Documents relating to the European Monetary System.
Date: 1982-09-22
Institutions: DG II – Economic and Financial Affairs
Subjects: Community budget, EU policy, Economic and Monetary Union, European Monetary System, economic analysis, economic convergence, economic growth, economic policy, economic reform, economic statistics, euro area, fiscal policy, institutional activity, own resources, report

ISSN  0379-0991

EUROPEAN
ECONOMY

COMMISSION  OF THE  EUROPEAN  COMMUNITIES  •  DIRECTORATE  GENERAL  FOR  ECONOMIC  AND  FINANCIAL  AFFAIRS

Documents  relating to the
European  Monetary  System

N« 12  July  1982

'EUROPEAN ECONOMY' appears  three times a year, in March,  July
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Commission  of the  European  Communities

EUROPEAN
ECONOMY

July  1982 

Number  12

The  manuscript was completed on 8 July  1982.

Reproduction is subject to  acknowledgement of the source,  except in the  case of  commercial  data-base networks,  where the
authorization of the Commission is required.

Printed  in Belgium,  1982

Catalogue number:  CB-AR-82-012-EN-C

Documents relating to the

European Monetary  System

Frederic
BOYER DE LA GlRODAY

Frederic Boyer de la Giroday was born in September  1918 on the island of Mauritius. He
studied economics first in Paris and then at Oxford.  In  1949 he entered the International
Monetary Fund and  left it in 1958 to join the Commission of the European Communities
at the time when the Directorate-General for Economic and  Financial Affairs  was being
formed.

The whole of his professional career was from  then on spent at  the Directorate-General
for  Economic and  Financial  Affairs, and was devoted to  monetary  questions.  Having
started in 1958 as a principal administrator, he was appointed Director in 1968 and at the
time of his departure in  1981 he was head of a Directorate of  four divisions dealing with
the whole range of monetary and financial questions. In the intervening years, he took an
active  part in  each of the  major  debates or  projects  which  marked the  history of
international monetary relations: he participated  with people such  as Ossola,  Mundell,
TrifTm, etc. in the great debates which marked the reform of the international monetary
systems,  the  creation  of  the  special  drawing  right,  the  introduction  of  the  general
arrangements to borrow. He made a special contribution, in his role of respected adviser
to men directly involved  such as  Robert  Marjolin,  Raymond  Barre or  Francois-Xavier
Ortoli to the Werner Plan, to the creation of the 'snake', to Community loans and to the
European  Monetary  System.

Fascinated by economic history, he was a popular and respected lecturer at the Universite
Libre de Bruxelles. He was an expert in the literature on international monetary questions,

was  familiar  with the  classical  authors on the  subject, and  took an  active  part in the

renewal of  ideas and  theories, persistent  in communicating his taste for  research  to  his
colleagues. His  personality was strong, his temperament  generous and  communicative.
His strength  of  character  was equalled  only  by  his soundness  of judgment.

Shortly  before  his  death,  on  29 December  1981  in  Arosa,  Switzerland,  he  had  been
appointed  honorary  Director-General  and  Special  Adviser  to  Commission  President
Thorn, He intended to devote his time to writing on subjects which had always interested
him,  such  as  the  European  capital  market,  the  Eurocurrency  system,  the  Bank  for
International  Settlements,  the  International  Monetary  Fund,  and  the  future  of
international  monetary  relations.

An earnest and enthusiastic supporter of European monetary integration, he never ceased

to demonstrate its advantages. A lucid observer of the difficulties  of this undertaking, he
never  allowed  himself  to  be  discouraged  by  the  interruptions,  the  false  starts  or  the
setbacks in the monetary construction of Europe. For  him, therefore, who had shared the
hopes  aroused by the  Werner  Plan, and the  subsequent  disappointments, the
establishment  of  the European  Monetary  System  was a  matter  of  great  satisfaction.

Foreword

This issue of  'European  Economy' analyses how the EMS has functioned in its first three years and presents
a dossier of the studies and discussions which have taken place within the Community on the development
of the system. It is built around three topics which are the product of the experience and reflection to date:
economic convergence in  relation to the  system in its existing form  (Part One), the  development of the
system  within  its present  institutional  framework  (Part Two), and  the  institutional phase of  the system
(Part  Three). The  public is thus given  access  to  hitherto unpublished  technical  studies and  documents.

The three topics are treated in the logical order of the system's development, from  the present phase to the
final  stage.  Chronologically,  the  work  on  the  institutional  phase—a  task  which'the  European  Council
explicitly  assigned  to  the  Community  institutions—preceded  the  studies  which  culminated  in  the
proposals for  non-institutional  development,  which  were presented in March  1982.

Except for those documents whose status is clearly defined (Commission communication, opinion of the
Committees, etc.), the analyses and assessments presented in this issue of  'European  Economy' are those of
the  departments  of  the  Commission's  Directorate-General  for  Economic  and  Financial  Affairs.  They
cannot be regarded as positions taken by the Commission. This is particularly true for Part Three, which is
a preliminary synthesis of the ideas put forward on the main areas of the institutional phase. The specific
proposals have been discussed in detail by the Alternates of the Monetary Committee, but the preliminary
synthesis is the fruit of the work of Commission departments. Certain assessments may be modified in the
light  of  changing  circumstances  and  of  a  more detailed  analysis  some  time  in the  future.

*

* 

*

The  EMS represents the most recent stage in the process, initiated by the Community in the late  1960s, of
providing itself with its own monetary identity and organization. The Treaties were devised and signed at a
time  when the  Community countries were integrated  into a  highly  structured monetary  system, that of
Bretton  Woods. The  organization  provided by  this  system was a  mainstay of the  Community's
construction  and  its existence  was  so  taken  for  granted  that  it  was  not  even  mentioned  in  the  Treaty.
However once this support started to weaken, the Community realized that a monetary organization was a
necessary complement to a commercial and agricultural organization. With varying success, it launched a
series of  initiatives  to  try  to  make good  the deficiency.

The EMS has been the most  successful of these initiatives. It has  maintained the unity of the Common

Market and has  made a  substantial  contribution to  closer  monetary  convergence in a  period  when

economic  crisis and  commercial  strains  have  reached a  degree of  gravity  unprecedented in the
Community's  history.  It  is  nevertheless  still  insufficient;  its  structures  not  being  strong  enough  to
encompass  national  economic  policies  within  a  common  monetary  discipline,  to  free  commercial
competitiveness  from  monetary constraints, or  to give the  Community a role in international  monetary
relationships commensurate  with  its  industrial  and  commercial  weight.

Aware  of  these  inadequacies,  the  system's  originators  from  the  beginning  intended  it  to  be  dynamic,
destined to evolve and to grow in strength. This dynamism has been one of the strong points of the system's
operation in its first  three years. It also provided the driving force for the discussions and  studies presented
here.

The proposals put forward  by the Commission in March 1982 mark an—unfinished—step along the road
which  leads  eventually but  inevitably  towards  European  monetary  inegration.

*

* 

*

This issue is dedicated to the memory of Frederic BOYER DE LA GIRODAY who, from his very earliest days
at the  Commission in  1958 until his  untimely  death in  December  1981,  placed his great  erudition, his

profound  idealism and  his extraordinary capacity for work at the service of the monetary construction of
Europe.

The European Monetary  System

Foreword

Part One — Economic convergence  and  the  European Monetary System 

Chapter 

I —  The links between economic  convergence  and exchange rate  stability 

Convergence of  living standards: long-term  trends 
The  interactions between  real  and  nominal developments  and  exchange rate  stability 
The  need  for, and  implications of, exchange rate stability 

21

Chapter II — The convergence of  economic and monetary policies under the EMS: the progress to be  achieved 

23

Insufficient  convergence towards stability 
Stronger  action  and  a  wider  range of  measures to  control  inflation 
Correcting structural macro-economic disequilibria 
A  suitable mix between  adjustment and  external financing 

33

29

Chapter  III  —  The  realignments of  February  and June  1982: the system  undermined  or consolidated? 

Operations carried  out  consistently  with  the logic  of  the  system 
Confirmation  of  the  importance attached  to greater  convergence 

40

Chapter IV —  Evaluation of the functioning of the EMS at 31 December  1981 

Part Two—The development of the European Monetary System in its present institutional framework 

39

Elements for  assessment 
Functioning of  the system's mechanisms 

Chapter V —  Analysis of the possible areas in which the EMS can be developed 

48

Assuring greater coherence of  the mechanisms 
Opening the  system 
Encouraging the private use of the ECU 
Strengthening policy  convergence 
Conclusions 

50

Chapter  VI —  Commission proposals for a non-institutional  development of  the EMS 

53

Draft  Resolution on the development of the European  Monetary  System 
Discussion  of some of  the proposals 

59

Part Three — Preliminary synthesis of  ideas on the  institutional stage of the  European Monetary

System 

63

63

The  ECU 
The  Fund 
Exterior aspects of the EMS 
Institutional  questions 

13

14
14
16

23
26

35
35
36

40
42

48
49

51
51

53

55

60
61

List  of  annexes

Annex  A

The system narrowing the margins of fluctuation between the

Annex B

currencies of the European Economic Community from April
1971  to  March  1979 
Main features of the European Monetary System in its present
phase 

Annex  C

—  Examination by the Monetary Committee of some aspects of
the non-institutional development of the European Monetary
System

C-l  —  Statement  by  Mr  Jean-Yves  Haberer,  Chairman  of  the
Monetary Committee, to the Economic and Financial Affairs
Council  of  14 December  1981, on  the  European  Monetary
System

C-2  —  Report on some aspects of the non-institutional development
of the European  Monetary  System  presented on 3 February
1982  by  the Alternates  of  the  Monetary  Committee

C-3 —  Supplementary  report on  some  aspects of the  non-insti-

tutional  development of the  European  Monetary  System
presented  on  26 February  1982  by  the  Alternates  of  the
Monetary  Committee

—  Commission communication to the Economic and  Financial

Annex D 

Affairs  Council of 15 March  1982 on the development of the
European Monetary  System

Annex  E 

Annex  F

F-l

—  Statement  by the  Chairman  of  the Monetary  Committee  on

the non-institutional development of the EMS to the Council
(Economic and  Financial  Affairs) of 15 March  1972
Statement and letter from the Committee of Governors on the
future  of  the  EMS

—  Oral  statement  from the  Committee of  Governors of the

central  banks  of  the  Member  States  of  the  European
Economic  Community  to  the  Council  (Economic  and
Financial Affairs)  of  15 March  1982 on the future of the EMS 

F-2 —  Letter of 29 April 1982 from the Chairman of the Committee

of Governors of the central banks of the Member States of the
European  Economic  Community to the  President of the
Council  of  the  European  Communities 

67

70

76

77

79

86

92

93

93

95

Annex  G 

—  Oral statement of the Chairman of the  Monetary Committee
on  the development  of the  EMS  to  the  informal meeting  of
Economic and  Finance Ministers on 17 May  1982 

96

Annex H 

—  Report  from the  Commission (of 20 March  1980) to the

European  Council on the European  Monetary Fund 

97

Annexes  I to 1-6  —  Preparatory  studies  on  the  European  Monetary  Fund 

100

10

List  of  tables

1.  Relative changes in per  capita GDP 
2.  Breakdown of  subsidies and  loans for  structural  purposes  granted by the

Community  institutions 

15

3. GDP  price deflators and effective exchange rates from  1950to 1982, in relation

to  17 major  partners 

24

24

4.  Price changes  within the Community 
5.  Changes in exchange  rates within the EMS 
6.  Monthly  variability of  major  currencies  against the ECU 
7.  Adjustment of relative changes in costs and prices in relation to EMS partners 
8.  Monetary  aggregates:  annual percentage changes 
9.  Budget  deficits and  changes in money  supply 
10.  Compensation of  employees 
11.  Unemployment and  growth 
12.  Changes  in  the  structure  of  GDP  uses  and  current  balance  of  payments

27

28

25

position 

13.  Balance of  payments on  current account 
14.  Appreciation or depreciation of ECU  central rates and bilateral central rates

from  13 March  1979 to  5 October  1981 
15.  Appreciation or depreciation of ECU  central rates and bilateral central rates

from 5 October  1981 to 14 June  1982 

36

16. EMS  calendar  1978 to  1981 
17.  Distribution  of  ECU  between  participants 
18.  Net use or accrual of ECU as a percentage of ECU received through the swap

operations 

List of  graphs

30

32

29

43

1.  Per capita  GDP 

l(a) at  1975 prices and  purchasing power  standards 
l(b)  at  current  prices and  exchange  rates 
2.  Relative price and  cost  movements in  relation to 17 trading partners 
3.  Operation  of  the exchange  rate mechanism

18

14

43

(maximum  spot  spreads  and  divergence  indicator)  -  graph  incorporated  in
Table 16 

16

17

25

31

35

45

46

14

14

11

Abbreviations and symbols used

Countries

F 

France

B 
DK 
D 
OR 

IRL 
I 
L 
NL 
UK 

Belgium
Denmark
Federal Republic of Germany
Greece

Ireland
Italy
Luxembourg
The Netherlands
United  Kingdom

EC 
EC 9 

Total of the member countries of the  European Community

Community  without Greece

BLEU 

Belgo-Luxembourg Economic Union

Currencies

BFR 

Danish krone

Belgian  franc

DKR 
DM 
DR 

FF 

IRL 
LIT 
LFR 

UKL 
ECU 
USD 
SFR 

HFL 

SDR 

German mark

Greek  drachma

French  franc

Irish pound  (punt)
Italian  lira
Luxembourg  franc

Dutch  guilder

-  Pound sterling

European currency  unit
US dollar
Swiss  franc
Special drawing right

Other abbreviations, etc.

Carriage, insurance and  freight
European Agricultural  Guidance and  Guarantee  Fund
European  Investment  Bank
European  Monetary Cooperation  Fund
European Monetary  Fund
European  Monetary System
European System of  Integrated  Economic Accounts
European  Atomic Energy Community
Statistical  Office  of the European Communities
Free on board  (valuation  basis for exports or  imports of  goods)

cif 
EAGGF 
EIB 
EMCF 
EMF 
EMS 
ESA 
Euratom 
Eurostat 
fob 
GDP (GNP)  Gross domestic  (national) product
GFCF 
IMF 
LDC 
MTFA 
OECD 
OPEC 
SOEC 
STMS 
VSTF 
( 
) 
: 
s.a. 
, 
Not  applicable
— 

Gross fixed  capital formation
International Monetary Fund
Less-developed  country
Medium-term  financial  assistance
Organization  for Economic Cooperation and  Development
Organization  of Petroleum Exporting Countries
Statistical  Office  of  the  European Communities
Short-term monetary support
Very short-term  financing  mechanism
Estimate
Data not available
Seasonally adjusted
Decimal  point

12

PART  ONE  '

Economic  convergence and the European Monetary  System

Convergence of economic performance is one  of the objectives of fye  European Monetary
System and is at the same time a basic precondition for its successful  operation. This dual
relationship is clearly brought out in the documents which prepared the way for or set up the
system. In particular, the final report' on the EMS, presented by the Monetary Committee
to  the  Council  and  the  Commission  on  7 November  1978, said  that,  'The  European
Monetary System ought to contribute to reducing divergences in economic performance,'
adding immediately afterwards, 'The credibility of the new system depends on progressive
convergence of economic performance.'  It is this very relationship which  is at  the heart of
the  present  discussions on the  appraisal of the  system a  little  over  three  years  after its
inception and the  possible  ways of  developing it  further. The  complexity of the  links
between economic convergence and  exchange rate stability needs to  be examined closely,
particularly in the light of past experience, if the objectives and the operations of the EMS in
this area are to  be viewed in a proper perspective and the progress to be achieved properly
measured.  It  is  similarly  against  this  background  that  the  recent  realignments  between
various participating  currencies should  be assessed.

Annex  1 to  the Twentieth  report  on  the  activities of  the Monetary  Committee,  OJ  C 240, 25.9.1979.

13

Economic convergence and the European  Monetary System

CHAPTER I

The  links between economic convergence and
exchange  rate stability

The very concept of convergence is ambiguous, depending as
it does on the economic variables that are taken as objectives
and on the rate at which such objectives are to be achieved. In
view of the  twin concerns jointly  underlying the  establish-

ment  of the EMS,  monetary  stability and progress towards
economic integration, a distinction should be made between
on the one hand the immediate need to ensure a convergence
of  nominal  variables—a  downward  alignment of  cost and
price trends—and on the other the longer-term pursuit of a
convergence of  real  variables,  i.e.  alignment  upwards of
living  standards and the  quality of  life.  This  distinction,
which is convenient for the  purposes of analysis, does not,
however, obviate the need to take account of the interactions
between nominal and  real developments in determining the
desirable  degree  of  exchange  rate  stability.  Similarly,
emphasizing the urgency of the need to combat inflation does
not  mean  that  less  importance is attached to  growth and
employment or that the two types of measures should not be
pursued jointly.

GRAPH  1 (a): Per capita GDP at 1975 prices and purchasing
power standards

Index: EC  10 in  1975 = 100

USA

150

100

SO

20

80
1950 
75 
70 
65 
60 
55 

Section  1 —  Convergence of  living  standards:

long-term trends

GRAPH  1 (b): Per capita GDP at current prices and exchange
rates 
Index:  EC  10 in  1975 =  100

-.

A detailed comparison of the performance of each economy
in  relation to the  other  member  countries and  their  main
industrialized  trading  partners is beyond  the  scope  of  this
study.  Such  an  analysis  would  require  a  large  number  of
interdependent factors to be taken into account (endowment
in  natural  resources,  demographic  trends,  technological
progress, etc.), and the  results might be subject to  different
interpretations  depending on the  criteria  applied.  Table 1

and Graphs  l(a) and  l(b)  simply show the development of

average  living  standards  during the  past few decades, by
tracing the  relationship  between per  capita GDP in  each
country and the Community as a whole. This indicator may
be measured, first, in terms of the purchasing power parities
established by the  Statistical  Office of the  European
Community.1 Subject to statistical imperfections, per capita

GDP is  measured  here in  terms of  domestic  purchasing

power. Alternatively, the indicator may be calculated on the
basis of current  exchange rates, thus reflecting  the external
purchasing power of each currency. It will, however, then be
affected  by  movements  in  real  exchange  rates  which  are
sometimes excessive relative to the basic economic situation
of each  country.

Eurostat - National  Accounts ESA - Aggregates -  1982.

14

USA

300

200

100

50

10

1950

55

60

65

70

75

80

85 

I

...j

The  links  between  economic convergence and  exchange  rate  stability

Table  1

Relative  changes  in per capita  GDP

At  current  prices  and
purchasing  power  standards

Indices  EC  10  =  100

At  current  prices
and  exchange rates

I960 

1965

1970

1975

1978

1980

1982  '

i960

1965

1970

1975

1978

1980 

1982  l

B 
DK 

D 

GR 
F 
IRL 
I 
L 
NL 
UK 
EC  10 
Dispersion

EC  10  2 

USA 
Japan 

98,0 100,3
114,8  118,7

113,4  113,7

37,3 44,4

99,2 102,2
62,2 61,1
78,7 81,3
152,6  133,5
104,8 103,1
116,7  109,3
100 

100

101,7
117,9
112,6
50,4
105,1
61,7
87,9
137,7
104,9
99,9
100

22,7 19,4
165,4  160,4
(53)  3  68,7

18,0
146,4
93,1

1 

Commission  extrapolation  based on the economic bud

- 

Average of  absolute  differences  from the mean.

Commission estimate.

J 
Source:  Eurostat  and  Commission  departments.

106,7
113,6
110,5
56,2
110,5
63,0
85,3
126,5
104,8
98,7
100

16,9
142,8
97,1

105,6
112,5
112,6
57,7
110,7
63,6
84,2
121,1
108,2
96,9
100

16,8
146,0
99,0

106,2
110,7
114,8
57,0
110,1
61,7
87,7
119,6
104,9
92,9
100

16,7
138,4
103,1

104,3
113,1
114,8
55,5
111,0
61,6
88,1
116,3
104,3
92,2
100

16,7
135,1
106,1

gets (May

1982).

