ECB in advance, given that only their own monetary authorities would be responsible for the variations in interest rates and/or interventions necessary to keep their exchange rates within the band. In this respect, the system would be, also formally, asymmetrical.

At the other extreme of the range of possible solutions, there is the EMS in its original formulation. This was formally based on the ECU, defined as a basket of currencies, since central rates towards the ECU are used to determine a parity grid of bilateral rates which establish intervention obligations. The grid implies a formal symmetry of obligations, since whenever currency X reaches its lower intervention limit against currency Y (i.e. depreciates), Y reaches its upper intervention limit against X and both central banks are bound to intervene without limits. The degree of co-operation required is high, since the parity grid, and changes in it, have to be agreed upon following a multilateral procedure.

Neither of the two alternatives seems to comply with the Treaty prescriptions. As we have already stated, a series of unilateral peggings would certainly be at odds with Art. 109m(1), since under this arrangement there is no guarantee that either the EMU countries as a group or each individual non-participating country would regard their intra-EU exchange-rate policy as a matter of common interest in a co-operative framework.

As for the original EMS, its mechanical transposition to Stage III would be at odds with the Treaty prescription to take account of the experience acquired in co-operation within the framework of the European Monetary System. The EMS crisis of 1992-93 proved that the EMS was undermined by the wide gap existing between the obligations formally prescribed by the agreement and those actually perceived by the markets and by the participating central banks. A recent study of the European Parliament (Collignon et al. 1994, p. 23) has pointed out that "the spectacular break of the EMS with the past consisted in the open-ended commitment to which the country and their central banks agreed....... For 13 years the EMS had been taken at face value. Only in the September 1992 crisis did it become apparent that no country could be reasonably expected to fulfil this commitment for ever, even under extreme conditions". This basically means that it would be unwise - and contrary to the letter and spirit of the Treaty - to repropose a game which the players are reluctant to play.

Can a more satisfactory solution be found? Probably yes, but it should be built on an analysis of the reasons why the EMS worked reasonably well for 13 years. The basic reason is that the ERM ended up, in practice, by being a highly asymmetrical system. In particular, the asymmetry of the EMS had two main aspects (Collignon et al, 1994). First, the traditional asymmetry of any fixed-but-adjustable exchange-rate regime resulting from the reserve constraint imposed on the depreciating currency by unlimited intervention. Secondly, the asymmetry due to the fact that it is relatively easy for the central bank of the "strong" currency to sterilise intervention, while for the "weak" currency any attempt to sterilise would result in a further loss of reserves. Thus, while the money supply remains stable in the strong-currency country, it decreases in the weak-currency country and the monetary policy of the strong-currency central bank sets the tone of the EMS countries' monetary policy as a whole: the strong currency becomes the anchor of the system and non-leader central banks have to accept the monetary policy followed by the anchor country.

What is therefore necessary is a system in which formal obligations fully correspond to actual obligations and the leading role of the "strong" currency is fully recognised. From this perspective, it is obvious that the ECU (single currency) would be the anchor of an EMS surviving after the beginning of Stage III. Several factors could underpin this leadership. Firstly, the Statute of the ESCB makes it clear that monetary policy must be geared to price stability. Therefore, the ECB cannot assume exchange-rate obligations toward OCUs; this also implies that the ECU will be a strong and stable currency, thus fulfilling the necessary conditions for its being an anchor. Secondly, in all likelihood, the ECU will be the single currency of a group of countries whose economy will be a multiple of the economy of each single EMU participant, as well as of any non-participating country. This, in turn, has two consequences: the ECB will be able to take a more liberal attitude towards the international use of its currency, including its use by countries with a derogation or on a opt-out clause; the much larger size of the underlying economy will make the ECB a natural leader. Thirdly, the anchor currency (the ECU) will be managed by the ESCB - an EU body, not a national institution. Thus, the very concept of monetary leadership should become more acceptable to the countries which will retain their national currencies in Stage III. In this last respect, it should not be forgotten that OCU countries will be directly represented in certain organs of the ECB, albeit not in those responsible for the conduct of monetary policy.



- Bini Smaghi, L., T. Padoa-Schioppa and F. Papadia (1994), The transition to EMU in the Maastricht Treaty, Essays in International Finance 194, Princeton: International Finance Section, Princeton University.

- Collignon S. et al. (1994), Europe's Monetary Future, London: Pinter.

- Gros, D., and N. Thygesen (1992), European Monetary Integration, New York: St. Martin's Press.

- Kenen, P., (1992), EMU After Maastricht, Washington: Group of Thirty.

- Kenen, P., (1995), Economic and Monetary Union in Europe: Moving Beyond Maastricht, Cambridge: Cambridge University Press, forthcoming.

- Papadia, F., and F. Saccomanni (1994), "From the Werner Plan to the Maastricht Treaty: Europe's Stubborn Quest for Monetary Union", in A. Steinherr, ed., Thirty Years of European Monetary Integration: From the Werner Plan to EMU, London: Longman.

(1) The most important differences between the two protocols concern:
- the content of the notification required: since the UK protocol is based on the presumption that the country does not intend to participate in Stage III, the UK will notify the Council only if it wishes to be included in the assessment under Art. 109j(2); in the Danish case, since the presumption is that the county does intend to move to Stage III, it will only notify its desire to be excluded from the Council assessment. It should be noted, however, that after the first, negative, referendum on the Maastricht Treaty, Denmark clarified that it did not intend to participate in Stage III.
- the treatment of the country: in the case of an opt-out, Denmark will be granted the same treatment as the countries with a derogation, whereas the UK will be treated according to specific clauses in the protocol.

(2) This will apply as long as Denmark and the UK do not participate in Stage III.