What is the European Exchange Rate Mechanism (ERM)?

The European Exchange Rate Mechanism (ERM) was a system introduced in 1979 as part of the European Monetary System (EMS) to promote stability and coordination among the currencies of European Union (EU) member states. It aimed to manage exchange rate fluctuations and foster economic convergence among participating countries.

Under the ERM, participating countries agreed to maintain their exchange rates within a specified range against the European Currency Unit (ECU), which was a weighted average of the currencies of the member states. The ERM provided a framework for countries to intervene in the foreign exchange market to defend their exchange rates if they were under pressure.

The ERM operated through a combination of fixed and adjustable exchange rate systems. Initially, the exchange rates were fixed, but in 1993, a new version of the ERM called the "ERM II" was introduced, which allowed for limited exchange rate fluctuations within a predetermined band.

The ERM played a crucial role in the lead-up to the establishment of the Eurozone and the adoption of the euro as a common currency. It served as a precursor to the Economic and Monetary Union (EMU) and helped countries align their economic policies and convergence criteria to qualify for joining the Eurozone.

However, the ERM also faced challenges, particularly during times of economic instability and speculative attacks on currencies. Notably, in 1992, the ERM experienced a major crisis known as the "Black Wednesday" when the British pound was forced to exit the system due to unsustainable pressure.

Overall, the European Exchange Rate Mechanism was a significant step towards European monetary integration, providing a framework for exchange rate stability and coordination among EU member states.