107,0
113,4
113,9
36,9
115,2
54,7
64,8
144,8
84,0
119,1
100

103,0
124,9
114,9
41,1
117,8
54,8
70,6
124,2
89,4
107,3
100

27,3
244,8
(40,1)3

23,6
207,8
53,5

107,1
131,2
125,0
46,3
113,4
53,9
76,6
130,3
99,3
90,0
100

24,1
197,2
80,5

120,8
142,5
130,2
44,1
123,0
49,7
65,9
125,7
116,1
79,3
100

31,9
137,9
85,7

128,0
146,9
138,6
44,8
118,2
49,7
61,3
130,3
130,6
74,8
100

36,2
129,2
111,6

114,3  98,9
125,3  123,9
128,7  321,8
40,6  45,9
117,4  118,0
50,2  58,9
66,8  69,7
121,6  101,3
114,6  109,0
90,2  97,0
100
100 

27,4  20,4
109,7  145,2
86,1 

103,1

Among the  10 present members of the Community, average
living  standards  measured  in  terms  of  purchasing  power
parities  showed  significant  convergence  between  1960 and
1975.  After  that  date, as a  result of the divergent economic

rise in  living  standards  coincided  during the  1960s  with a
period  of sharp  inflation  and  monetary  turbulence and  did
not  come to a  halt  until  1978  with the  return to  greater
monetary  discipline.

and monetary policies pursued since 1972-73 and of differing
reactions to the economic crisis, this measure of convergence

showed  only  very  modest  progress. If  average  living
standards are measured  in terms of  current exchange rates,
the slowdown in the convergence process was more marked

and  began  earlier,  reflecting  from  1970 onwards the

weakening in the  discipline  previously  imposed by the
Bretton  Woods  system. The  process  resumed  with the
introduction of the  EMS.  This  overall  pattern has  been
accompanied by  considerable  changes in the  relative
positions of  each  country.  Germany, the  Netherlands and
Ireland have, at very different levels, more or less maintained
their  initial  positions,  measured  in  terms  of  purchasing
power  parities.  Belgium,  France  and,  particularly,  Greece
improved their positions distinctly at least up to the middle of

the  1970s. By  contrast,  there has  been an  appreciable

deterioration, in relative terms, in average living standards in
the United Kingdom and in Luxembourg (where the figure is
of  limited  significance  because of the  weight of the  steel
industry in  that  small  economy).  Denmark and  Italy  have
seen a slight deterioration in their relative positions as  from
1975-78. It is interesting to note, in the case of Italy, that the

towards the end of the  1970s.

In  relation to the  Community's two  major  industrialized
trading  partners,  the  same  phenomenon  of  rapid  conver-
gence in  living  standards can be  observed,  even  more

markedly, up to  1970,  followed by  some  subsequent

slowdown. In  1960, per  capita GDP in the  United  States,
measured in terms of purchasing power parities, was about
65%  above  the  Community  average;  the  difference  has
narrowed today to  only 35%. Japan, whose living standards
in  1960 were  only  half those of the Community, caught up
with  and  overtook  the  Community  in  spectacular  fashion

It  would be  dangerous to  draw  hard and  fast  conclusions
from such a brief survey. However, the above facts do justify
a  number  of  general  observations.  In  the  first  place, it was
during the 1960s, when the growth of the world economy was
sustained  and  relative exchange  rate discipline maintained,
that the clearest progress towards convergence was achieved.
Secondly, convergence of  real variables is a very long-term
process  which,  while  benefiting  considerably  from  lasting
stability in  international  monetary  relationships, is  also

15

Economic convergence and the European  Monetary  System

dependent  on  the  development  strategies  pursued  by  each
country. For  example, the different growth rates between the
various  areas may be  attributable,  among  many  other
factors,  to  significant  long-term  differences  in  investment
ratios as  between the  Community  (from 20% to  23%), the
United States (17%  to  19%)  and Japan  (30%  to  35%).  The
scale of these differences and,  above all, their persistence over
several  decades  provides  a  measure  of  what  convergence
implies  in  terms  of  allocation  of  resources,  the  functional
distribution of  incomes, and the  formation and use of
savings.

There are many ways in which  the Community  as such can
contribute  to  achieving  gradual  alignment  in  living  stan-
dards. One obvious way is in freedom of trade. Another more

modest but not  insignificant way is in the financial  area. As

may  be  seen  from  Table 2,  the  Community's  financial
instruments, in the form of subsidies or loans for structural
purposes, are beginning to become significant at macroecon-
omic  level.  The  aid  granted  amounted  in  1981 to  1,1% of
GDP in Italy, 1,4% in Greece and 4,7% in Ireland. In Ireland,
it  represented  some  15% of  fixed  capital  formation.

Section 2 — The  interactions between  real and
nominal developments and
exchange rate stability

The  degree  of  exchange  rate  stability  depends  on  the
combined effect of the economic performances of the various
countries  and  their  relative  price  trends,  with  these  two
factors being able either to offset  or to reinforce one another.
Clearly,  underlying  economic  trends  such as  those  briefly
described  above,  which are  based on  differing  levels of
productivity,  the  discovery  or  exhaustion  of  natural
resources and  lasting changes in the terms of trade, cannot
but be reflected sooner or later in exchange rates. This long-
term  phenomenon  may  be  illustrated  by  two  significant
examples.

The first example is provided by the devaluation of sterling in
1967.  As a result in particular  of the strict monetary policy
pursued,  the  rise  in  prices  in  the  United  Kingdom  had
followed a  trend  that was very  close to  those of its  main
partners  (see Table 3 and  Graph 2).  During the 17  years
preceding the devaluation, the total cumulative differential
in prices was less than 5%. The devaluation was due therefore
not  so  much  to  a  lack  of  nominal  convergence  as  to  real
divergences  between  the  United  Kingdom  economy  and
those of its trading partners. With its investment ratio being
distinctly below those of its partners (17% of GDP  between
1958  and  1966  as  against  21,5%  for  the  Community  as  a
whole),  it  was  not  possible  for  the  modernization  and
extension of productive capacity to keep pace. Any attempt

16

to reflate  the economy came up against the weakness of the
productive apparatus and  resulted in considerable external
deficits (1951,  1955,  1960 and  1964), obliging the authorities

to adopt a restrictive stance once again (stop-go policies). It is

only recently, with the advent of North Sea oil and the efforts
to  achieve structural  stabilization  of the  United  Kingdom
economy, that  these  trends  have been  reversed.

Table 2

Breakdown of subsidies ' and loans 2 for structural
purposes granted by the Community  institutions

Country

B
DK
D
GR
F
IRL
I
L
NL
UK

EC  10

B
DK
D
F
IRL
I
L
NL
UK

EC  9

As % of GDP

As%ofGFCF

Subsi-
dies

Loans

Total

Subsi-
dies

Loans

Total

0,05
0,12
0,04
0,90
0,09
2,32
0,45
0,14
0,04
0,16

0,16

0,05
0,08
0,03
0,05
0,50
0,10
0,05
0,04
0,06

0,05

0,47
0,28
0,02
0,48
0,09
2,33
0,60
0,00
0,00
0,07

0,17

0,06
0,07
0,08
0,12
0,80
0,24
0,02
0,06
0,13

0,13

1981

1974

0,52
0,40
0,06
1,38
0,18
4,65
1,05
0,14
0,04
0,23

0,33

0,11
0,15
0,10
0,17
1,30
0,34
0,07
0,10
0,19

0,18

0,25
0,76
0,17
4,42
0,42
7,58
2,14
0,49
0,21
0,98

2,42
1,72
0,07
2,36
0,44
7,60
2,82
0,01
0,00
0,43

2,67
2,48
0,24
6,78
0,86
15,18
4,56
0,50
0,2!
1,41

0,80

0,84

1,64

0,21
0,33
0,12
0,19
2,00
0,43
0,20
0,18
0,27

0,23

0,26
0,30
0,35
0,51
3,22
1,07
0,08
0,26
0,65

0,55

0,47
0,63
0,47
0,70
5,22
1,50
0,28
0,44
0,92

0,78

EAGGF (Guidance Section), Social  Fund and, for  1981,  Regional  Fund  and  EMS
interest  rate  subsidies.
E1B, ECSC and, for  1981, Euratom and  NC1.

2 
Source: Commission departments.

1
 
The  links between economic convergence and  exchange rate stability

Table 3

GDP  price  deflators  and effective  exchange rates from  1950  to  1982,  in relation to  17 major partners

Relative
prices
(Indices)

3 = 1 :2

(a)

1960 in relation to  1950

Effective
exchange
rate1
(Indices)

Real exchange
rate
(Indices)

4

5 =  3 x4

Movement of prices
(in  national  currency)

in  partner
countries

2

4,0
4,0
3,9
3,3
4,3
3,8
3,4
3,8

Country

B
DK
D
F
IRL
I
NL
UK

B
DK
D
F
I R L2
I
NL
U K2

B
DK
D
F
IRL3
I
NL
UK  3

B
DK
D
F
IRL
I
NL
UK

in each
country
(% Pa.)

1

1,8
3,6
3,1
6,6
4,6
3,4
3,7
4,3

3,2
6,0
3,1
3,9
4,7
4,3
4,9
3,7

7,1
9,5
5,4
8,5
11,2
12,2
7,9
10,3

5,3
9,1
4,4
11,6
15,9
17,2
5,3
13,4

80,3
97,0
92,1
137,4
102,7
96,2
103,6
104,2

94,9
120,1
93,6
102,7
106,9
106,7
111,1
100,5

(b)

1968 in relation to  1960

3,9
3,6
4,0
3,6
3,6
3,5
3,5
3,6

7,8
8,3
8,3
8,1
8,7
7,4
7,5
7,2

(c)

1978  in relation  to  1968

93,1
111,8
76,0
103,7
131,1
154,8
103,5
141,0

<d)

1982 in relation  to  1978 4

8,2
9,0
9,0
8,5
10,8
7,8
7,7
8,6

89,7
100,3
84,2
111,8
119,7
139,8
91,5
118,8

Export  weighting,  variable  from  year  to year  until  1977.

1 
2  UK and Ireland:  1966/60.

3 UK and Ireland:  1978/66.

1982 effective  exchange rate using June  1982 central rates for EMS countries and  forecasts for other countries appearing in economic budgets (May 1982).

Source:  Eurostat  and  Commission  departments.

106,7
103,8
106,1
73,3
102,0
107,2
104,4
102,9

99,1
95,3
105,6
100,1
100,4
100,1
105,8
99,6

115,8
109,9
159,1
83,4
75,7
52,5
118,0
54,1

87,8
81,0
107,2
87,1
86,9
76,9
104,2
116,0

85,7
100,6
97,6
100,7
104,8
103,1
108,1
107,2

94,0
114,5
98,9
102,7
107,3
106,8
117,5
100,0

107,9
122,9
120,9
86,5
99,2
81,3
122,2
76,4

78,7
81,3
90,3
97,4
104,0
107,5
95,3
137,8

17

Economic convergence and the European  Monetary  System

GRAPH 2: Relative price and cost movements in relation to  17 trading partners

(Indices: 1970 =  100) 1

(a) in national currency

FR of  Germany

(b) in common  currency

FR of  Germany

— ^_x— ->^

>

"™^ ULC

65 

70

France

65 

TO

France

"ULC

EXR

50 

55 

60 

65 
Italy

70 

75 

80 

85

50 

55 

60 

.ULC

70 

75 

80 

85

65 
Italy

60 

65 

70 

75

85

50 

55 

60 

65 

70 

75 

80 

85

The Netherlands

The Netherlands

70

65 

60 

55 

50 

75

85

50

55

60

65

70

75

=  GDP  deflator  (total  unit costs).

P 
ULC =  Unii  labour costs for the whole economy (=  ratio between  wages and salaries per employee and  overall  productivily per  person employed, in indices).
EXR  =  Effective  exchange rale.

= GDP  deflator, in common currency.

PC 

:  Export  weighting, variable  from  year to  year.

ULCC  =  Unit  labour cosls for  the whole economy  in common currency.
1 
1981-82-83: Economic budgets of  8.6.1982.
Exchange  rates:  from  June  1982 onwards, ceniral rates as at  14.6.1982.

18

The  links between  economic convergence and  exchange rate  stability

GRAPH  2  (continued):  Relative  price  and cost movements in relation  to  17 trading  partners

(Indices:  1970 =  100) 1

(a)  in  national  currency 

Belgium

(b)  in common  currency

Belgium

50 

55 

60 

65 

70 

75 

80 

85

50 

55 

60 

65 

70 

75 

80 

85

UK

UK

SO 

55 

60 

65 
Ireland

70 

75 

80 

85

75

70 

65 

60 

Ireland

75

80 
70 
65 
60 

85

75 

70 

65 

60 

55 

50 

Denmark

Denmark

160

140
120

100

80

60

50

55

60

65

70

75

85

SO

55

60

65

70

75

60

= GDP  deflator  (toial unit  costs).

P 
ULC  =  Unit  labour costs  for the  whole economy  (=  ratio  between  wages and  salaries per  employee and  overall  productivity  per  person  employed, in  indices).
EXR  =  Effective  exchange rate.

= GDP  deflator, in common  currency.

PC 

ULCC =  Unit  labour costs for  the  whole economy in common  currency.
1 
:  Export  weighting,  variable  from  year (o  year.
1981-82-83:  Economic  budgets of  8.6.1982.
Exchange rates:  from  June  1982 onwards, central rates as  at  14.6.1982.

PC
ULCC

19

Economic convergence and  the European Monetary  System

GRAPH 2  (continued):  Relative price and cost movements in relation to  17 trading partners

(Indices:  1970 =  100)'

(a) in national  currency

USA

(b) in common  currency

USA

Japan

Japan

= GDP deflator, in common currency.

=  GDP  deflator  (total  unit  costs).

P 
ULC  =  Unit  labour costs  for the whole economy  (=  ratio between  wages and  salaries per  employee and overall  productivity per  person  employed,  in indices).
EXR =  Effective  exchange  rate.
PC 
ULCC =  Unit  labour costs for the whole economy in common  currency.
1 
:  Export  weighting,  variable  from  year to  year.
1981-82-83:  Economic  budgets of  8.6.1982.
Exchange rales:  from  June  1982  onwards, central  rates as  at  14.6.1982.

Japan provided a different illustration of the long-term effect
of  basic  economic  variables  on  exchange  rates.  The  rapid
establishment of an  industry characterized  by high  produc-
tivity and  high  profitability  allowed the Japanese economy,
where the growth rate of real GDP rose from the already high
level of 7,2%ayear in the early  1950s(1952 to  1955) to 12,9%
towards the end of the 1960s (1966 to 1969), to cover most oif
the  gap  in  living  standards  which  separated  it  from  the
United States and the Community. Throughout this period,
the effective  exchange rate of the yen remained  remarkably
stable (see Graph  2). The high level of growth did not lead to
an  external  deficit:  the  productivity  gains  allowed  the
necessary resources to be made available for the development
of exports and prevented a rate of inflation higher than those

of its trading partners (a difference  of 1,6% a year during the
period  on  average)  from  harming  its  competitiveness.  A
similar,  though  less dramatic, development  occurred in the
Netherlands  in  the  process  of  the  country's  rapid  indus-
trialization and of the exploitation of natural gas and the rise
in  its price.

Differences in relative economic performance may thus fully
justify  changes in  exchange  rates.  Deferring  them  too  long
results in  costly  distortions in the  allocation of  resources.
This  was  no  doubt  the  case  in  the  example  of  the  United
Kingdom cited above, where the overvaluation of sterling, in
connection with its initial status as a reserve currency under
the  Bretton  Woods  system,  considerably  reduced  growth

20

The  links between economic convergence and  exchange  rate stability

potential. Conversely, such differences in economic perform-
ance may allow price divergences to continue without having
an impact on current accounts and exchange rates. It should
be  emphasized,  however,  that  the  exchange  rate  shifts  and
the  inflation  differentials  implied by the  movements in the
real  economy  are  by their  nature of  limited  size.  As stated
previously, the  long-term  growth  path of an  economy is
determined  by long-run  policy options and  by fundamental
factors.  Changes in the long-term  growth path can  only  be
gradual,  barring  severe  economic  or  political  shocks.
Moreover,  at  least  during  a  transitional  period  and  within
certain limits, compensatory capital  flows may facilitate  the
necessary  restructuring  and  reduce  pressure  on  exchange
rates  (see  Chapter  2,  Section  4  below).  In  the  search  for
stable exchange  rates,  the main  effort  in  the  short  and  the
medium  term  must  therefore be  concentrated on the
convergence  of  prices;  the  fact  of  the  matter  is  that,  at
present, divergences of costs and  prices within the EMS are
well in  excess of  what  might be  expected  from the  real
phenomena  described  above.

Section  3 — The  need  for,  and  implications of,
exchange  rate  stability

The development of international trade, and in particular of

intra-Community trade, has been based to  a large extent on
exchange rate stability. It is difficult  to imagine how frontiers
could have been opened up and common policies established
at European level if there had not been a substantial degree of
certainty  about  economic  variables  as  important  as  the
relative  prices  of  currencies.  This  achievement  must  be
safeguarded and  reinforced. The  adoption of  protectionist
policies and the fragmentation of capital markets would turn
the present stagnation into a deep depression aggravated by

an  international  financial  crisis.  Growing  commercial and

financial interdependence is an enormous asset, but it implies
responsibilities,  which are  themselves  growing,  towards
other  countries,  especially  in  the area  of exchange  rates.

The  need for stable exchange rates derives not  only from  the
requirements  of  economic  integration.  Recent  experience
shows  that  attempts  to  shake  off  the  policy  constraints
imposed on  economic  policies by the  need to  maintain
currency  parities may  rapidly  prove  fruitless, and  indeed
harmful. The  switch to a  system of  floating  exchange rates
gave national  authorities greater  freedom in the  conduct of
economic  and  monetary  policy.  This  room  for  manoeuvre
was  used  in  very  different  ways  by  Member  States,
particularly  when  they  faced  major  problems  of  domestic
adjustment  and  of restoring external balances following the
first  oil price shock. A look  at  Graph  2 shows the extent of
the  resultant  divergences  in  terms  of  relative  prices  and
exchange rates. Some countries, such as Italy and the United
Kingdom,  thought  they  could  tolerate  greater  monetary

and of increasing their cost by delaying them. The cost and

expansion and price increases than their partners, in the hope
that they could thus underpin their growth and prevent a fait
in employment. In the Federal Republic of Germany and, to

a lesser extent, in the other countries making up the 'snake', it

was thought preferable  to contain monetary expansion and
inflationary pressures, in the belief that more moderate price
trends  provided  a  better  basis  for  investment,  growth  and
employment.  France for its part adopted a middle course.
The  result  of  these  differing  options  was  that  nominal
divergences  steadily  increased and fed on  themselves; a
cumulative process involving exchange rates, prices and costs
became established and contributed nothing to the solution
of  the  underlying  problems.  At  least,  the  establishment  of
'virtuous circles'  of  revaluation  and  price stabilization  had

the advantage of bringing such problems out into the open;

conversely, countries that allowed themselves to get caught
in a spiral of devaluation and  revaluation were in danger of
masking the scale and  urgency of the  adjustments  required

price  divergences  resulting  from  these  differing  economic

and  monetary  options  have  proved  extremely  difficult to

reduce, and  their  effect is  still  felt  today  within the  EMS.

The fact  that such wide divergences have developed since the
abandonment  of  the  Bretton  Woods  exchange  rate  system
and the move to floating exchange rates raises the question as
to which system served better to promote the convergence of
economic  policy,  while  avoiding  excessive  rigidity.  In
examining  this  question, practical  arrangements governing
the application of such systems are more important than the
principles which led to their introduction. Clearly, exchange
rate fluctuations since 1973 have been erratic and on a larger
scale  than  the  advocates  of  floating  exchange  rates  had
anticipated. The introduction of that system did not in itself
mean the abandonment of the disciplines that were necessary
for  stability.  Experience has  shown,  however,  that  people
seriously  underestimated  the  danger  that  certain  trends
which  corrected  in  many  cases  a  back-log  of  delayed  and
necessary  adjustment  would  be  magnified.

The exchange rate system established at Bretton Woods was
accompanied by fairly remarkable stability and convergence
of prices (see Table 2 and  Graph 2). Divergences in relative
prices  between  1950  and  1968  above  or  below  an  average
Community  inflation  rate of  less  than 4%  were  rarely in
excess of an annual rate of 2%, the average divergence being
close to 1%. Nevertheless, the  accumulation of  such  small
divergences  led,  because  of  the  relative  rigidity  of  nominal
exchange  rates,  to  the  undervaluation  or  overvaluation  of
currencies  over  long  periods.  The  persistence  of  such
situations  produces  disequilibria: the  export  industries in
countries with undervalued currencies develop too fast while
countries  with  overvalued  currencies,  failing  adjustment
through a fall in relation to prices, are forced to restrict their
growth so as to prevent their external deficits from growing.

21

Economic convergence and  the European  Monetary  System

overcome must not be underestimated. The nature and scale

of the problems to be solved will be examined in greater detail

in Chapter II. It is, however, possible at this point to outline
in  broad  terms the measures to be pursued.

The  defence  of  stable  exchange  rates  rests  primarily  with
national  monetary policies and their close coordination. To

put an  extreme  case,  monetary  policy may  successfully be

used  to  defend  the  parity  of  a  currency  even  where  an
unfavourable  inflation  differential  has  built  up  vis-a-vis
trading partners. In such circumstances, the pressures on the
exchange rate will  require an ever more restrictive stance of
monetary policy. Such a tightening is beneficial, and  indeed
essential, in thwarting inflationary  expectations and  reveal-
ing  the  need  for  domestic  adjustment.  However, just  as  a
relaxation of monetary discipline cannot in itself generate a
lasting  resumption  of  growth,  so  a  tightening of  monetary
policy, unaccompanied by budgetary rigour and moderation
in  the  growth  of  nominal  incomes,  will  not  be  sufficient  to
establish a  secure  process of  disinflation,  save  through a
renewed  depression  in  economic  activity.  These  general
considerations  explain why the  pursuit of  convergence is
often  seen as incompatible with the requirements of growth
and  employment.  In  point  of  fact,  it  is not  so  much  in  the
stance to be adopted by policy as in the formation of the mix
of the various measures that the risks of incompatibility arise

at present.

The  floating  of  currencies  should  have  allowed  gradual
correction of  such  situations. The  differing  options chosen
for economic and monetary policy, though not an inevitable
by-product of floating  currencies, contributed greatly to the
phenomenon  of  overadjustment.  However,  the  risk  of
exchange rate instability would have been there even if there
had  been  greater  convergence.  In  the  absence  of  fixed
margins of fluctuation, the markets were led to adopt a very
short-term view of economic performance  and  to overreact
to  the  signals  given  by  the  direction  of  economic  and
monetary  policies.  Graph  2  show  that  in  many  cases,
particularly  in  Germany,  Italy  and  the  United  Kingdom,
exchange  rate  fluctuation  went  well  beyond  the  point
justified  by inflation differentials—great  as these were—and
by the  correction of  unsatisfactory  initial  positions. The
disadvantages of  excessive  exchange  rate  rigidity  were
replaced by the  undoubtedly  graver  disadvantages of
disorderly  movements  around  highly  divergent  medium-
term  trends.

Despite  recent  experience, and  whatever the exchange  rate
system operated, it is entirely feasible that nominal variables
should converge towards greater price stability. The success
of a number of countries within and outside the Community
in the  fight  against  inflation  proves  this, as  does the
satisfactory convergence of prices and costs during the  1950s
and  1960s.  However,  the  extent  of  the  difficulties  to  be

22

The  convergence of economic and  monetary  policies  under the  EMS: the  progress to be  achieved

CHAPTER  II

The  convergence of economic and monetary

policies under the EMS: the progress to be
achieved

The setting up of the EMS was a defensive reaction designed
to  ward  off the  dangers  of  disintegration  posed  in  the  late
1970s by monetary disorder and  growing uncertainty in the
international  economic  environment.  It  was  a  positive
reaction,  since it did not  mean a  return to  isolation, but a
difficult  effort to establish jointly a zone of stability. It was a
realistic reaction, because past experience prompted a certain
degree of modesty in its declared ambitions. ' The first  task
was to  redefine  intervention  rules and  credit  mechanisms,
adapting them or broadening them as the case might be, so as
to  achieve greater  symmetry between  the obligations of the
'strong' currencies and  those of the 'weak' currencies. There
was  above all a  need to  reaffirm in  practice the  principle
already laid down in the Treaty whereby policies with regard

to rates of exchange must be treated as a matter of common

concern  (Article  107) and  to  draw  from  this  principle  the
fullest conclusions for the convergence of economic policies.
By  rejecting  fixed  parities and  deciding to  make changes in
central  rates a matter of mutual agreement  rather  than the
automatic application of pre-established economic criteria, a
pragmatic approach was adopted based on the coordination
of national  policies and  aimed at  endowing the system with
sufficient  flexibility.  Such  an  approach  was  necessary,
because  trends as  divergent as  those  which had  recently
developed  could not be  changed  immediately,  while the
Bretton  Woods  system  had  shown  the  disadvantages  of
excessive exchange rate  rigidity.

Price  rises  in  1981  and  those  anticipated  for  1982  (see
Table 4(a)  and  (b)  indicate  only  a  modest  change  in  the
inflation  rate for the  Community as a  whole. In  1982, the
Community consumer price deflator  will have risen again by
10%, whereas the increase will have slowed down distinctly in
the  United  States  (6,4% as  against  8,3% the  previous  year)
and  will  have  stayed  at  a  low  level  in  Japan  (4,3%).  The
persistence of these differentials may be expected to affect  the
competitiveness of  European  products on  export  markets
and  to  mean  that  the  European  currencies  will  show  a
continued tendency to weaken, thus limiting the scope for a
fall in  interest  rates,  even if they  were to  fall in the  United
States.

This mediocre performance for the Community as a whole is
the  result  of  the  very  uneven  performance  achieved  in  this
area in the various Member States. Price differentials  within

the  Community are  today  wider  than  those  recorded on
average during the period 1974-78 following the first oil price
shock.  In  1981, taking  only  the  Member  States  effectively

participating in the EMS  exchange  rate  mechanism,  there

was a difference of close to  15 percentage points between the

most  stable  country,  Germany,  and  the  country  in  which
inflation was highest, Ireland. The inflation  rate in France is

twice, and in  Italy  three  times, the  rate in  Germany. The

forecasts for 1982 indicate that the Member States with a low
level of inflation, such as Germany and the Netherlands, will
improve  their  performances.  In  the  other  Member  States,
progress will be  uneven. In  Italy and  Ireland, though  there
will be an appreciable improvement, the rise in prices will still

be in  excess of  15%. In the  United  Kingdom, the  inflation

rate will fall below 10%. There will be no major deceleration
in France and  Denmark, and  Belgium will feel the  effect of
the devaluation of the Belgian franc which occurred early in
the year.

Section 1  —  Insufficient  convergence towards

stability

Recent  assessments of the  operation of  the EMS  from its

introduction on  13 March  1979 up to the end of  19812

highlight the fact that the greater exchange rate stability and
improved monetary management attributable to it have not
resulted  in  increased  convergence  in  the  area  of  costs  and
prices.  The  available  forecasts  for  1982  confirm-the
persistence  of  a  high  average  inflation  rate  for  the
Community  and  marked  divergences  between  Member
States.

1  On  the  setting  up of the  EMS, see  European  Economy  No  3, July  1979.,
2 
See  Chapter  5  of  the  Annual  Economic  Review  1981-82,  European
Economy  No  10. November  1981, and  Part  Two  below  entitled  "The
development of the EMS in its present  institutional framework'.

Beyond a certain threshold such divergences in inflation rates
will inevitably have an impact on the nominal exchange rates

of the EMS currencies. During the three and a half years of

its operation, the EMS has  seen six concerted  realignment
operations,  the  main  features  of  which  are  set  out  in
Table 5(a).  Taking the  last two  realignments (of  February

and June this year) into account, the variations in effective

exchange  rates  between the  participating  currencies  have
been close on average to those which occurred between 1973
and  1979 (see Table 5(b). At  first  sight,  this  might prompt
doubts  as to the capacity of the system to establish greater
exchange  rate  stability.  The  recent  trend  towards  more
frequent  and  more extensive realignments provided  serious
cause for concern (see Chapter III  below). However, taking

the period of operation as a whole, the results achieved may
be  seen to be positive.

First,  there  has  been  a  reduction  in  the  very  short-term
variability of exchange rates between  currencies participat-

23

Economic convergence and the  European Monetary  System

Table 4

Price changes within the Community: annual rates of

change (%)

1968
1960

1974
1968

1978
1974

1979
1978

1980
1979

1981
1980

1982,
1981

(a) Consumer prices
7,6
3,9
7,9
10,7
9,6
9,9
5,9
4,0
4,5
24,4
17,7
12,6
10,9
9,8
12,5
13,4
20,5
15,1
15,0
19,0
16,7
4,3
7,4
6,7
14,3
15,6
10,7

6,5
11,5
5,3
23,7
13,2
18,3
20,4
6,6
15,5

10,2
10,1
4,7
24,0
13,3
18,5
15,0
5,8
9,5

,9
5
,6
8
,4
5
,3
8
7
,2
10
,3
,7
8
7
,8
,7
8

7

,3

10,4

9,7

12,1

11,0

10,0

3,2
5,3
2,9
2,3
3,9
3,8
3,8
3,9
3,5

3,5

0,4

1

,2

4,1

4,3

4,9

3,7

3,6

B
DK
D
GR
F
IRL
I
NL
UK

EC : mean 2
EC :  weighted  disper-
sion 3

B
DK
D
GR
F
IRL
I
NL
UK
EC: mean2
EC :  weighted  disper-
sion 3

3,2
5,7
3,0
3,0
4,0
4,5
4,3
(4,9)
3,7

3,8

0,5

(b) GDP  deflator

6
,8
,2
9
,1
6
9
,0
7
,2
10
,6
9
,0
,9
7
8
,7

7

,6

7,6
10,2
4,3
13,4
10,5
16,2
17,1
7,9
16,5

10,8

4,3
7,7
3,9
18,7
10,6
12,4
15,7
4,2
15,1

4,4
8,4
4,7
18,4
11,5
14,1
20,4
5,3
18,9

5,0
9,6
4,3
20,2
11,8
18,1
17,6
6,0
11,8

8,2
10,6
4,4
23,2
12,7
18,6
15,8
6,2
8,5

9,9

11,8

10,2

9,6

1

,1

4,3

4,5

5,6

4,1

3,9

Forecasts: economic budgets,  May
2  Weighted by GDP  valued at  1975  purchasing power  parities.
3  Weighted  averages of absolute differences  from the mean (see Note 2).
Source;  Eurostal and  Commission  departments.

1982.

have  experienced  more  rapid  inflation  than the  other
countries, has  been  constrained  within  narrower  limits
during the period of operation of the EMS than the previous
period. The  adjustments in  central  rates  have  only  partly
compensated for the movement in relative costs and prices.
This has  resulted in a  gradual  real  appreciation of  these
currencies,  particularly  the  Irish  pound  (see Table 7).  The
establishment  of  the  EMS  has  thus  put  an  end  to  the
phenomena of overadjustment  previously observed and has
made  for  a  return  to  more  normal  conditions  and  a  less
tolerant approach to inflation. This same concern to correct
initial situations which  were not  sustainable in the long run
justified the downward  adjustments in the  central  rates for
the Danish krone and the Belgian franc.  On the other hand,
the  relative  positions  of  Germany  and  the  Netherlands
altered  little  between  1978 and  1982, protecting  these
countries  against  imported  inflation  and  preserving  a
necessary  pole of stability  within the system as a  whole.

Table 5

Changes in exchange rates within the EMS

(a)  Realignments in central rates,

percentage change against  the group of currencies
whose  bilateral parities were  not  changed

Dates of realignments

30 
September  November 

24 

22 

22 
March  October  February 

5 

14
June

1979  1979 1981  1981  1982 1982

BFR/LFR
DKR
DM
FF
IRL
LIT
HFL
—  +5,5
— 

-2,9  -4,8 —  —
+ 2 
__ 

—  +5,5
_  -3
__ 

— 
__ 

—— 

—— 

—— 

——

—  — 
— 

- 6 -3

(b)  Variations in  effective  exchange  rates 1
relative to EMS partners,
annual  percentages

-8,5  —
-3  —
— 
— 
— 
— 
— 

+4,25
-5,75
—
-  2,75
+4,25

ing in the  system, including the Italian  lira,  which  enjoys a
wider  margin  of  fluctuation  about  its  central  rate  (see
Table 6). By  contrast, the  exchange  rates of the  non-
participating  currencies  have  remained  highly  volatile  and
and  this  short-term  instability  has  been  part  of  very  large
long-term fluctuations: since the middle of 1980, the yen has
appreciated  by  some  50%  against  the  ECU, following  a
similar fall during 1979 and early 1980; in June 1982,1 ECU
was worth less than USD 1 as against USD  1,45 in July 1980,
equivalent to a depreciation of the order of 50% in the ECU
against the dollar.

1979
1973

+  1,3

-1,1
+  4,6
-3,0
-6,1
-9,4
+  1,7
-4,9

1 982 2
1979

-3,1
-3,9
+ 4,7
-2,2
+ 0,2
-4,8
+ 2,6
+ 6,5

1980
1979
-0,1
-6,8
+ 1,2
+ 1,0
+ 0,1
-3,5
+ 0,7
+ 9,9

1981
1980

1982 2
1981

-0,4
+ 0,1
+ 3,0
-1,1
-0,5
-5,0
+ 0,7
+ 9,9

-  9,1
-  4,7
+ 10,0
-•6,4
+ 0,9
-5,9
+ 6,5
-0,0

B
DK
D
F
IRL
I
NL
UK  3

1 

Export  weightinj

;,  variable  from  year  to  year  until

1977.

Secondly, Table 5(b) shows that the fall in effective exchange
rates in countries  such as  France,  Italy and  Ireland,  which

24

1982  is taken  into account.

In  relation to  Community countries.

3 
Source: Eurostat and  Commission  departments.

1
 
The  convergence of economic and  monetary policies under the EMS: the progress to be achieved

BFR/LFR
DKR
DM
FF
IRL
LIT
HFL

EMS average

UKL
USD
Yen

Table 6

Monthly  variability  of major currencies against the
ECU'

It  may  be  concluded  that  despite  the  instability  of  the
international monetary environment, the disruptions caused
by the  second oil price  shock and  persistent  divergences in
nominal variables, the EMS has succeeded in reestablishing a
more orderly structure of exchange rates between  particip-
ants and in reducing volatility. This achievement, the fruit of

an  initial  phase  during  which  order was  restored,  will be

seriously compromised  if greater  convergence in economic
policies is not  established.  Greater  exchange  rate  stability
requires more moderate and more closely aligned growth of
nominal  variables,  and  this  achievement  cannot  without
damage be put  off any longer. Failing this, the EMS would
gradually change in nature to become something similar to a
crawling peg system of  parities.

1976 

1977

1978

1979 

1980

1981

38,5
33,8
42,7
30,1
63,5
55,5
39,0

6,2
32,4
11,6
9,6
11,3
2 1 , 1.
5,7

11,4
7,7
11,7
18,0
23,8
24,8
11,3

8,4
32,7
8,6
7,4
7,7
9,8
9,0

9,0
4,5
9,6
6,1
9,2
17,9
4,4

8,3
8,4
19,7
13,8
6,3
21,8
21,0

43,3  13,9 15,5  11,9  8,7  14,2

11,3  23,8 32,2  44,7  40,3

63,2 
20,1  24,9 49,1 28,1 34,4 62,3
34,1  39,2  70,8 87,5 82,2  25,9

The  measures  to  be  taken  towards  this end  are  in no  way
inconsistent with the efforts which, irrespective of the EMS,
must be  made in all the  Member  States to  promote
employment and growth. Appropriately applied, they are on
the contrary  likely to  reinforce  them.

1 

Coefficient  of variation (standard deviation of end-of-month rates foreach currency in
ECU,  divided  by  the  annual  average  of such  rates).  Results  multiplied  by  1 000.

2  Unweighted  average.
Source:  Commission  departments.

Table 7

Adjustment  of  relative changes ' in costs and prices in relation to EMS partners

{a)  Relative  change in unit  labour costs 2
—  whole economy; indices
in common currency

Relative  level
•in  1978
(<=  available  margins
relative to
different  base
periods  =  100)

Relative  level
in  19823
(=  margins  still
available relative

to different  base
periods =  100)

(b)  Relative change in GDP  price:
indices in common currency

Relative  level
in  1978

;ins

(=  available  marf
rel alive to
different  base
periods  =  100)

Relative  level
in  1982 3

( =  margins still
available relative
lo different  base
periods =  100)

1978 
1970  061-70 

1978

1978
(
Z  68-72

1982
1970

1982
061-70

1982
0  68-72

1978
1970

1978
0  61-70

1978
0  68-72

1982
1970

1982
0  61-70

1982
0  68-72

117,8 
111,4
102,7  104,8
99,1  106,4
92,6  81,1
77,9  74,8
82,7  81,4
112,9  121,7
76,3  69,8

115,1
102,7
103,0
89,3
82,2
82,7
111,5
77,7

99,0
90,3
94,6
103,0
103,0
95,7
112,6
112,2

93,9
92,1
102,0
90,2
99,0
94,2
121,3
102,6

96,9
90,3
98,8
99,3
106,2
95,8
111,2
114,2

105,6
110,2
104,0
92,9
82,6
77,6
119,1
80,1

102,5
112,5
111,2
83,3
80,1
76,5
123,2
73,4

105,7
110,3
107,2
89,9
83,4
78,0
116,3
80,6

87,8
100,7
101,9
98,6
110,4
90,9
121,2
117,8

85,2
102,9
109,0
88,4
107,0
89,6
125,2
107,9

87,9
100,8
105,0
95,4
111,5
91,4
118,3
118,5

Country 

B
DK
D
F
IRL
I
NL
U K4

Export  weighting, variable  from  year to  year  until  1977,
Index of compensation of employees per  employee  divided by the index of  productivity per  person  employed.
Forecasts: economic  budgets. May  1982. The  realignments of  14 June  1982 are taken  into  account.

1 
2 
4  Change  relative to Community countries.
Sources: Euros la t and Commission departments.

25

3

 
Economic convergence and  the European  Monetary  System

Section 2 —  Stronger  action and a wider  range

of measures to control inflation

As  earlier  reviews  show,' the EMS has provided a  major
incentive to  improved  coordination of  monetary  policies.
First, domestic monetary conditions have been adjusted on
several occasions, in an orderly and carefully judged  way, to
enable the  margins to be  respected. In  this  day-to-day
management,  interest  rates  were  often  changed to  avoid
breaches of  fluctuation  margins or a  need for  substantial
intervention.  Moreover,  in  spite  of  occasional  strains,  the
extreme volatility of US interest rates has not been reflected
in the nominal  interest rates for EMS currencies, which have
been approximately parallel even  though  at  different  levels
because of differences in rates of inflation.  Secondly, in the
longer-term  perspective  adopted in  this  study,  policies to
regulate  monetary  aggregates  have  been  more  closely
convergent  than  in the past.

Between  1979 and  1981, most of the Member States reacted
to  the inflationary  strains resulting  from, the  further  rise in
the price of oil products by considerably reducing the rate of
expansion of the money supply. During those three years, the
growth of the broadly-defined money supply (M2-M3) was
much  slower in most of the Member States than it had  been

from  1974 to  1978, and about the same as it was in the  1960s

(see  Table 8).  The  slowdown  was  particularly  marked  in
Belgium, Germany and the Netherlands. It was less marked

in the other Member States, especially in Ireland and  Italy,

where the money supply continued to expand by over  15% a
year.

In present conditions, monetary  policy has  very little room
for  manoeuvre.  Germany, the  Netherlands and the  United
Kingdom  have already taken advantage of the scope for a
gradual  reduction  in  interest  rates  opened  up  by  lower
inflation  and  improved  external  balance.  In  the  other
member  countries,  however,  although  the  slower  rate  of
monetary  expansion was  reflected in  stable or  declining
liquidity ratios, the regulation of monetary aggregates has on
balance  been  fairly  accommodating  towards  inflation, to
judge by the trend of the money supply per unit of output (see
Table 8), which has continued to expand at the same rate as

previously or only slightly less. In these countries, any easing

of  quantitative  monetary  policy could  only  lead  to  further
inflationary surges. On the other hand, a marked decline in
the  rate  of  monetary  growth  would  lead  to  a  significant
decline in the  rate of inflation  only at  the cost  of a  further,
damaging  fall in economic activity.

Monetary policy cannot bear the burden of the fight  against
inflation  alone. If the constraints on monetary policy are to

and in Ireland, and to a lesser  extent in Italy, the financial

See  note  2  on  page 23..

1 

26

be loosened  and  a  fall  of interest rates is to get  under way,
then  support  must  come  from  other  types of  action.
Convergence must be sought in two other areas of economic
policy, where progress has been more modest and results very
varied: the control of budget deficits and the moderation of
wage costs.

In  1981 and  1982, the  general  government  borrowing
requirement  for the  Community  as a  whole reached  5% of
GDP, a figure previously recorded only in 1975, after the first
oil shock. None of the Member  States can boast a general
government surplus, but the deficits vary from  less than 2%
of  GDP  in the United  Kingdom  to  over  14% in Ireland.

These large budget  deficits  make it  much  more  difficult  to
control  monetary  expansion,  since  rising  interest  rates or
stricter  credit  controls  have  adverse  effects on  private
investment  expenditure and  real  growth. The  longer  these
deficits last, the less likely it is that the public will believe that
a stabilizing monetary policy will be persisted in. Quite apart
from  the  bad  effect  of  the  budget  deficit  on  the  current
account  of  the  balance  of  payments,  these  expectations
aggravate the downward  pressure on the exchange rate and
push  interest  rates  still  higher.  The  increase  in the  cost  of
servicing the debt then further swells budgetary expenditure.

Table 9 shows, for the various  Member States, the ratio of
the  absolute  value of the  general  government  borrowing
requirement  to  that  of  the  annual  change  in  the  money
supply. These  ratios  are  not  directly comparable  from  one
country to another, since they depend also on the structural
liquidity ratio of each economy. However, the changes of the
ratio in any given  country  can  serve  as an  indicator  of the
restrictiveness of monetary  policy in relation to  changes in
fiscal  balance. It is a  more  significant  indicator  than a
breakdown  of the  means of  financing  the budgetary deficit
into  categories of  lenders  (banking  sector,  non-banking

sector and  external  sector); it  allows for  compensatory

movements between the various counterparts of the money
supply and the  banks'  opportunities for  developing  non-
monetary  commitments.

From  1979-80, the general government borrowing  require-
ment  increased  in relation  to  the extra monetary  financing

put at the  disposal of the  economy  each  year in all the

Member  States except the  United  Kingdom. The  increase
was particularly large in Belgium, where a marked expansion
of the public deficit coincided with a substantial slowdown in
the rate of increase of monetary  financing. The phenomenon
was less noticeable in Germany and the Netherlands, where
the  general  government  borrowing  requirement  has  re-
mained  fairly  stable as a percentage of GDP.  In Denmark

pressure  resulting  from  fast-growing  or  very  large  budget
deficits was  partly  offset  because the  rate of  monetary
expansion slowed down less. In France, the rate of monetary

The convergence of economic and  monetary  policies under the EMS: the progress to be achieved

Table 8

Monetary  aggregates:  annual  percentage changes

1968
I960

1974
1968

1978  1979
1974  1978

1980
1979

!981
1980

jgSja
1981

1968
1960

1974
1963

1978  1979
1974  1978

Belgium

Denmark

1980 
1979  1980

1981

1982;
1981

7,9

1.  Money  supply '
2.  Liquidity  ratio
3.  Money  supply per  unit

of  output

8,3
0,4

3,6

12,7 
11,8
2,2
2,9 
-0,6

4,3
-2,5

1,0

6,1

10,7 

5,4

1,8

FR  of Germany

5,4
1,6

6,6

6,5
2,1

6,5

7,4
-1,2

6,9

5,6
0,2

4,6

10,5
0,2 
-0,5

13,6 
0,8  -1,6

9,8
-2,6

9,3

5,2

6,3

8,6  12,0
11,1 

6,1

8,4  11,8

12,0
-1,6

8,8

13,7
3,8

7,9

France
14,9  13,5
1,0  -0,4

- 1,0 0,5

11,8  12,6

14,1
-0,8

14,1
0,9

8,1

11,6  10,1

10,4  12,4

11,8

Italy

21,5
LI

17,5
i  i
— j, i

13,6
3,0

16,2
2,0

22,4  22,8
2,8 

1,2

19,9  17,9
-4,2 

0,5

15,8
-1,8

10,3
2,7

10,9
0,1

9,2 
2,2 

9,6
1,1

5,3
-1,4

5,8

6,2

6,7 

5,0

3,2

9,2
0,3

15,2
-0,4

Ireland
17,7  29,2
-3,0  12,2

14,5
-1,5

4,8

10,2

12,8  26,1

12,4

19,4

15,0

7,4

11,1

20,4  17,1

15,3  18,1

13,7

8,5
-1,4

13,7
0,3

The  Netherlands
10,6 
0,2  -1,1

4,8

8,0
2,0

3,5

8,3

8,1 

3,0

7,4

6,6
2,0

8,1

6,8
0,0

6,2

5,4
-1,4

13,7
2,1

United  Kingdom
9,9  12,8

-7,3  -3,4

14,9  15,6
-  2,0  4,7

12,4
2,3

2,3

11,0

7,9 

11,2

16,5  17,0

11,0

1.  Money  supply '
2.  Liquidity  ratio
3.  Money  supply  per  unit

of  output

1.  Money  supply '
2.  Liquidity  ratio

3.  Money  supply per  unit
of  output

1.  Money  supply '
2.  Liquidity  ratio
3.  Money  supply per  unit
of  output

Average  money  supply,
DK,  F.  NL:  M2

D, 1, IRL: M3

B;  M2H
U K : U K L M3

- 
Commission  staff  forecast,
Source: Commission  departments.

expansion  has  followed  the  changes  in  the  fiscal  balance

The  limits  encountered in the  implementation of  stability-

fairly  closely, and  only at the end of the period did  signs of

crowding out rrbegin to appear on the capital markets. In the
United Kingdom, in contrast to other member countries, the
capital  market  pressure  coming  from  general  government
has  been  progressively  reduced,  without  any  relaxation  of
monetary  policy,  since  fiscal  deficits  are  gradually  being
eliminated.  This  schematic  analysis  demonstrates  that
reducing government deficits, or at least keeping them under
control,  could  make  monetary  stabilization  easier;  in  the
countries  where  the  rate  of  monetary  expansion  is  suf-

ficiently low and  where  inflation  rates are  beginning to

decline, such action could  restore a margin for real growth;
in the other countries, it would make it possible to slow down
the rate of monetary expansion without creating intolerably
restrictive  effects.

oriented monetary policies and the varying degree of success
attained are also due to the difficulty  of containing nominal
increases in  income,  particularly  wages. The  simultaneous
achievement  of  lower  inflation  and  rising  levels of  employ-
ment depends in fact  on a shift in the functional  distribution
of  incomes which  changed  markedly  in the  first  half  of  the
1970s.  After  increasing  rapidly  during  this  period,  the  real
wage gap (the gap between changes in real wages and changes

in  productivity  adjusted for changes in the  terms of  trade)

afterwards narrowed only very slowly in the Community as a
whole (see Table  10). This general tendency covers divergent
trends in the different  Member States. In  Belgium, the  fairly
satisfactory  development of prices was not accompanied by
an equivalent slowdown in nominal wages. In France, Italy

and  Ireland, the real wage gapp was wider in  1981  than in

27

1
 
Economic convergence and  the European  Monetary  System

Table 9

Budget deficits  and changes in money  supply '

1973

1974

1975

1976

1977 

1978

1979

1980

1981

1982 2

1.
2.
3.

D / A M (1 =  2:3)
D/Y (as  %)
AM/Y {as %)

D / A M (1  =  2:3)

1.
D/Y (as %)
2.
3.

AM/Y (as %)

1.
2.
3.

D / A M (1  =  2:3)
D/Y  (as  %)
AM/Y (as  %)

D/AM  (I =  2:3)

1.
D/Y (as  %)
2.
3.

AM/Y (as  %)

9,7

1.
2.
3.

1.
2.
3.

D / A M (1 =  2:3)
D/Y {as %)
AM/Y (as %)

D/AM{1 =  2:3)
D/Y  (as  %)
AM/Y  (as %)

1.
2.
3.

D / A M (1 =  2:3)
D/Y (as  %)
AM/Y  (as  %)

1.
2.
3.

D/AM{1 =  2;3)
D/Y (as  %)
AM/Y (as %)

32,8
3,0
9,2

31,0
2,0
6,8

-115,0
-5,9
5,1

-48,8
-1,8
3,7

38,2
1,4
3,6

—8,8
-0,6
7,1

59,9
7,2
12,0

-28,5
-1,2
4,2

-14,1
-0,9
6,7

29,1
3,9
13,2

37,2
7,0
18,8

-18,2
-1,1
6,1

38,0
3,5
9,2

41,2
4,3
10,6

19,9
2,0
10,0

154,6
5,8
3,7

27,1
2,2
8,3

60,5
5,1
8,6

16,1
0,8
4,9

97,6
3,6
3,7

8,1
0,5
6,0

Belgium
81,2  86,7
5,3 
6,7 

5,7
6,8

170,7
7,0
4,2

Denmark

40,3  78,7

77,5
3,1
4,0

1,7 
4,3 

2,2
2,9

FR  of Germany

49,2  54,5
2,4 
5,0 

2,8
5,1

106,8
3,0
2,8

France

12,4  31,2
0,8 
6,5 

1,8
5,7

12,4
0,8
6,6

Ireland
79,8  56,2
7,1 

8,6

108,0
11,9
11,0

46,1
9,5
20,7

105,6
11,3
10,7

97,0
7,7
9,0  15,2
7,9

Italy

56,1
8,0 
7,0
12,5

48,3
9,0
18,6

60,2
11,7
19,4

40,4  46,0

19,7  21,2

1,5
0,1
6,0

97,3
3,8
3,9

144,5
2,7
1,9

223,9
4,9
2,2

The  Netherlands

116,7  160,1

1,4 
1,2 

2,2
1,4

United  Kingdom

118,7  103,8

3,4 
2,9 

4,3
4,1

139,3
3,1
2,2

94,1
3,3
3,4

34,5
2,4
6,8

172,9
5,0
2,9

515,9
9,4
1,9

130,4
5,9
4,5

118,9
3,5
2,9

-9,9
-0,5
4,5

124,1
12,8
10,3

56,3
8,4
14,9

248,7
3,4
1,4

72,9
2,5
4,9

297,8
13,1
4,5

244,6
12,4
5,2

163,8
7,2
4,4

189,1
4,5
2,4

36,7
-1,9
5,2

144,9
15,1
10,4

84,3
11,9
14,1

288,0
4,6
1,6

62,6
2,4
3,8

171,2
8,8
5,2

151,1
3,9
2,6

47,9
-2,9
6,1

166,5
14,4
8,6

84,7
11,1
13,1

261,9
4,2
1,6

65,8
1,9
2,9

1  D: General government borrowing requirement ( + ) or  financial  surplus (-).
Y: GDP at current prices.

A M: Change in  money supply during the  year (absolute value). The  money supply is defined as in Table 8, Note  1.
Forecasts by Commission  departments (economic budgets for May-June  1982).

2 
Source: Euros tat  and  Commission  departments.

1975, when it was already very wide compared to the average
level of the  1960s. The  forecasts for  1982, however, indicate
an improvement in these countries, especially in Ireland and,
thanks to the recovery plan introduced after  the realignment

of the Belgian franc, in Belgium. In the other Member States,
the real wage gap  should continue to  improve.

There  is  no  alternative  but  to  persevere  in  the  attempt  to

28

The  convergence of economic and  monetary policies  under the EMS: the progress to be achieved

control  wage  costs, and to  support  such  restraint by
measures  to  promote  saving,  if  the  foundations  of  a

sustainable recovery of investment are to be laid and the rise
in  unemployment  held  back.

Table  10

Compensation of  employees

DK

5,0
3,5
0,9
-0,4
-2,9
-0,7
1,7

100,0
111,1
103,0
101,8
98,7
97,6
96,2

4,1
6,2
3,9
1,8
1,3
I .I
-2,6

100.0
116,6
119,6
120,4
121,8
124,3
119,3

1960-1968
1968-1974
1974-1978
1979
1980
1981
19823

1961-1970
1975
1978
1979
1980
1981
19823

1RL

NL

UK

(a) Per capita compensation ': annual change as %

4,7
6,3
2,7
1,5
1,2
-0,6
0,0

100,0
110,5
106,9
106,1
107,7
107,4
104,9

6,6
5,7
2,9
2,4
1,3
0,7
2,1

5,1
4,6
4,1
2,4
0,9
1,3
0,7

4,6
5,5
4,3
3,9
1,9
-1,9
-2,1
(b)  Real  wage gap2: annual  average  1961-70
100,0
108,2
102,9
108,4
113,4
109,7
102,9

100,0
107,1
108,2
107,3
108,6
110,7
110,2

100,0
117,8
117,5
115,6
114,5
117,5
118,1

6,0
5,6
2,3
1,5
-1,1
-2,7
-0,1

100,0
115,3
114,0
116,7
116,6
113,5
110,0

100

2,7
3,9
0,9
3,0
4,1
2,7
-0,6

100,0
116,4
104,8
106,5
109,3
107,4
104,5

EC

4,5
5,3
2,5
2,1
1,4
0,4
0,1

100,0
112,5
109,1
109,0
107,9
108,0
106,2

! 
2 

Compensation  of  employees  per employee divided  by retail  price  index,
Compensation of  employees per  employee  divided by retail price  index and  aggregale  productivity  (real GDP per person employed) adjusted for changes in the terms of  trade.
Forecasts;  Economic budgets,  May 1982.
Source:  Eurosiat  and  Commission  departments.

Section 3 —  Correcting structural macro-
economic disequilibria

Apart  from  a  brief  pause in  1978-79  following  a  moderate
recovery of economic activity, unemployment has been rising
steadily in the Community since 1973. As a percentage of the
labour force, the average rate of unemployment in  1982 will
be  twice  as  high  as  that  observed  from  1975 to  1978 (see
Table  11).  The  deterioration  of  the  labour  market  began
earlier and was more gradual in Belgium, France,  Italy and
Ireland; it  began  later but was  even  more  brutal in  other
countries and  it now affects  all the Member States. Cyclical
recovery  alone  will not  reverse so  strong and  persistent a
trend  and  such  a  recovery  appears  uncertain  at  present  in
view  of  the  international economic and  monetary  environ-

ment. The restoration of a durable growth vigorous enough
to reduce unemployment depends on an internal adjustment
which  will  require  great  effort. To  achieve this aim, all the
instruments of economic policy must be deployed to a single
end.  The  specific  measures  needed  in  areas  as  varied  as
industrial  policy,  employment  and  the  improvement  of
financial  flows  must be  part of a  general  macroeconomic
approach  designed to  correct the  growing  structural
disequilibria  which  have  gradually  come  to  disfigure  the
European economies.

A comparison of the present breakdown of the uses of GDP
with  that  prevalent  from  1968 to  1972,  when  growth,
employment and the current balance of payments position
were satisfactory  in most of the  Member States, shows how

29

3
 
Economic convergence  and  the  European  Monetary  System

Table  11

Unemployment and  growth

1960- 
1968  1974

1969-

1975-
1978

1979  19801981

1982 '

1968
1960

1974
1968

1978
1974

1979
1978

1980
1979

1981
1980

1982,
1981

6,2

B
DK
D
GR
F
IRL
I
L
NL
UK

EC

(a)  Rate of  unemployment

as

% of  labour  force  2
9,4
6,3
4,7
3,7

8,7 

2,7
1,3
1,1

2,2 
1,2 
0,9 

5,3 

3,4

3,4 
(2,2)  (2,8)
6,0 
7,4 
7,5 
0,7 
4,1 
5,3 

6,4
8,3
8,0
0,7
4,8
6,9

11,5
8,5
4,8
(3,1)
7,6
8,7
8,8
1,0
7,5
10,6

0,8 
4,4 
5,6 
0,1 
0,8 
1,8 

1,6
5,4
4,8
0,0
1,8
2,7

4,1
8,3
5,8
0,3
3,9
4,6

2,13 

2,43

4,63

5,4 

6,0

7,9

(b)  Annual growth  rate

of  real  GDP  (as  %)

4,5
5,0
4,2
7,3
5,4
4,2
5,7
2,7
4,8
3,0

4,5

5,3
3,5
4,3
6,2
5,4
4,3
4,5
5,2
5,0
2,5

4,2

1,8
2,5
2,3
5,5
2,8
4,1
1,6
-0,2
2,3
2,0

2,4

2,3
3,0
4,3
3,8
3,0
2,4
4,9
4,1
1,8
1,4

3,3

2,5
-0,2
2,0
1,7
1,3
1,9
4,0
0,7
0,6
-1,4

-1,1
-0,2
0,0
-0,7
0,2
1,8
-0,2
-2,4
-1,4
-1,2

1,4

-0,3

0,5
2,9
1,0
0,8
2,2
2,2
1,8
0,6
0,5
1,3

1,5

13,4
8,9
6,7
(3,6)
8,7
10,8
9,6
1,3
9,9
11,7

9,2

Forecasts by Commission  departments: Economic budgets
SOEC  definition.
Excluding Greece.

1 
2 
3 
Source: Eurosiat  and  Commission  departments.

. May 1982.

the  allocation  of  resources  has  become  distorted  (see
Table 12).

the  deterioration  of  the  trade  balance  may be  regarded  as
acceptable or at  least as not yet out of control.

improvement in external positions is essential, to  allow for

The  figures  show  that  the  adjustments  made  after  external
shocks  were  insufficient to  keep the current  account of the
Community as a  whole in  surplus. The  expansion in the
volume of exports of goods and services served only partially

to  offset the  deterioration in the  terms of  trade and the

growing debt service payments caused by rising interest rates
and  the expansion  of  foreign  borrowing.

During  this  period, the  United  Kingdom and the  Nether-
lands  managed  to  improve  their  balance  of  payments
positions on goods and  services, by developing their oil and
gas and  obtaining higher prices for them.  In Denmark also
the balance on goods and services improved, but this was not
reflected in an improved current balance, because of the cost
of  servicing  the external  debt.  With  the exception  of  these
countries and of Germany, where the deficit is shrinking, the
balance on goods and  services in the Member States was in
deficit  in 1981. In particular,  foreign  trade has  deteriorated
considerably in  recent  years in  Belgium and  Ireland. The
deficits of these countries reached disproportionate levels in
1981. Belgium is the only Member State where the balance on
goods  and  services,  adjusted  for  changes  in  the  terms  of
trade, has not  improved since  1968-72. In France and  Italy,

30

Present  forecasts for the  current  account of the  balance of
payments  in  1982  (see  Table  13)  indicate  that  the  Com-
munity as a whole will achieve a sustainable balance close to
zero, if oil prices and  the dollar exchange rate remain  fairly
steady. However, there will still be considerable differences
between  the  Member  States.  The  improvement  in  the
external balance should be maintained in Germany and  the
Netherlands, but achievements will be more modest in most
of the other Member States. In France and Denmark, present
current  deficits may  well  increase slightly. A  more marked

interest  payments  and  the  gradual  redemption  of  external
debt.

To reinforce the competitiveness of the European economies

while at the same time improving the employment situation,
not  only must  internal absorption of resources be reduced,
but there must be at the same time a reallocation of resources
towards  productive uses.

The  share of  total  consumption in  Community GDP has

increased considerably (almost 5 percentage points of GDP).
The  relative  expansion  of  consumption  expenditure  was

The convergence of economic and monetary policies under the EMS: the progress to be achieved

Table  12

Changes in the structure of GDP uses and current  balance of payments position (as  a %  of  GDP)

(a)  Average  1968-72 

(b)  1982

Consumption

Private

Public

Total

61,4
64,9
+ 3,5

56,9
56,1
-0,8

54,8
55,4
+ 0,6

70,1
70,9
+ 0,8

60,7
65,1
+ 4,4

70,7
63,4
-7,3

63,4
64,2
+ 0,8

56,8
60,5
+ 3,7

62,5
60,3
-2,2

60,8
62,6
+  1,8

14,1
19,6

+ 5,5

20,0
28,0
+ 8,0

16,4
21,0
+ 4,6

12,6
17,2
+ 4,6

13,4
15,8
+ 2,4

14,4
21,5
+ 7,1

15,3
18,1
+ 2,8

16,3
17,9
+  1,6

17,8
22,1
+ 4,3

14,6
17,7
+ 3,1

75,5
84,5
+ 9,0

76,9
84,1
+ 7,2

71,2
76,4
+ 5,2

82,7
88,1
+ 5,4

74,1
80,9
+ 6,8

85,1
84,9
-0,2

78,7
82,3
+ 3,6

73,1
78,4
+ 5,3

80,3
82,4
+ 2,1

75,4
80,3
+ 4,9

B

DK

D

GR

F

IRL

1

NL

UK

EC

(a)
(b)
-  (a)

(b)

(a)
(b)
-(a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(a)
(b)
-  (a)

(b)

(b)

(b)

(b)

(b)

(b)

(b)

(b)

(b)

Gross capital
formation

Balance on  goods
and  services

Fixed
capita!

21,4
19,5
-1,9

24,3
15,6
-8,7

24,8
22,8
-2,0

24,9
20,8
-4,1

23,5
21,1
-2,4

22,9
30,1
+ 7,2

20,6
20,3
-0,3

25,3
19,0
-6,3

18,5
16,2
-2,3

22,5
20,2
-2,3

Slocks

Total

Exporis 

Imports

Balance

1,3
0,3
-1,0
0,7
-0,3
-1,0

1,5
-0,1
-1,6

2,5
2,8
+ 0,3

2,1
-0,1
-2,2

1,4
-0,1
-1,5

0,7
0,9
+ 0,2

1,5
-1,3
-2,8

0,7
-1,8
-2,5

1,4
-0,3
-1,7

22,7
19,8
-2,9

25,0
15,3
-9,7

26,3
22,7
-3,6

27,4
23,6
-3,8

25,6
21,0
-4,6

24,3
30,0
+ 5,7

21,3
21,2
-0,1

26,8
17,7
-9,1

19,2
14,4  .
-4,8

23,9
19,9
-4,0

42,3  40,6
64,0  68,4

+ 21,7  +27,8

+  1,7
-4,4
-6,1

25,5  27,4
36,8  36,3
+ 11,3  +8,9

-1,9
+ 0,5
+ 2,4

21,1 
29,5  28,7

18,6

+ 8,4  +10,1

8,1  18,2
14,7  26,4

+ 6,6  +8,2

+ 2,5
+ 0,8
-1,7

-10,1
-11,7
-1,6

14,8  14,4
22,2  24,0
+ 7,4  +9,6

+ 0,4
-1,8
-2,2

32,1  41,5
53,2  68,1

-9,4
-14,9
-5,5

+ 21,1  +26,6

16,0  16,0
24,7  28,2
+ 8,7  +12,2

0,0
-3,5

__  1C

46,1  46,0
58,9  54,9

+  12,8  +8,9

0,1
4,0
+ 3,9

21,7  21,3
27,1 
23,9
+ 5,4  + 2,6

+ 0,4
+ 3,8
+ 2,8

21,0  20,3
29,9  30,1
+ 8,9  +9,8

+ 0,7
-0,2
-0,9

GDP 

goods and

Change  in
balance  on

services  at
constant  prices

100
100
0

100
100
0

100
100
0

100
100
0

100
100
0

100
100
0

100
100
0
too
100
0

100
100
0

100
100
0

0,0

+ 8,3

+  1,6

+ 4,1

+  1,5

+ 4,9

+  2,4

+ 7,9

+ 2,4

+ 2,8

Svum>:  1968-72:  Euroslat,
1981 : Economic bu

except B, D, NL:  National  Accounts.

dgets. Commission  departments,  May-June

1982. For  EC: extrapolation of  1980 data on the basis of rates of  growlh given in economic budgets.

greatest  in  Belgium,  Denmark  and  France.  The  rate  of

the  rate  of  investment  and  stockbuilding,  particularly  in

expansion is close to the  Community  average in Germany,

Greece and the Netherlands. The impact of this trend on the
external balance was attenuated by a considerable decline in

Denmark and the  Netherlands,  where the  decline was so

marked  as  to  result  in  an  improvement  in  the  balance  on
goods  and  services.  The  degradation  of  the  pattern  of

31

Economic convergence and the  European Monetary  System

Table 13

Balance of  payments on current  account (as % of  GDP)

B
DK
D
GR
F
IRL
I
L
ML
UK

EC  10

1959-1963

1964-1968

1969-1973

1974-1978

0,02

-1,1

0,9
2,2 2
1,1
-2,2
0,7
6,P
2,1
0,1

0,6

0,4

-2,0

0,7
-3,6
0,0

-1,9

2,7
6,4

-0,4
-0,6

0,3

2,3
-2,2
0,8
-2,7
0,0

-3,6

1,1
13,9
1,0
0,4

0,5

-0,7
-3,2

1,3

-3,0
-0,8
-3,7
-0,6
25,2
1,6

-1,6

-0,2

1979

-2,9
-4,5
-0,6
-2,9
-0,1
-10,1
1,6
28,1
-1,2
0,0

-0,5

1980

-5,2
-3,4
-1,8
-0,9
-1,3
-8,4
-2,5
22,2
-1,4
1,4

1,3

1981

1982'

-6,3
'3,1
-1,0
-2,2
-1,5
-12,8
-2,3
20,3
2,5
2,9

0,6

-4,8
-3,5
0,6

-2,1
-1,9
-10,2
-1,6
18,4
4,4
1,0

-0,5

Forecasts: Economic budgets, May 1982.
1960-63.

2 
Sources:  1959 to  1980: Eurostat and  OECD national accounts;  1981  and  1982:  Economic budgets (May  1982).

domestic  uses of GDP was  less  marked in  Italy,  where
investment  declined  little in  relative  terms,' and in the
United Kingdom, where gross capital formation nevertheless
fell further from an initial level which was already rather low.
Ireland was an exception among the Member States in that
the marked deterioration of its external position was mainly
associated with rapidly expanding investment. The share of
consumption in GDP has  remained  stable,  although at a
higher  level  than in the  Community as a  whole, and the
substantial increase in public consumption has been entirely
offset  by  the  relative decline in private consumption.

The  inadequacy  of investment is further  aggravated  by  the
fact  that  some  proportion —  difficult to  quantify — of
productive capacity has become obsolete as a result of cost
changes  and  technical  development.  Since  the  stock  of
capital is expanding too  slowly in relation  to the growth  of
the  labour  force,  an  insufficient  number  of  new jobs  has
appeared and  cyclical  unemployment has  given way to
structural  unemployment. By  holding  back  productivity
gains, this process reduces the competitiveness of European
products both in terms of price and in terms of technological
content.

In the  Community as a  whole the  decline in the  rate of

investment as a proportion of GDP is an imperfect indicator
of the weakness of capital formation in the Community as a
whole. The growth of GDP, 
itself  declined  considerably;  and  part  of  the  flow  of  gross
investment is destined simply to renew plant and equipment.
In fact, at constant prices, net investment (i.e.  after deduction

the other term in the ratio, has

of the consumption  of fixed capital as estimated in national
accounts) has contracted  in the  Community  as a whole  by
almost 3 % a year on average since  1973.  Between  1960  and
1973, it had  increased at an  annual  average  rate of 5,6 %.

The  rate of investment observed in Italy during the reference period  1968-

72 was already considerably lower than during the period  prior to  1964.

Practically all the Member States face the dual requirement,
more  pressing  in  some  than  in  others,  of  improving  the
external  balance  while  shifting  domestic  demand  from
consumption to  investment.  At  macroeconomic level, such
adjustment requires the same type of measure as those which

must be  undertaken to  moderate the  trend of  costs and

prices. Lasting export growth must be based on the control of
relative  price  changes. The  reestablishment of  surpluses
which can be devoted to the internal financing of firms and
the  reinforcement  of  profitability,  which  are  essential
conditions for a recovery of business investment, requires a
gradual adjustment in the functional distribution of incomes.
It is moreover unlikely that easier credit would constitute an
efficient  incentive  for  this  purpose,  since  the  effects  of  any
easing  of  interest  rates  that  was  not  based  on  a  parallel

32

1
 
The  convergence of economic and  monetary policies under the EMS: the progress to be achieved

decline in inflation rates would probably be rapidly annulled
by  the  reinforcement  of  inflationary  anticipations  and  a
downward  pressure on exchange rates. The  stabilization of
public  finance  should  contribute to  slowing  down the
expansion of  public  consumption,  and, by  attenuating
pressures on interest rates, help to avoid  such crowding out
on  the  capital  markets as  may result  from  budget deficits.

conditions.  To  restore  the  confidence  of  the markets,  the
borrowing country will have to  accept a greater increase in
interest rates than could be economically justified in relation
to  the  domestic  economy,  or  call  on  conditional  official
financing.  Basically the need to adjust  will merely have been
evaded and when it can be avoided no longer the adjustment
will be the more  severe for having been  so long delayed.

Section 4  —  A  suitable  mix between

adjustment and  external  financing

The rate at which the required adjustments can  be made will
depend  mainly on the  rate of  growth of the  European
economies, and  will vary widely from  one Member State to
another. In view of the limited availability of official  reserves
and  the  economic  cost  of  any  brutal  adjustment,  external
borrowing can  help as  a  transitional device  temporarily  to
prevent a serious current payments deficit  from  leading to a
spiral of devaluation and inflation, the undesirable effects of
which  have already  been  stressed. Otherwise, there is a  risk
that  protectionist  measures  aimed  directly at  reducing the
flow  of  payments abroad  will multiply. Apart from  the  fact
that such measures are usually effective only partially and for

a  short  period,  they  seriously  disturb the  working of the

Community itself.  External  borrowing does not  involve the
same  risk  of  market  distortion  and  the  accumulation  of
internal  strains,  at  least  in the  short  term.

The  Member  States  and  the  Community  itself  have  some
room  for  manoeuvre  in  their  borrowing.  Although  the
surpluses of  the oil-producing countries are  at  present very
small,  the  volume  of  funds  available  on  the  international
markets is  very  large, and  investors are  more  than  ever in
search  of  financial  assets issued  by borrowers  with  a  good
credit rating. Finally, in a broader context, adjustment in the
industrialized  countries must not be so rapid as to  transfer
current deficits to the developing countries, which have much
more limited access to external financing. Nevertheless, as in
any  borrowing  process,  prolonged  recourse  to  external
financing brings increasing risks and costs, and a gradual loss
of  independence.  Foreign  borrowing  cannot,  therefore, be
considered a  permanent  subsitute for  policies  aimed at
adjustment.

Thus,  external  financing of  a  large  budget  deficit  makes it

possible in the  early  stages to  reconstitute the  external

reserves  required  to  support exchange  rates and  to prevent
crowding  out  on  the  national  financial  market.

If the  flow of  external  financing is mainly  channelled  into
productive  uses  which  fit  in  with  the  general  adjustment
process, it  will  continually add to the  productive  capacity
which  will  provide  the  means  of  repayment.  Even  in  such
cases, the volume of debt and,  particularly, its rate of increase
cannot exceed certain limits, imposed by the need to service
the  debt  before  the  investments  become  fully  productive,
and,  ultimately, to  produce a current  account  surplus  with
which  gradually to  reduce the volume of debt.

Recent changes in current deficits and  their present size (see
Table  13) give,  for the various  Member  States,' a  summary
indication of the  external  borrowing  requirement and the
available  margins for  manoeuvre.  Apart  from the  United
Kingdom,  the  Netherlands  and  Germany,  which  have
restored a current surplus, the Member States require foreign
financing obtained either by encouraging capital to enter the
country,  or  by  foreign  borrowing  in  the  name  of  public
departments and  undertakings.  External  financing  should
remain  fairly  small in  France and  Italy. In  Denmark and
Greece, although there has been no marked deterioration in
the  current  payments  position  over  the  past  few  years,
repeated deficits have resulted in a level of outstanding debt

The  same  is  true  in  Belgium,  where  current  deficits  have
increased  considerably  since  1976,  leading to a  very  rapid
build-up of foreign  debt and  eventually  to  devaluation  and
the introduction of a recovery programme. In relation to the
size of its economy,  Ireland is the country  with the  largest
foreign  debt  in  the  Community.  However,  recourse  to
external  financing is  closely  linked in  Ireland  with the
necessary  accumulation of  capital. In  view of the  require-
ments  of  economic  development,  massive  redemptions
would  probably  not  be  in  order,  and  the  possibility  of
supporting  the  investment  effort  through  a  regular  flow  of
external  financing  should  be preserved.

While  implementing  common  policies and  ensuring  closer
coordination of the economic policies of the Member States,
the  Community  can  make  a  specific  contribution  to
determining  the  right  mix  of  adjustment  and  financing
through  its borrowing and  lending instruments.

such as to set a severe limit to the scope for future borrowing.

However, assuming that the proceeds of the borrowings are
not sterilized by the central bank, the effects  are identical to
those of  monetary  financing  of  the  government  deficit.  As
debt grows, and with it the cost of servicing, lenders will tend
to  withdraw  from  the  market,  or  to  lend  only  on  stricter

First  of  all, the  Community  lending  instruments  with  a
structural purpose (European Investment Bank, ECSC, New
Community  Instrument,  Euratom)  enable  the  recipient
countries to obtain the necessary  supplementary financing
for the development of  priority  sectors and  regions on the

33

Economic convergence and the European  Monetary  System

most  advantageous  market  conditions  without  directly
committing their own credit. This external financing,  which
is  partly  subsidized,  must  be  accompanied  by  an  effort  to
mobilize and  channel- national  savings so  that  they can
gradually  take  over.  The  volume  of  Community  loans
granted  to  some  countries has,  in  view  of  its  relative  size,
reached  macroeconomic dimensions (see  Table 3).  Further
substantial development of these operations should perhaps
be  based  on  a  global  adjustment  programme  which  the
receipient  countries  would  undertake  to  implement  in
addition  to  the  microeconomic  criteria  specific  to  each
project.

Secondly, the Member States have at their disposal balance
of  payments  support  mechanisms  either  with  the  other
Member  States  (medium-term  financial  aid)  or  with  the
Community (Community loan mechanism). Because of their
purpose, these mechanisms cannot be used directly to cover
immediate and  specific needs of the domestic economy, such
as  a  budget  deficit.  It  is nevertheless  essential  to  use  these
mechanisms in good time, in order to ensure that adjustment
is gradual, to maintain confidence on the capital markets and
thus to prevent a balance of payments crisis which would be
costly  both for the  country  concerned and for its  trading
partners.

34

The realignments of February and June  1982: the system undermined or consolidated?

CHAPTER  III

operation of  14 June resembled that of October of last year,
although the widest bilateral change, that between the mark

and the French  franc, was slightly larger: the mark and the

The realignments of  February and June  1982:
the system  undermined or consolidated?

Since the beginning of the year, the monetary authorities of
the member countries have twice realigned parities between
the  currencies  participating  in  the  EMS.  These  two
operations give serious cause for concern, since the frequency
and the size of the adjustments threaten a gradual erosion of
the  system's  credibility.  The  conditions  surrounding  these
realignments—both the  decision-taking  processes and the
economic  programmes  adopted  at  national  level—make  it
quite clear, however, that the participating countries wish the

EMS to  function  well and  that  there is a  common

commitment to  achieve a  higher  degree of  convergence
towards stability.

Section 1 —  Operations carried  out
consistently  with the logic of the
system

The last realignments were separated by an interval of only
four  months. On  22 February  1982, the  central  rate of  the
Belgian and  Luxembourg francs was devalued by 8,5% with
respect to the other participating currencies, much the largest
EMS  adjustment up to  that  time. The  Danish  krone was
readjusted  downwards by 3% at the  same  time. The

Dutch  guilder  were  revalued by  4,25% in  relation to the
group of  currencies  whose  bilateral  rates  remained un-
changed, while the French franc was devalued by 5,75% and
the  Italian  lira by 2,75% in  relation to the  same  group of
currencies. The four earlier realignments since the EMS was
set  up  in  March  1979 were separated  by longer  intervals—
two  of  them,  indeed,  by  a  period  of  stability  of  almost
16 months. An examination of Tables Hand 15 shows how
the  accumulated  change  in  bilateral  central  rates  resulting
from the  latest two  readjustments  compares  with  changes
prior to 1982. In relation to the mark, the currency which has
appreciated  most  within  the  system  since  its inception,  the
largest  central  rate change (12,2%)  was that  of  the  Belgian
franc. The French franc depreciated over the same period by
approximately the same amount in relation to the mark as it
did  between  March  1979 and  the end  of  1981, a little under
10%. The  other  currencies  participating  in the  EMS,
particularly the  Danish  krone and the  Italian  lira, de-
preciated much less in relation to the mark as a result of the
last two realignments than they had  over the preceding two
and  a half years.

Although changes in central rates have undoubtedly become
larger and more frequent, the cohesion of the system and the
discipline it requires have been preserved. As before, the two
recent  realignments  were  decided  by mutual  agreement  at
meetings of the Ministers of Finance and the Governors of
the  central  banks,  and  the  Community  nature  of  these
decisions was less than  ever a matter of pure form.  Indeed,

the direction and the size of adjustments were the subject of

Table 14

Appreciation (+ ) or depreciation (-) of ECU central  rates and bilateral central rates from 13 March  1979 to 5 October 19811

BFR/LFR
DKR
DM
FF
IRL
LIT
HFL

ECU

Bruxelles
in
BFR/LFR

Kabenhavn
in
DKR

—
-7,5
+ 7,6
-3,0
—
-8,8
+ 5,5

+ 3,3

•

+ 8,1
—
+ 16,3
+  4,8 
+ 8,1
-1,4
+  14,0

+  11,7

Frankfurt
in
DM

-7,1
-14,0
—
-9,9
-7,1
-15,3
-2,0

-4,0

Paris
in
FF

+ 3,1
-4,6
,  +10,9
—
+ 3,1
-6,0
+ 8,8

+ 6,5

Dublin
in
IRL

_
-7,5
+ 7,6
-3,0
—
-8,8
+ 5,5

+ 3,3

Roma
in
LIT-

Amsterdam
in
HFL

+ 9,7
+  1,5
+ 18,0
+ 6,4
+ 9,7
—
+ 15,7

+ 13,3

-5,2
-12,3
+ 2,0
-8,1
-5,2
-13,6
—

-2,1.

I 

The table is to be read horizontally. For  example, the central rate of the Belgian franc  appreciated  by 8,1% over the reference period  against the Danish krone in Copenhagen and
depreciated  7,1% in that period  against  the German  mark  in Frankfurt.

35

Economic convergence  and  the European  Monetary  System

Table 15

Appreciation (+) or depreciation (-) of ECU central rates and bilateral  central rates from 5 October  1981 to 14 June  1982

Itruxcllcs
in
BFR/LFR

Kobe aha vn
in
DKR

+ 6,0
+  13,9
+ 3,0
+ 9,3
+ 6,3
+  13,9

+ 10,3

-5,7

+ 7,5
-2,8
+ 3,1
+ 0,3
+ 7,5

+ 4,1

Frankfurt
in
DM

-12,2
-7,0

-9,6
-4,1
-6,7
—

-3,2

Paris
in
FF

-2,9
+ 2,9
+  10,6
—
+ 6,1
+ 3,2
+  10,6

+ 7,1

Dublin
in
IRL

-8,5
-3,0
+ 4,3
— 5  7
—
-2,8
+ 4,3

+ 1,0

Roma
in
LIT

-5,9
-0,3
+ 7,2
-3,1
+ 2,9
—
+ 7,2

+ 3,8

Amsterdam
in
HFL

-12,2
-7,0

-9,6
-4,1
-6,7
—

•3,2

BFR/LFR
DKR
DM
FF
IRL
LIT
HFL

ECU

1 

Sec Note  l  lo Table  14.

discussions  which  became  intense and at  times  difficult
before unanimous consensus could be reached on a balanced
rearrangement  of  the  parity  grid.  At  the  same  time,  as  we
have  already  stressed  (see  Chapter II,  Section  1),  the
adjustments  have  preserved  the  stabilizing  influence  of  the
in  the  sense  that  the  changes  in  central  rates  were
EMS, 
smaller  than  the  inflation  rate  differentials  which  had
accumulated  between  the  participating countries.

currencies  were  devalued,  stabilization  policies  are  now
being  applied. The  French  Government has  introduced
measures intended rapidly to reduce the rate of inflation, and

to  encourage the  recovery of  investment. The  measures

include a four-month prices and incomes freeze, at the end of
which  the  rate  of  inflation  should  have  declined  con-
siderably, the control of public finances, with a budget deficit

kept down to 3% of GDP, and a return to a balanced budget

Section 2 —  Confirmation of the  importance

attached to  greater  convergence

At  each of the  last two  realignments, the  countries  most

affected  agreed  to  implement  accompanying policies which
would  enhance  the  beneficial  effects  and  neutralize  the
perverse  effects  of  the  changes  in  parity.  In  Belgium,  the
February devaluation was an integral part of a recovery plan
designed to  resolve the1 structural problems in the economy.
Apart from a temporary price freeze and specific measures in
favour  of  employment,  the  measures  taken  by  the  Belgian
Government  were  mainly  intended  to  improve  profitability
in the productive sector by combining the mechanical effects
of  devaluation  with  a  loosening  of  wage  indexation,  while
controlling developments in public finance.  In this perspec-
tive, the devaluation should be seen as an important part of
the measures taken and as making them easier to apply. The
programme  should  progressively  alleviate  external  imbal-
ance and the budget deficit, while improving the employment
situation.

The  June  realignment  is  also  indicative  of  a  concern  to
establish  greater  convergence.  In  the  countries  whose

36

for  the social security funds. The countries whose currencies
were revalued  have recognized that the readjustment  could
make  it  easier  for  them  to  apply  policies. which  would
promote  economic  recovery. The  Commission has for its
part  actively encouraged the process of convergence. It has
not confined  itself simply to following through as effectively
as  possible the  coordination  procedures for  economic
policies provided for in Community texts. It has tried to spell
out  what  convergence should  mean  in  practice.

In the middle of  1981, the Commission was led to  make its

position  clear  on  several  occasions  and  in  varying circum-
stances. On 22 July  1981, the Commission, as authorized by
the Council Decision of February  1974  on the attainment of
a high degree of convergence of the economic policies of the
Member  States,  took the  initiative and  addressed a
recommendation to the Belgian Government. This recom-
mendation  stressed the  need to  restore  external and
budgetary  equilibrium  while pursuing a  rigorous monetary
policy and  holding back the expansion of real incomes. The
summary given earlier of the recovery measures taken when

the Belgian franc was devalued in February  1982  shows that

the  Belgian  authorities  have  now  stepped  up  the  already
substantial efforts devoted to achieving the objectives of this
recommendation. On 22 July 1981 the Commission also sent

The  realignments of February and June  1982: the system undermined  or consolidated?

the Council a communication on the principles of indexation
in the Community, warning against the risk that general and
excessively  rigid  index-linking of prices and  incomes would
spread  the inflationary  process and  block  necessary  adjust-
ments. The earlier decision taken in May  1981 by the Italian
authorities  to  introduce  a  compulsory  deposit  for  the
purchase  of  foreign  currency  had  led  the  Commission  to
examine  the  economic  and  financial  situation  in  Italy.  On
1 July  1981,  it  addressed  to  the  Government  of  Italy  a
recommendation pursuant to Article 108(1) of the Treaty, in
which it expressed its concern about the risk of protectionist
chain  reactions  that  could  be  provoked  by  such  measures
(which  were  in  fact  gradually  relaxed,  and  finally  dis-
continued  in  February  1982).  The  Commission,  stressing

that measures to hamper trade can only delay the correction
of basic factors,  also  recommended  an  effort  to  reduce  the
government  deficit and  restrain the  growth of  nominal
incomes, in particular through a less automatic application
of the mechanism  linking pay to  prices.

Finally, at the time when the Council was  fixing its annual
budget guidelines, the Commission adopted, on  1 July 1982,
a  communication on  budget  discipline and  economic
convergence which sought to bring the Member States into a
discussion in depth of the fiscal and  budgetary means to be
adopted in order to correct  developments considered to be
extremely disquieting in a  number  of Member  States.

37

PART TWO

The  development  of  the  European  Monetary  System  in  its  present
institutional  framework

As a result of circumstances—cyclical and more structural in nature—the EMS could not be

definitively  consolidated in the two  years  originally planned, the  Commission  therefore

took the  initiative in  proposing a  non-institutional  development of the  system,  after

evaluating the  results achieved  from  1979 to  1981 (see Chapter IV).

The  areas in which progress can be envisaged are set out in Chapter V while Chapter VI

presents and  comments on the  proposed  resolution  presented to the  Council by the
Commission  on  the  transition  from  the  system's initial stage to  its second  phase.

39

The  development  of the  European  Monetary  System in its present  institutional  framework

CHAPTER IV

Section 1 — Elements for assessment

The  report  which  follows,  adopted in  February  1982 and

7 and 10% against the other currencies apart from the guilder

Evaluation of  the functioning  of  the EMS  at

31  December  1981

At the start of 1982, Commission departments, at the request

of the  Council  (Economic and  Financial  Affairs)  held on

14  December  1981, prepared an  initial  evaluation of the
functioning of the EMS, the successor to the agreement on
the narrowing of  margins which  was in  force  from  1972 to
1979  and  which  is briefly  described  in  Annex  A.

The  studies  in question  were  chiefly  intended  to  clarify  the
discussions  of  the  European  Council  of  March  1982,  and
were made  with  a  view  to  proposing  improvements  to  the
system. '

already communicated to the Monetary Committee and the
Committee of  Governors by the  Commission,2  examines
how the EMS has worked for almost three years, in the light
of its objectives and the changes which have taken  place in
the economic environment  since its establishment.

in  Europe'.  Stability  should be  interpreted as

The  objective  of  the system,  clearly  defined  by  the  European
Council at  Bremen, is  to devise  'a scheme for  the creation of
closer  monetary  cooperation  leading  to  a  zone  of  monetary
stability 
extending  over the  whole  range of  prices,  exchange  rates,
interest  rates  and  other  monetary  variables.  The  degree  of
success should be measured  with  reference  to  various criteria,
including the previous performance  of the EMS  economies, the
comparative performance of  non-participating  countries and
the amount of economic and monetary  cooperation induced by
the system.

Part One of this report first  examines the main elements for an
assessment of  the performance  of  the participating  economies.
Part Two then goes on to discuss the operation of the system's
mechanisms.

See  Annex  B:  Main  features  of  the  European  Monetary  System  in  its
present phase.
2 The  texts  already circulated by the Commission are  printed in italics.

1 

40

1.  Central  rates

Since the start of the EMS, the participating  currencies have

achieved among  themselves a greater degree of exchange rate
stability  than  during the previous period.  This  stability  also
contrasted  with  the  volatility  of  non-Community  currencies,
the dollar  and yen,  and of  the non-participating  Community
currencies, sterling and the drachma.

Over the period, there have been four  changes of central rates,
only  two  of  which have  involved more  than one currency.  All
have  been  made by  mutual  agreement in  orderly  market
conditions,  and  a  common  procedure  has  been  developed.
Between the start  of  the system and the  October realignment
the  maximum  bilateral  change,  18%, has  been  between the
German mark and the lira. The German mark has revalued by
nearly as much against the Danish krone, and by between about

against  which it has revalued by  only  2%.  These amounts are
almost exactly  half  its appreciation  against the lira and French
franc  respectively  over the  previous  three-year  period. The
changes  have  in all  cases been  in  the  direction  suggested  by
price and  cost  movements, and no  central  rate  change has
subsequently  been  reversed.

exchange  rates  preserving 

The  central rate adjustments  have not led to large movements
in  Community  effective 
trade
between  EMS  countries.  This  stability  contrasts  with  the
strongly  divergent  exchange  rate movements recorded  within
the  Community  in  the period  1973-78,  and  is  an  important
positive factor for an  area in  which  trade  amongst  member
countries in  1980 amounted to  over 50% of  their  total  trade.
However,  in  view of  the persistent  inflation  differentials 
(see
below)  between the participants,  this development  also means
that  currencies having  relatively  high  inflation  have  imported
stability  through the  mechanism of  direct price  interdepend-
ence, while countries having less inflation  have gained in terms
of  export  potential.

The  relative stability  within the EMS  contrasts strongly  with
the  volatility  of  sterling,  the  drachma,  the  dollar  and  yen
against  the participating  currencies.  The  dollar's  movements
have  been  dominated  by  the  reversal  of  the  US  balance  of
payments  position  and  by  interest  rate  differentials.  The
policies of the US  administration  have not  prevented  saw-
toothed  movements of  interest  rates, nor the  resultant short-
term  capital  inflows  and  outflows.  Until  mid-1980  the  ECU
rate of the dollar fluctuated  widely  around a slight  downward
trend.  There  was then a steady  rise to a peak  in August  1981
about 45% above the level of July  1980. Since then the rate of
the  dollar  declined  somewhat,  again fluctuating  around  its
trend.  Over the  whole period  these  dollar fluctuations  have
considerably added to the uncertainties for  international trade.

Evaluation of the  functioning of the EMS at 31 December  1981

The two non-participating  Community currencies, sterling and
the  drachma  rose  by  20% and fell  by  18% against  the  ECU
excluding  sterling,  respectively  since  March  1979.  The
depreciation  of  the  drachma  in  1979 and  1980 has partially
followed the inflation  differential.  Sterling's evolution has been
much more erratic and has reflected1  interest  rate differentials
of from  3,5  to 5,5 points against the average for  participating

currencies in 1979 and 1980; and again in mid-November  1981,

when sterling benefited from  a favourable  differential  after  the
fall  in US rates. Added  to this was the current account surplus
between 1978 and 1981, attributable to North  Sea  oil and  the
recession.

the 2,25% band has caused some inertia in the movement of the

indicator, despite  the corrections made.

to  maintain  the
The  amount  of  intervention  necessary 
fluctuation  margins has at  times been substantial but  has not
caused problems for  monetary  targets or depletion  of reserves.
The  currencies  supported  by  interventions  were  at  different
times the  French and  Belgian francs and the  Danish  krone.
Speculative  bouts have generally  been contained,  and in only
one  case  was  extensive  intervention  activity  followed  by  a
realignment of  central rates.

2.  Exchange  rate  management

The  basic  texts of the EMS 
interventions  will  be  in  the  currencies  of  the  participating
countries'. In  practice,  however,  dollar  interventions,  which

'in  principle

specify 

that 

may be addressed  either at  curbing fluctuations  against  that

Between  realignments full use has  been  made of the  limited
fluctuation  margins. The  maximum  permissible  spread
between two currencies has repeatedly  been taken up. In 1979,

the  Belgian franc was at its  lower  limit  against the  German

mark in late May and early  June and then against the Danish

krone in October. At  the start of 1980, it was again at its lower
limit but  against the  French franc and guilder. The  German
mark was weak for a large part of  1980, several times falling to
its lower limit  against the French franc.  Their positions  were

however reversed  in early  1981, following  interest  rate moves

by the  Bundesbank,  implying a  total  bilateral  movement of

4  '/2% in a relatively  short period. ' Such  reversibility  within

the  margins  weakens the  impact of  short-term  interest  rate

differentials  on  capital  movements,  thus  when  there  are  no
expectations  of  central  rate  changes  reducing  the  need for
intervention.

currency  or be primarily for  currency management  within the
EMS,  still predominate. In part, this is because  a number of
countries prefer  to maintain  their  currency  near  the centre of
the fluctuation  band. This has been true particularly for  Italy,
whose  currency has a  wider  band  (6%). For  intra-marginal
intervention,  agreement  must  be  obtained  to  use  another
participant's  currency,  which is not the  case for the dollar.

3.  Interest  rates and monetary  aggregates

When the  markets do not  anticipate, a  change in  exchange
rates, short-term capital movements are dominated by nominal
interest  rate  differentials,  which  makes  these,  together  with
interventions, an  important  instrument of  currency  manage-
ment.  There  have  been  a few  examples  of  policy  conflict
between domestic and external objectives in the area of interest
rates. Shortly  after  the start of  the system both Denmark and

Italy had to  lower  their  interest  rates,  because of  capital

The  divergence  indicator has on the  whole  been a  useful
additional  element to the arrangements. Given the underlying
inflationary  situation, it is  consistent  with the  aims of the
system  that it has been systematically  activated only  by  weak
currencies although  this  was probably  also  influenced  by  the
strength of  the dollar.  When  the threshold has been reached or
overstepped, the necessary measures have normally been taken
to redress the situation, although there is still some difference
of opinion over the interpretation of a 'presumption  to act'. The
currency  most frequently  divergent  was the Belgian franc:  it
crossed its  divergence  threshold from May to  July  1979, in
February  and March  1980, from  February  to April  1981 and
again in December  1981. The Danish krone and French franc
have  also  crossed  their  thresholds. The most frequent  policy
reaction has been to raise interest rates. There have, however,
been a number of occasions on which bilateral limits have been
reached  before  any  currency  has  crossed  its  divergence

threshold and the movement of sterling and of the lira beyond

1 

See the calendar of events on page 43 for a graph of maximum spot spreads
between  currencies  participating in the  narrow-band  system and
indicating  which  currencies  crossed  their  upper  or  lower  divergence

threshold for more than  five  days.

inflows,  when  relative  domestic  conditions  would  have
suggested the  contrary.

While  in most  Community  countries  there  were  domestically
generated  reasons for  relatively  high  interest  rates, peaks in
US  rates may  have led, in a number of  member countries, to
higher  interest  rates  than  generally  warranted  by  purely
domestic  considerations. But as  with  interventions, it is
difficult 
and those in response to changing outside circumstances. There

to distinguish between measures inspired by the system

has been a steady  rise in interest rates between 1978 and 1981.

For domestic reasons, European monetary  authorities neither
followed  the fall  of  transatlantic rates after  March  1980, nor
their spectacular  rise in the second half of  1980. But the high
external deficit  and persistent  inflation,  which was likely  to be
further  aggravated by the strong  rise in the US  dollar,  made
further  upward movement of interest rates inevitable in 1981 in
Europe,  despite the low  level of  activity and  high  unemploy-
ment.

Since  1979,  the  stance  of  quantitative  monetary  policy  has
become  more  restrictive in  practically  all  Community

41

The  development  of  the  European  Monetary  System  in its  present  institutional  framework

countries.  This  change  has  been  prompted  by  the  need  to
combat  inflation  generally  and  in particular  by  the  desire  to
prevent  the  emergence  of  secondary 
following 
maintaining  central  rates  and  adhering 
monetary  objectives  have been avoided.  Furthermore the  very

effects
the  rise  in  the  price  of  oil. Conflicts  between
to  quantitative

inflationary 

existence of the EMS has  provided a  strong  incentive to

improve  de  facto  coordination  of  monetary  policies.

4.  Costs  and prices

in  national

In  1978, the average of the  Community GDP price deflators,
which reflect  the overall change in domestic costs, had fallen  to
8,5%, compared  with an average over the previous three years
of  11%. The  dispersion  between  Member  States had  also
declined.  Following the  second oil  shock,  however,  both the
average and the dispersion  have again increased. In  1979, the
Community  average was nearly 10% and in 1980 over 11,5%,
with  a  range  from  4,3% in  Germany  to  20,3%  in  Italy.
Exchange  rate  stability  and  satisfactory  monetary  manage-
ment  have  not  therefore  been  matched  by  a greater  conver-
gence of  costs and  prices.  When  expressed 
currencies, average annual divergences in cost and price trends
between EMS  partners were, in many cases, quite substantial.
Over the period  1979-81, the average annual  consumer price
inflation  rate has been 16,3% in Italy  whereas that in Germany
has  been  5,6%.  In  contrast  the  lira/German  mark  bilateral
central  rate  varied by  only  18%  over the  whole  period
Furthermore aggregate  variations in the relative levels of  unit
labour costs in national currency have ranged from  — 14,5% to
+ 32,7%.  Such a  large  change in  competitive  positions in a
relatively  short  period,  is  the  result  both  of  previous
movements, in the  reverse  direction,  accumulated  mainly
through  excessive  nominal  exchange  rate  movements  during
the pre-EMS  period; and of  the policies tailored to maintain-
ing  nominal  exchange  rates. In the  future,  maintaining
exchange  rate  stability  requires decreasing the divergence of
cost and price  trends.

The shift  from  a low to a high relative cost and price level in a
country  with a  stable  exchange  rate  should  serve to  exert
pressure to implement  appropriate  policies to ensure domestic
stability. Maintaining  exchange rate stability is often the only
way in  which the  real problems of  domestic  adjustment are
forced  into the  open.  These  problems  would  otherwise be
obscured  by  the  spiral  of  devaluation  and  inflation;  with  the
devaluations doing nothing to resolve the basic problems. This
was the experience of the  United  Kingdom and Italy  between
1973 and  1978. It is  important  that the EMS  stabilization
mechanism should work fully in those countries where inflation
or the level of relative costs is still too high; this not only means
that monetary policy  must  defend  the exchange rate but  also
that domestic adjustment,  notably  in the areas of  incomes and
public finances,  must  be  encouraged  and  speeded  up  through
other  appropriate  measures.  Quite  independently  from  the
existence of  the EMS,  such internal adjustment  is necessary in

42

order to increase possibilities of economic growth in conditions
of  stability  and higher  employment.  The  EMS  highlights  the
need  for  adjustment  and  provides  one  of  the  necessary
ingredients  to  help  its  realization.

Section 2 —  Functioning of the  system's

mechanisms

In  summary, in its first  three  years of  life, 

the  European

Monetary  System has been remarkably  successful in assuring
exchange  rate  stability  through a  period of  great  world
monetary  turbulence. It has provided a monetary environment
favourable to the  orderly  development of  intra-Community
trade; and has succeeded  in avoiding  the excessive  exchange
rigidities  that  eventually  led  to  the  collapse  of  the  Bretton
Woods  parity  system. The  system has  been  managed in a
realistic  way, avoiding  on  the  one  side  full  or  over-
accommodation of  cost and  price  trends and on the  other
stubborn  defence  of  unrealistic  exchange rates. Although  the
situation  would  have  been  worse  without  it,  the  EMS  has
however failed to produce the desirable degree of  convergence
towards price stability. Since 1978 inflation  rates have become
higher and more divergent  because of the second oil shock, the
extraordinary  appreciation of the  dollar, and  insufficient
domestic discipline in the areas of costs and public finance. The
political commitment  underlying the EMS, and the mechan-
isms created by the system itself,  have been an essential, albeit
insufficient,  factor  pushing for  stability-orientated policies in
member  countries  in  which  monetary  stability  was  most
needed. A stronger impulse in this direction can only come from
a strengthened EMS.  The critical appraisal  of  the functioning
of the  system's  mechanisms,  which is made in the following
paragraphs, can show the appropriate  ways to achieve such a
strengthening.

1.  ECU  creation

There  has  been  a  dramatic  increase  in  the  total  quantity  of
ECU  created from  about  27000  million, resulting from the
initial  swap  operations  at  the  start  of  the system,  to  nearly

50 000 million in April  1981. '  This  amount subsequently has
declined  to 42 000 million  ECU.

Taking the swap  operations of July  1979 and January  1981 as

an example, it can be seen that against almost exactly the same

amount  of  gold,  15 800  and  38 300  million  ECU  were
respectively  created, because of an increase in the price of gold
used in the  swap  operations of  over  140%  between the two
periods. ECU  created  against  dollars fell  only from  11600
million  to  10 900  million  because  the  decline  of  6%  in  the
amount of  dollars  transferred was not  entirely  offset by the
appreciation of the  dollar in  terms of  ECU.

Annex B shows the ECU  creation  resulting  from the  swap operations.

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3

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The  development  of the European  Monetary System in its present  institutional framework

The key to the  growth in ECU has  therefore  been the  rule
determining the price of gold used for  the swap operations. The
automatic link  between the price  of gold and the  quantity of
ECU determines, outside the control of the system, the degree

has had a net positive position. The  total of the  negative or

to which gold is mobilized. The gold price rule used in the swap

arrangements  (whichever  is  lower  between  the  six  month
average and the latest market price)  did moderate the increase
in supply  of  ECU  somewhat  over  the period  when gold prices
were  rising  rapidly.  The  swap  price  reached  a  maximum  of

447 ECU per  ounce  whereas the  market  price  went  above

670  ECU  per  ounce.

As  the participants  transfer  gold and dollars  in  very  different
proportions the number of ECU  that they have each received at
successive  swap  renewals,  and  hence  the  distribution  of  the
quantity of ECU  between them, has been highly  affected by the
changes in the prices of  these  two assets.'

In contrast, the  use of  ECU  or the  effect  on ECU  creation of
the  loss  or gain of  dollar  reserves has  had little  effect  on  the
distribution of  ECU. For  example, the  amount of ECU
received through the swap  operations by the Netherlands and
Denmark,  which  have  both  seen a  similar  reduction in the
amount of dollars that they  transfer, has respectively  increased
by  nearly  90%  and decreased  by  11% between  July  1979  and
October  1981 because  the  increase  in  the price  of  gold  has
affected 
these  two countries.

in very  different  proportions the allocation of ECU to

ECU  creation is determined by a rule in  which the  three key

variables (the price of gold,  the dollar  exchange rate and the
respective  proportions of  these two  assets) are  outside the
control of the system.  Under  these circumstances, the quantity

of ECU  created cannot be expected necessarily to be consistent

with the aims of the system, and hence a wider use of the ECU

as a  means of  settlement and as a  reserve  asset  could not

4%  of  its  ECU  holdings.  Denmark  and  Belgium  have
consistently had substantial net negative positions, and France

positive positions  has  reached  8%  of  the  quantity  of  ECU
created  through  the  swap  arrangements  (see  Table  18,
page 46).

Interest on  these net ECU  positions is  calculated as the
weighted average of the official  discount rates of the currencies
of  which the ECU  is composed.  There is therefore  no scope for
discretionary  decisions  that  would  affect 
the attractiveness of
the ECU  relative to the dollar. Both its  value and its yield are
given. Furthermore market interest rates can at  times deviate
consider ably from  official  discount rates which can result in an
even greater  variation in its relative attractiveness than in its
price relationship  vis-a-vis  the dollar.

Debtors have been reluctant to buildup large negative net ECU
positions because of the uncertainty  over  what  will happen at
the  end  of  the  transitional  phase,  when,  unless  there  is  a
decision  to  the contrary,  they  would be required to clear  their

ECU  positions by  acquiring ECU from  other  participants.

Creditors have not  encouraged the use of ECU  both because
the  interest  rate  rules have generally not  been favourable to
them and because the creation method is unlikely to limit the
volume of ECU  thereby  being an  element of  restraint on
potential debtors.

With the  limited use  reflecting  both  inadequate  inducements
and provisions within the system as well as the reticence of the
participants, it would be inadvisable simply to increase the use

of the ECU by abolishing the acceptance limit or by  enlarging

the categories of transactions over which one of the parties had

the  right to use ECU  without  amending  other parts of the

contribute  towards  achieving greater monetary  stability.

system  in such a way as to make the quantity  and the yield of

2.  The  use  of ECU

the ECU the  result of  stability-orientated  decisions.  Only a

scarce  currency  can induce  discipline.

Participants  have  a  right  to  use  ECU for  settlement  at  the
maturity  of  a  very  short-term financing  operation  'with  the
proviso  that a  creditor  central  bank  shall not be  obliged to
accept  settlement by  means of  ECU  of  an amount more  than

50% of its claim which is being settled'.2 With the agreement of

the  creditor,  ECU  may  however  be  used for  any  settlement
between participating  central banks.

In practice, ECU  use has been limited. Italy,  Ireland  and the
Netherlands  have practically  never had a net ECU  position ;
and  when  they  have  it  has  been a  very  low percentage  of  the
that  they  received  through the  swap  operations.
Germany's  net  position  has  changed from  being positive  to
negative and then positive again, but at the maximum reached

ECU 

Moreover, and for  reasons indicated below, it is unlikely  that

the ECU can become an element inducing stability  when its use

is in addition to, rather than as an alternative to, other reserve
assets and settlement instruments. It  is for  these reasons that

the  Commission in its  report of 20  March  1980 to the

European Council suggested that the possibility of adopting the

ECU as an  exclusive  instrument of  settlement  between the

Community's  central  banks  should be considered.

3.  Credit  mechanisms

Substantial use has been made at times of the very short-term
financing. For marginal intervention in Community currencies,

the facility is  automatically  available at the  demand of the

intervening central bank. With agreement from the creditor, it

See Table 17, page 45

Paragraph  16.1 of  the Agreement of 13 March  1979  between the central
banks.

44

Evaluation  of  the  functioning  of  the  EMS  at  31 December  1981

Table  17

Distribution  of  ECU  between  participants

Banque Nationals de  Belgique
Danmarks Nationalbank
Deutsche Bundesbank
Banque de  France
Central  Bank  of  Ireland
Banca  d'ltalia
Nederlandsche  Bank
Bank  of  England

Share of  lotal  ECU  issued

Proportion of ECU

received  against gold

Change in dollar
reserves between

Initial '

October  1981

Initial  l

October  1981

and  October  1981

6,9
2,1
36,9
17,6
0,7
16,3
9,3
10,3

8,9
1,0
32,7
21,0
0,3
18,2
10,7
7,1

100,0

100,0

78,3
12,1
40,8
73,3
9,1
64,9
75,1
31,7

85,8
36,1
65,0
87,1
28,6
81,7
91,9
59,4

+  17,8
-49,8
-25,7
-19,7
-53,5
-18,3
-47,4
-43,2

1 

The  initial  positions  were established  over the  period  March  lo  April  1979 (July  1979 for  the  Bank  of  England).
The proportion of each national central bank's ECU which it receives in return for swapping 20% of its gold varies because of changes in its dollar holdings. Gold holdings have remained

2 

virtually  unchanged  over the  period.

may  also  be  used  to finance  intra-marginal  interventions.  In
both 1979 and 1980, about 2 000  million ECU of financing  was
obtained  by  activation  of  the  mechanism.  In  1981 use  has
amounted to about  7 000  million. The overwhelming majority
of  these operations have been repaid in the creditor's currency,

and the  balance has  resulted in  transfers of ECU and  other

reserves.

Both the short-term and medium-term credit mechanisms were
increased substantially  at  the start  of  the EMS. The granting
of  medium-term  financial  assistance is  discretionary: it is
subject  to a Council decision, which lays down economic policy
conditions.  In  the  case  of  the  short-term  monetary  support,
credit can be granted to a central bank  automatically on the
demand  of  a  debtor  up  to  its  limited  quota, beyond  which  it
becomes  discretionary.  Neither of  these  mechanisms nor the
Community  loan facility  for  balance  of payments  needs  has
been used since the start of the EMS, but in contrast  there has
been  considerable  use  of  unconditional  credit  from 
international capital  markets to finance  external imbalances.
Following  the  second  oil price  shock,  the  Community  as  a
whole  went  into  substantial  deficit,  for  which financing  was
necessary  while  domestic  adjustments and an  increase in
OPEC  absorption 
took  place.  The  deficits  have  differed
considerably  between Member  States as a percentage ofGDP,

the

The EMS has an  important  role to  play in the  existing

as have the amount and changes in amount of  official  external

debt.

The imbalances have been financed  with little change in overall
reserve  positions.  In  1980, the  Community's  31 000 million
ECU  current account deficit  was financed  by capital inflows  of
28 000  million and  a reserve fall  of  only  3 000  million.

In  these circumstances the EMS  credit mechanisms cannot on

their own  contribute  towards  imposing a  tighter  monetary

discipline 
in the  Community,  without  general  provisions
regarding  the  official  recourse  to external financing.

4.  Exterior  aspects of the system

international monetary  relationships. Since the late 1960s and
again even more obviously  throughout 1981, the dialogue with
the American authorities has been hampered  by  the lack  of  a
strong Community  monetary  organization comparable  to that
existing  in  the  areas  of  trade  and  agriculture.  This  dialogue
becomes increasingly  important both with the development  of a
multi-currency  reserve  system  and  since  the  US  monetary
authorities  have  changed  their  method of  monetary  manage-

45

 
2
The  development of the  European  Monetary  System in its present  institutional framework

Table 18

Net use ( - ) or accrual ( + ) of ECU as a percentage of ECU

received  through  the swap operations

End of  month

Belgium

Denmark

FRof
Germany

France 

UK

Ireland 

The 

Italy 

Nelherlands

—

— 

— 

1979 April
May
June
July
August
September
October
November
December

1980  January

February
March
April
May
June
July
August
September
October
November
December

1981  January
February
March
April
May
June
July
August
September
October
November
December

-8,2
— 
-14,7
-15,0
—
-13,9
—14,0
-14,2
-12,9
-13,5
-  25,2

— 

+ 27,4
+ 33,2
-1,8
-1,9
—1,9
-1,9
-2,3
-26,9
-5,6

-27,9
-39,7
-54,1
-43,3
-37,6
-31,2
-  24,8
-25,0
-24,8
-24,4
-25,7
-30,8

-31,6
-50,0
-69,9
-67,0
-67,2
-68,1
-71,7
-72,3
-72,9
-78,0
-78,7
-79,4

—

—

_ 

-9,8
-21,1
-29,1
-45,7
-46,1
-46,5
-38,8
-39,1
-39,5
-33,6
-33,8
-34,1

-30,1
-30,4
-30,6
_
-30,6
-30,9
-31,2
-31,5
-31,8
-36,4
-41,7
-42,1
—
-42,5

— 

— 

_ 

— 

—

_
— 
— 
— 
— 
— 

_

_

__

— 
— 
— 
— 
— 

— 
— 
— 
— 
— 

—
—
—
—
—

— 

— 
— 
— 
— 
—  +0 ,9 

— 
—  + 0 ,8 
+ 3 ,5 +6 ,2  —
+ 2 ,6 +1,6  —

— 

—

+ 0,2 
— 
+ 0,2 

_
+ 0,8
+ 2,8
+ 2,8
+ 2,9
+ 2,9
+ 2,7
+ 3,8
+ 4,2

+ 2,8
+ 3,9
+ 0,8
-1,4
-1,5
— 
-1,5
— 
-1,5
-1,5
-1,5
-3,0
-3,0
-3,1

— 
— 

— 
+ 0 ,2 
+ 0,2 
+ 0,2 
+ 0,2 
+ 0,2 
+ 2,5 

+ 4,8 
+ 9,6 
+  15,4 
+  17,2 
+  17,4 
+  15,8 
— 
+  13,6 
— 
+ 13,7 
+  13,6 
+  15,6 
+ 16,0 
+  17,4 

_
— 
— 
— 

_

_

__

— 
— 
— 

— 
— 

_ 
_ 
— 
— 
— 
— 
— 

—
— 
— 
—
+3 ,0  —

+2 ,2  —
+3,4  —

_ 
_ 
— 
— 
— 
— 
— 

_
_
—
—
—
—
—

— 

—
— 

+1,8 

-3,1
_  -11
+ 0^6
_ 
+  1,1
+  1,1
+  1,1
+ 1,6
+ 2,2
+ 2,3
+ 3,1
+ 3,2
— 
+ 3,2

— 

_ 

+ 17,6 
— 
+ 25,0 
+ 27,0 
+ 27,3 
+ 27,5 
+ 27,7 
+ 29,2 
+ 28,6 
+ 28,9 
+ 30,2 
+  30,5 
+ 30,8 

— 

.
+2,0 — 
— 

— 
— 

_ 
_ 
— 
— 
— 
— 
— 

—

—

Tola!

±0,6
+ 1,1
+  1,2
±1,0
±1,0
±1,0
±1,0
±1,4
±1,9

±2,3
±3,3
±4,5
±4,3
±3,8
±3,8
±3,0
±3,0
±3,0
±3,4
±3,5
±4,0

±4,0
±5,7
±6,4
±6,3
±6,3
±6,4
±6,8
±6,9
±7,0
±7,4
±7,4
±7,5

ment  and  have  concentrated  heavily  on  domestic  policy
objectives.

A  multi-currency  reserve  system  needs  more,  not  less,
management  than an international monetary  system  based on
only one currency, and as Europe will inevitably, in one form  or
another, be one of  the reserve issuing centres, it should be able
to  discuss  monetary  matters  productively  with  the  United
States.

Over the last 20 years, the relative position of the United States
in  the  world economy  has profoundly  changed and  a  tripolar

46

system has emerged. Not  only in terms of industry, agriculture
and per  capita  income, but  also  as  a  trade  partner  and  as  a
holder of  international  reserves, the  Community has become
one of the  three great  areas of the  industrial  world.

An  appropriately  developed EMS  could be a  useful way of

the  creation  of  a  common  and  stable

organizing the  European  pole of the  international  monetary
system.  Through 
monetary identity for the Community, it would help the orderly
evolution  of  the multi-currency  reserve system, both  through
helping  to  limit  the  number  of  currencies  that play  a  reserve
role and through putting greater  economic weight and depth of

Evaluation of the functioning of the EMS at 31 December  1981

financial  markets  behind  the  ECU.  Internally,  it  would  help
cohesion  within  the  EMS  spreading  over  several  European
shoulders  the responsibilities  of  an international currency  role
that  have  proved  quite  heavy  even  for  politically  and
economically  great powers.

A fundamental part of  the exterior aspects  of  the system is the
exchange  rate  relationships  vis-a-vis  third  currencies. The
internal  exchange  rate  arrangements of the EMS are
somewhat facilitated  when  the dollar  is strong  relative  to  the
EMS  currencies.  When  the opposite  is true, short-term funds
tend  to flow  into  the  German  mark  in preference 
to  other
Community  currencies  thereby  accentuating  any  tensions
already  existing  in the system. Just  such a movement  was the
catalyst for  the  September  1979  realignment.

In theory, in a system with one dominant currency, (he exterior
position  could be determined as  two-step procedure in  which
the dominant currency manages its exchange rate vis-a-vis the
outside and the others manage theirs against it. In practice, this
procedure is not suitable to any of  the EMS  partners. Nor  can

the  problem be  ignored.  Even  when the US  monetary

authorities are pursuing a policy  of  allowing the dollar  to find

The  basic EMS  texts mention that  European  economies with
especially  close ties to the Community  could participate  in the
system  in  some  way.  Some  countries  already  maintain  very
close exchange rate links  with one of  the EMS  currencies, but
nothing has been  done to  integrate  these  relationships  within
the EMS  or to extend  the use of  the ECU  to  this  wider zone.

The  Community  has  been  in deficit  to  the  OPEC  countries,
who in turn are looking for  ways of  diversifying  their reserves.
A  move  towards  allowing  them  to  hold  ECU  together  with
invoicing of  their  exports 
advocated by some as beneficial  to both sides and could again
extend  the use  of  the  ECU.

to  Europe in ECU has  been

The  expression  of  a  monetary  identity  cannot  however  be
confined  to official  holders; private use of, and markets for,  the
ECU  will  have to  develop. The  international  financial
community  has  started  to  use  ECU  for  a  number  of  credit
operations  including  opening  of  deposit  accounts,  issuing  of
deposit  certificates,  granting  of  loans and  issuing  bonds.  The
last of these took  off  in 1981. There  have been six  bond issues
totalling nearly 250 million ECU,  which may be a small figure
compared  with  the  total  in  all  denominations  over  the  same
period  (USD  18 000 million), but it nevertheless amounts to

its own level in the exchange markets,  that  level is a matter

about 5% of the total of public issues in currencies other than
indifferent 

the dollar: a remarkable percentage for a start.  Three of the

about  which  the  Community 
nor
completely  impotent. On the other hand, it is not a question on
which any rigid guidelines can be pre-specified.  As stipulated  in
the Bremen Annex and the Brussels Resolution, any actions on

is  neither 

issues have been made by  Community  institutions, two by  the
EIB  and one by  Euratom. Other  Community  institutions use

the ECU for  accounting  purposes and  have  opened ECU

accounts for  the relevant transactions with a number of banks.

Today,  there  are  still  a  number  of  obstacles,  as  well  as
unfamiliarity, 
ECU. The syndicate  leaders of the ECU  denominated  bonds

to  this  development of the private use of the

are banks from  those  Member  States  whose  authorities  have

allowed the use of the ECU  through giving it the same status as

the dollar should  therefore be subject to a common procedure

which would result in some compromise between the different
national positions and  the aims of  the system.

5.  Wider use of the ECU

All ECU  created by the  EMCF,  whatever  their  creation
method, have  the same characteristics of  being  'official'  sight
liabilities usable  only  between participants  in  the system.  On
the  other  hand, as the ECU  becomes the  expression of the
Communities' emerging monetary identity, deeper and broader
financial markets operating in ECU will develop and a broader
category  of holders  will have access to it. Both these facts pose

the problem of a  wider use of the  ECU.

a foreign  currency.  In other Member  States, the ECU  is still
disadvantagedby its hybrid nature. As seen from any individual
country,  it is composed partly  of national currency  and partly
of foreign  currencies. The national currency part naturally falls
under any  regulations  directed at  domestic  monetary  policy
and the foreign  currency part is subject  to any exchange control
type  regulations. The result is that the ECU is disadvantagedas
compared  to  either domestic  or foreign  currency.

47

The  developmentj)f the  European  Monetary  System in its present  institutional  framework

CHAPTER V

Analysis of the possible  areas in which the EMS

can be developed

The  evaluation of the way in which the EMS has functioned
demonstrates that  there are  a  number of areas in which  the
system could be improved.

The  possible  areas for the  development  proposed by the
Commission,1  which  tend to  respect the  present  balance
between strictness and  solidarity, derive from an analysis of
the areas in which progress could be made within the present
legal  framework,  and  consequently  without  recourse  to
Article  236 of the Treaty  of  Rome.

further  developments are

The  analysis  made in  Chapter IV has shown  that  despite the
undeniable  successes of the  EMS, 
necessary; and they are likely to become more necessary as the
external environment worsens: its achievements have been the
result  of a combination of favourable  external circumstances
and its own internal strengths. Similarly  its disappointments,  in
terms  of  convergence  towards  stability,  stem from  hostile
external factors  and from  certain shortcomings in the system
itself. 
Its  mechanisms,  relying  excessively on  prespecified
rules,  have not  always  worked  cohesively 
underlying  objectives, and have not been broad-ranging enough
to  induce a satisfactory  level of price stability.

towards the

The  aims  therefore  should be to develop the system: to make
the  mechanisms more  responsive  to changes  in environment,
endow  them  with a greater  disciplinary  effect; 
public and private  economic  agents to model  their  behaviour
more  closely  on  necessity  of  monetary  stability;  and  to
organize 
in  a  more  orderly  and  effective  manner  (he
Community's  role in the multiple  reserve  currency  system.

to  encourage

Possible  developments,  based  on  technical  analysis  and  on
extensive discussions both within the Commission departments
and  in  the  competent  Committees  as  well  as  on  the  above
assessment, are briefly  described in the following  paragraphs.

ECU  creation  eliminated, the use of the ECU  should be

They can be grouped  around four  main areas for  action:

(i)  coherence  of  the  mechanisms;

(ii)  opening  the system;

(Hi) use of the ECU on the  markets;

(iv)  policy  convergence.

Annex C-2 presents a technical study by the Alternates of the Monetary
Committee  on  some  of  the  problems  which  could  be  posed  by  non-
institutional  development  of  the  EMS.

48

Section 1 — Assuring greater  coherence of the

mechanisms

Three  years'  experience  suggests  that  when  the  system  was
designed and put  into effect,  excessive confidence  wasplacedin

the  virtues of the automatic mechanisms  which did not prove

justified. The effect  of discipline,  inducing rigour and stability,
which was  expected to be  induced by the  operation of the
mechanisms,  has  not  been  sufficiently  marked.  Adjustments
could  therefore  be  made  by  improving  the  control  over  and
coherence of the main  constituent parts of the system.

1.1.  The  ECU

The ECU  used within the system has two defects:  its creation is
unmanaged,  and  it  is little  used.

Within the swap system, the creation of ECU  can only be fully
controlled  by  introducing  more  discretionary  decisions.  It  is
possible to  moderate the  effects of  erratic movements of the
price of  gold or the  dollar  exchange  rate on the  quantity of
ECU  created,
  by  increasing  the  duration  of  each  swap  or
lengthening  the  reference  period  over  which  averages  are
taken.  The  consequence  of  these methods  however  is that  the
internal  valuation of  the assets and  the market  valuation  will
diverge, with adverse  consequences for the use of the ECU. A
more efficient  method is to keep the quantity  of ECU fixed and
make  the  necessary  quarterly  adjustments  to  the  amounts of
reserve assets  transferred  according to  variation in their ECU
price.  This has been  called the  'closed pool' and would mean
determining, (i)  t he initial pool of ECU, and (ii) the procedure
for  any  subsequent  alterations  to  the pool.  It  should  not  be
possible for  such a decision to be taken except solemnly and at
fairly  long  intervals. One possibility  would  be for the  central
banks  or the  Board of  Governors of  the EMCF  to agree each
year on the volume of ECU to be created. Another would to be
to set an annual rate of growth for the volume of ECU  (linked,
for  example, to the growth of  the Community's  external trade
or of  intra-Community  trade), a rule from  which the  central
banks  could not  depart  except by  unanimous decision.

With the inflationary  danger involved in the present method of

encouraged. The  abolition of the  ECU's  present  acceptance
limit in the settlement of  operations covered by the very short-
term financing  would enable the debtor to clear his debt  in full
by  surrendering  ECU.  In return, the creditor  would receive a
higher  remuneration on his net ECU  position  (the rate of
interest could be set each month by  the Board of  Governors of
the EMCF at a level derived from the market level)  3 and could

2 

3 

See Annex C-2: Severing the link between the volume of ECU issued and
the price of gold  or  the exchange rate of  the dollar.
E.g.  the average of three-month interbank rates on the internal market of
various  EMS currencies,  or  the three-month  Euro-ECU  rate.

2
Analysis of the possible areas in which the EMS can  be developed

be authorized  to mobilize  his net  ECU  credit position  on  the
basis  of formulae to be  agreed.1

Adopting all the above provisions  would appreciably  enhance

the  ECU's  properties, by  reaffirming 
settlement instrument and as an instrument based on stability.

its  role  both as a

At the same time the balance of rights and obligations between

creditors  and debtors  would be  respected.

1.2. The  mechanisms.

In the same way as the ECU's properties can be improved and

with the  same  object in  view,  certain  gaps in the  existing
mechanism  could  be.filled.

and the Federal Reserve Bank of New  York by a single credit

amount  of  undesirable  dollar  interventions,  but  without
eliminating  the problem  which  the  dollar  represents  for  the
system  as  a  whole.  The  sharp  fluctuations  of  the  dollar
exchange  rate  over  the  last  three years  and  the  large fund
movements which they produced,  represent so great a threat to
the cohesion of  the EMS  that they call for  active efforts  for  the
definition  of a common attitude  towards  the dollar on the part
of the EMS  currencies. This common attitude would be defined
by the central banks at short and regular intervals, as part of an
assessment exercise resulting in a quantitative formulation  of a
'zone  of probability'for 
later stage, the same exercise might moreover be contemplated
for  the ECU/yen  exchange rale. Such a zone, which would have
to be fairly  wide (±  10-15% around an ECU/dollar  exchange
rate),  would serve as a point of  reference for the Community
central banks, which would be expected  to act on their interest
rates or to intervene in order to stop the dollar} ECU  rate from
leaving the zone. The markets could be informed  of it in order

the ECU/dollar  exchange rate. At a

to  benefit  from an announcement  effect.

The  Community  monetary  authorities  represented by the
EMCF  should  also use  their  influence to  persuade the US
authorities to reconsider  their laissez-aller exchange rate and
interest rate policy: the moves made by the Community  would
gain in credibility  if  they  were supported  by  the same methods
on the American side. In this connection, the start of talks with
the  US  authorities  with  a  view  to  replacing  the  existing
network of  swaps  between certain  Community  central  banks

line between the latter and the EMCF  would provide  tangible
evidence of the European determination to close ranks vis-a-vis
the  United  States.

Third, a step would be taken towards the consolidation of credit
mechanisms—planned for a  later  stage—if it was decided to
make  the  EMCF  responsible  for  the  short-term  monetary
support  mechanism.  This  would  strengthen the  EMCF's
functions and act as a signal of the determination to organize
the existing institutions in function  of the needs of the workings
of  the EMS.  No  legal  difficulty  would  be  involved,  since  the
provision  is  contained  in  the  Council  Regulation  of  3 April
1973  establishing the EMCF and was subsequently  confirmed
by  the Bremen  and  Brussels  European  Councils.

Section 2 — Opening the  system

The EMS is at present a closed system in which only the central

banks  of  certain  Member  States  participate,  whereas  the
Community  is  open  to  the  outside  world.4  If  the  EMS  were
opened up to the  central banks of  certain  third  countries, by
authorizing  them to  acquire and hold  ECU, the  Community
could strengthen  the  system  (by  extending  its geographical

4  See Annex C-2: The  external  role of the ECU.

49

 At present, a central bank's use of a

First, organization of the use of Community currencies in intra-
marginal  interventions.
Community  currency  for  intervention  inside  the  margins  is
subject  to  the goodwill  of  the  central bank  whose  currency  is
requested. Although interventions of this kind might prevent a
currency's  movement  towards its  margin,  interventions are
instead  made  in  dollars  and  this  often  has  the  effect  of
undermining  the coherence of  the participating  central banks'
attitudes  towards  that  currency. Alternatively,  if  no interven-
tion is made inside the margins, the currency under threat slides
until  it  reaches  its  bilateral  margin,  at  which  point  the
intervention amounts may be far  greater than those that would
have been necessary to reverse the trend earlier. Both so as to
prevent the  latter  situation  from  occurring—in  order to
economize as much as possible on intervention funds—and  to
reduce the predominance of dollar interventions, which tends to
place  thai  currency at the  centre of the  system,  the use of
Community  currencies in intra-marginal interventions must be
organized by defining  guidelines within the spirit  and the letter

of the system. One possibility  would be to authorize the central

bank  whose currency  had crossed  the divergence  threshold or
had  gone  beyond a  given  bilateral  limit to  intervene, at its
discretion, in  Community  currencies.^  These  interventions,
which could benefit from the very short-term financing facility,
would nevertheless be subject  to  a  ceiling.

the  purpose of.  intra-marginal

Another possibility  would be to limit solely  the availability  of
Community  currencies for 
intervention, without making provisions as above, for  specific
cases where they would be allowed. In this case, provision could
be made for the central bank, whose currency is used, to have
the right to request suspension  of interventions in its currency.

Second,  relations  with  the  dollar.  The  organization  of  intra-
marginal intervention in Community  currencies will reduce the

See  Annex C-3: Mobilization  of  net  ECU creditor  positions.
See  Annex  C-2: Intra-marginal  interventions - eligibility for the  VSTF
facility.

The choice of intervention currencies would then  relate to the currencies
whose premium or discount over the divergent currency was the greater.

2
The  development of the  European  Monetary  System in its present  institutional  framework

area and increasing the possibilities for  mobilizing the ECU),
and  could protect  it from  international  monetary  instability
(by  channelling  at  least  part  of  the  tendencies  of  reserve
diversification  towards  the ECU):  at  the same  time  it  could
help  with the financing  of an overall external payments deficit.
Hence  the importance  of planning  and organizing  this kind of
internationalization  of  the ECU.

A general principle  should govern  the opening  of  the system:
third holders should be subject to substantially the same rights
and obligations concerning use of and remuneration  in ECU  as
the  participants.  Extending  its  role  beyond  the  Community
shouldnot destroy the single nature of the ECU. The conditions

for  acquiring ECU  will  accordingly  have to  reflect 
its
precarious  existence, so long as the swap system is used for its
creation.

2.1. A  first  possibility  would be to  extend the  ECU's
negotiability  by permitting designated  third holders to acquire
existing ECU assets from participating  central banks. A  third
holder  arrangement  setting out in  detail 
conditions for  acquiring, mobilizing and restituting  ECU would
be necessary.  Participating  central banks  could  thus mobilize
their ECU  against dollars, offer ECU as a settlement of a debt
or  satisfy a  demand for 
without  affecting 

the  total  volume  of  ECU  in circulation.

temporary  reserve  diversification,

the  terms and

control the use of the ECU on the markets.

Community  loans mechanism  could thus be handed over to the
EMCF.

the  Community  would  have an  interest in

Since the EMCF has little  room for  manoeuvre in the field of
diversification, 
promoting the  private  market of the  ECU, thus  making
available  to  third  country  monetary  authorities,  wishing  to
their  reserves,  a wide  range of  instruments  in ECU.
diversify 

Section 3 — Encouraging the private use of the

ECU

Alongside the official ECU  circuit and unconnected  with it, a
genuine private ECU circuit is now developing. It is natural for
operators  and  markets  to  be  interested  in  the  monetary
expression  of  a  vast  economic  area  in  the  process  of
integration.  The  Community  can  nevertheless-  not  be  in-
different 
only promote, but also monitor, and even guide this expanding
private  use  of  the  ECU  so  as  to  turn  it  to  the  greatest
advantage.  Whence the  importance  of  proposals  designed to
supplement 

to this use of its monetary  'image', and it should not

the  existing  provisions and to  encourage and

to  existing  participants,  i.e.  against  a  swap  of

2.2. A  second possibility  would be to permit the  EMCF to
issue ECU to third countries under the same conditions as those
applying 
reserves.  This formula,  which  would  imply the  creation of
additional ECU, would seem most suitable for  those European
countries  'with particularly  close economic and financial  ties
with the Community'  wishing to be associated in the exchange
rate mechanism.  The association  agreement  would have to set
out  the  conditions for  acquiring  and  using  ECU  on  terms
analogous to  those  applied to member  central  banks.

2.3.  In a broader perspective  another possibility  would be for
the  EMCF to  issue ECU for  reserve  diversification by  non-
Community  institutions. The purpose of this kind of suggestion
is as a contribution  to shelter  the EMS from  strains possible as

a result of the  (rend  towards diversification  when it is directed

overwhelmingly  towards one or other Community  currency. In
view of  both  the problems which would be posed  if  the EMCF
were to  shoulder an  exchange  risk and of the  ECU's
characteristics,  notably  the  absence  of  institutional  convert-
ibility,  it would seem  that  the possibilities, in the present  state
of  affairs, are limited. However,  certain  'substitution account'
formulae  might  be  envisaged,  based  either  on  increasing  the
ECU's negotiability  (e.g. by designation formulae),  or on the
EMS  members  directly  shouldering the  exchange  risk.  This
would be the  case if the  EMCF,  having  issued ECU  against

reserve assets, re-lent  the latter  to  those of  its members  which
had  an external  deficit  to finance.  Seen from  this  angle,  the

50

3.1.  It is important  to define  a sort of ECU  'trademark' so that
the  term  and  the  instrument  'ECU'  is  used  correctly  by  the
markets. For example, contracts referring  to an 'ECU' defined

as a closed  basket  should be avoided  because the ECU is by

construction  open  to  the  currencies  of  future  Community
members. The  necessary  Community 
adopted  to  ensure  that  the  ECU  is not  deflected.  Thus, for
example, prohibiting the insertion of an indexation  clause in an
ECU  contract  would ensure  that  it  remains  an  instrument  of
stability  which is its purpose. The overall purpose  would be that
the  wider private  use  of  the ECU  would  be solidly  based.

legislation  should be

3.2. The EIB and the other Community  institutions, which use

the capital markets for  raising funds,  should set an example  by
launching ECU  issues and  systematically  expanding 
ECU  borrowings.  Greater  use  of  the  ECU  by  various
Community  institutions  would  strengthen  the ECU's  role  on

their

the  markets and at the  same  time  reaffirm 

its  role as the

Community  monetary  identity.

3.3.  Other  steps  should be taken to promote the wider use of
the  ECU  by  the financial  markets.  First  the discriminations
currently  applying  to  the ECU  in national  regulations  should
be removed  (being neither a national nor a foreign  currency, it
is  subject  to  any  regulation  applying  to  either).  The  ECU
should be given  the status of  a foreign  currency—a privileged
one—as it is an infant  future  common currency.  The principle
of free  movement  within the Community  of ECU-denominated
capital  should  also  be  established,  and finally 

the  EMCF

Analysis of the possible areas in which the EMS can be developed

addressed  primarily at the  technical and policy  management

should  be empowered  to monitor  ECU  operations  and  issues
(calendar,  endorsement  or joint authorization  by  the EMCF
and  the national authorities, etc.).

The  adoption of a regulation  containing the  above proposals

would provide a  stable foundation for the  expansion of the
private  use  of  the  ECU, and  would  make  it  an  instrument
capable  of  developing  the  Community's  ultimate  objectives.

Section 4 — Strengthening policy convergence

The development  of the EMS  will not be a real success without
greater convergence of economic and monetary policies. Three
years'  experience  have  shown  that  monetary  policies  were
conducted  largely  on  the  basis  of  the system's  requirements,
which helped to make it a success, but that price and cost trends
continued  to  diverge.  The  persistence  of  these  divergences
imperils  the  very  nature  of  the  EMS, which  is  in  danger  of
gradually  being  transformed  into a crawling peg system. Even
the measures to strengthen  the system  discussed  above  could
prove  useless  or  ineffective 
if  not  backed  by  real  progress
towards  convergence. New  efforts 
nation and  convergence  must  therefore be made.

to  improve  policy  coordi-

All dimensions  of  economic policy  should be  considered, and
approached  anew from a  single  view-point,  that of  their
contribution to  convergence  towards  stability. It is clearly a
long  and  difficult  exercise.  This  problem  should  always  be
borne in mind  when  economic policies are formulated.  Some
concrete decisions should be taken at the Community  level and
be rapidly  implemented, indicating a unerring determination to
move  towards  convergence.  These  could be:

4.1.  phasing-out  or  modifying  restrictions  on  capital  move-
ments at present authorized  under  safeguard  clauses;

4.2.  discussion, guided  by  the  operating  requirements  of  the
EMS,  of the intermediate objectives  of national monetary and
interest  rate policy;

4.3.  regular  examination of the  instruments of  national
monetary policy and their use, and laying down a list of internal
and external monetary policy measures and instruments which
are  incompatible  with  participation  in  the  EMS  and  the
customs union;

4.4.  establishing a  system of  mutual  information and a
monitoring procedure
indebtedness  (with a  view to  encouraging  early  recourse to
conditional  Community financing).

  on balances of payments and external

As  agreed by the  Monetary  Committee in its  October  1980 report on

recycling (§ 3.4).

Most of the  necessary  decisions  relate to a  more  active
concertation of monetary policies. It cannot be claimed that by
themselves  they  could  remedy 
the  inadequate  degree of
convergence, but  only  that  they  could  help to do  so:  they
therefore  only  represent a number of  small steps forward.

Section 5 — Conclusions

The possibilities for  developing, strengthening and consolidat-
ing  the EMS, presented above, form  a balanced  whole.  They
maintain  the  system's  existing  degree  of  solidarity  and
strictness while extending  its scope; and, as has been shown in

the  report of the Alternates of the Monetary  Committee of 3

February  1982, putting  them into  effect  would not  generally
give rise to any  insurmountable technical problems.  They are

domains; and are within the limits of the existing institutional
framework.  They  represent  a  necessary  step  forward.  The
analysis  of nearly  three years of  operation has shown that  the
successes are fragile.  The system  must  be strengthened from
within and its ability  to resist outside shocks must be increased.
In summary  the possibilities for  development  discussed  above
amount  to:

(1) Making the system  more coherent:

-  by reinforcing  the ECU role as the centre of the system
through  establishing some  degree  of  control over  the
process of creating ECU  which, together with removing
its acceptance limit modifying the interest rate formula

and  increasing its  negotiability,  will  encourage an
increased  use within  the system;

-  by removing certain imperfections  and filling some gaps

in  the system  mechanisms  through:

- organizing the use of Community currencies for  infra-

marginal interventions and extending the  very  short-
term financing to  these interventions;

-  coordinating relations vis-a-vis the dollar by defining
a  common attitude,  with a quantitatively  expressed
'zone of probability', and by cooperating over interest
rates;

-  taking  a  step 

towards  consolidating  the  credit

mechanisms by making the EMCF responsible for the
short-term monetary  support.

(2)  Opening the system towards the outside by permitting third
country  monetary  authorities to hold  and use  the ECU.

(3)  Encouraging the use of the ECU on the financial  markets

by protecting its image of stability, by increasing the ECU

borrowing and lending activity  of Community  institutions,
by  minimizing  restrictions  on  the  use  of  the  ECU  by

51

 
l
The  development  ofthe  European  Monetary  System in its present  institutional  framework

progressively 
nominated capital.

liberalizing the  movement of ECU de-

(4)  Reinforcing  policy  convergence  by  fully  utilizing  the

existing framework and by  improving the follow-up to
measures taken.

the narrowing to 2,25% of  the Italian  lira's present margins)

would bring the system to full fruition  and would act as a signal
to  the markets  and to public opinion  of  the determination  to
pursue  in common  the attempt—accepted  and  recognized  by
all—to establish a zone of  monetary  stability in Europe.

As well as these technical improvements, there are others, with
more  political  content.  These  are,  in  particular,  the  full
participation  of sterling and  the lira, and the issue of  an ECU
coin which would circulate freely  throughout  the Community.

The  European  Monetary  System  will not  assume its  full
significance and  will not  achieve its full  potential  until it
organizes, on an equal footing,  the exchange rate relationships
of  all  the  Community  currencies:  sterling's,  and  later  the
drachma's, participation in the exchange  rate mechanism (and

From another point of  view, the issue of an ECU coin ' would
strike public opinion just as hard, though in a different  way: by
bringing the ECU  out ofthe  specialists'  circle (central banks,
exchange dealers, capital market operators)  to which it is now
confined,  and putting  it in the pocket  ofthe  man  in the street,
the ECU's destiny  as the monetary symbol ofthe  Community
would  be fully  affirmed.

See Annex C-2: Minting an  ECU coin.

52

Commission proposals for a non-institutional development of the EMS

CHAPTER VI

2. The ECU

Commission proposals for a non-institutional
development of the EMS

In the spring of 1982, as a result of the postponement of the
institutional  phase and the  Council's  manifest  intention
nevertheless  to  develop  the  EMS  to  some  extent,  the
Commission presented the Council (Economic and Financial
Affairs)  of  15 March  1982  with  proposals  for  action  that
could be implemented without it  being necessary to  amend
the Treaties.

Section I below reproduces the text of the Draft  Resolution
submitted  to  the  Council'  by  the  Commission,  while
Section II reviews the principal arguments put forward when

the text was examined by the Community bodies concerned.

It will be remembered that the Council, meeting in informal
session on 15 May  1982, was unable to agree on the draft, but
that  it  instructed  the  Monetary  Committee  and  the
Committee of  Governors to  keep  these  questions  under
review.

2.1.1.  At the next quarterly swap, the base volume of ECU  will

be set at 40 000 million 2.  This  base  volume  will  remain until
the  end  of  the present period of  swaps.

During  this period,  quarterly  value  adjustments  will  relate to
the quantities of gold and dollars  transferred  to the EMCFby

the  central  banks.  Volume  adjustments  will  continue to be

made  according  to  the existing  system.

A new base volume will be fixed  when the decision is to be taken

on the  renewal of  (he  swap  system  (15 March  1983).

Alternatively, the reference period to be used for gold valuation
will  be extended  to  two years.

2.1.2.  The  acceptance  limit  on ECU  is raised  to  100%.

2.1.3. The  remuneration of ECU net  credit positions  will be
fixed by the  Central Bank  Governors on the basis of market
exchange  rates.

2.1.4. Any  participant  whose net  positive  position has
exceeded 5Q°/
these  ECU  against  dollars  for 
period of  swaps.  Mobilization  should not be done for the sole
purpose  of  changing  the  composition  of  reserves.

 of its ECU  allocation may, on demand, mobilize
•  duration  of  the  existing

t: 

Section 1 —  Draft  Resolution on the

development of the European
Monetary  System

1.  Introduction

1.1. At the Council meeting  of 15 March  1982, the Ministers

of  Economics and  Financial  Affairs of the  Member  States
examined  the Commission's  communication on strengthening
of the  European  Monetary  System and listened to reports on
this subject from  the chairmen of the Monetary  Committee and
Committee  of  Central Bank  Governors.

carry out  operations in ECU. ECU  bond  issues  will be the

its  determination to  continue

1.2. The  Council  confirms 
strengthening the system until its transition to the institutional
stage at  the  appropriate  time. It  agreed  to keep  under  review
the work  on the transition to the final  stage of  the system  and
the  creation  of  the  European  Monetary  Fund  already
undertaken by the Commission and the competent committees.

1.3. The  Council is  determined to  move forward 
establishing  the final  phase  of  the  system  by  adopting  the
following  provisions  and measures.

towards

The draft was preceded by a communication to the Council (see Annex D).

2.2.  Private use of the ECU

2.2.1. The ECU  will be the subject  of a basic Community  text

which will lay down its characteristics and the way in which it is
used.

2.2.2. The ECU  will have the status of a foreign  currency in all
Member  States. National monetary authorities will permit the
financial  institutions under  their control to open accounts and

subject  of  a  Community  mutual  information  procedure.

2.2.3.  Indexation  clauses will not be permitted to apply,  apart
from  by  exception,  to  claims,  values  or prices  expressed  in
ECU.

2.2.4.  The  various Community  institutions, and  the EIB  will
be invited to do the same, shall, with the active collaboration of
the Member  States, undertake  to promote the widest possible
use of  the ECU  in the areas for  which they are responsible;  in
particular:

- 

the  ECU  will  be progressively  used for  borrowing  and
lending  operations  as far  as  is  compatible  with  its  sound

This number  corresponds  approximately to the  amount of ECU  which
would be created if the existing rules were applied at the start of the next
swap  period  (April  1982).

53

0
The  development  of the  European Monetary  System in its present  institutional  framework

establishment on the financial  markets, the object in  view
being for it to  account for a  similar proportion of  such
operations  as do  those national currencies which are most
used;

-  Community  institutions'  accounts in national  currencies
will,  in principle,  be  replaced  by  accounts  in ECU;

- 

the financial  rights and obligations of these institutions will,
as far  as possible, be denominated  and settled  in ECU.

3.  Measures to develop convergence

3.1.  The  actual  conduct  of  the economic policies of  Member
States must be assessed, as regards its results and its methods,
by reference to the objectives laid down by common agreement.
The  Commission is invited, in this context, to make full  use of
the existing  consultation and recommendation procedure.

3.2.  The  Council  of  Ministers  ECO/FIN  will  regularly
discuss, on  the basis of  a report  by  the Monetary  Committee

and the  Committee of  Governors, the  intermediate monetary

targets  and  the  level  of  interest  rates  in  the  Community
countries in the  light  of  their compatibility  with the objectives
of economic policies. Where the intermediate monetary  targets
are  concerned, the  discussion  will  take place at  least  once a
year  during the fourth  quarter.

3.3.  Measures  which  are  incompatible  with  the  proper
functioning  of the EMS  must be avoided. The Council will, on a
proposal  of  the Commission, draw  up a list of  measures which
impede current transactions; implementation of such measures
will  be prohibited,  in  the  absence  of  a  decision  made  at  the
Community  level and for  a limited period.

relation to the EMS can be acted  upon.

3.4.  Except for  derogations granted  under  the  Treaty,  there
will be free  movement of ECU-denominated capital. Liberaliz-
ation of  other  capital  movements  currently  subject 
restrictions  will be  sought  through an  examination of the
restrictions  in force.

to

3.5. A  mutual  information and monitoring procedure  will be
established  on  the  balance  of  payments  situation  and  the
external indebtedness of the Member  States, in line  with the
suggestions of the  Monetary  Committee of  October  1980.
Early  use  of  Community  credit  will be  encouraged  when  it  is
complementary to a policy  aimed at  external  balance.

4.  Organization of the exterior aspects of  the system

4.1. The competent Community institutions will propose to the

US  and Japanese  authorities that  their regular discussions on
monetary problems of  common  interest  should be  reinforced.
These  consultations should  also  take place  when the foreign
exchange  market  appears  to  be  unrelated  to  the  underlying
economic  data—i.e.  where  rates are  obviously  outside the

54

limits  that  economic  likelihood  would  suggest—or  when
interest  rate  differentials 
cause  excessive  and  undesirable
strains on the  Community's  money  and financial  markets.

4.2. The  European  authorities  will  continue to  request the
United States to abandon the principle of not intervening on the
foreign  exchange  markets.  Cooperation  with  Community
central banks will be facilitated  by the establishment of a single

credit  line  between the FED and the EMCF.

4.3.  Coordination of  Community  central banks'  interventions
in third currencies will be increased. Interventions wilt be based
on a common assessment of the ECU's exchange relationships

and bearing in mind the average level of interest rates desirable

in  the  Community.

of its  bilateral  rate is  more  than 85% of the

4.4.  When a  currency  crosses its  divergence  threshold
(lowered to 50% for  wider  band  currencies) or  when the
difference 
maximum  permitted  fluctuation  margin  against  another
participating  currency,  the  central  bank  of  the  currency  in
question  is presumed  to  be  able  to  intervene  in  Community
currency and to have access to the  very  short-term financing.
The  issuing  central banks  of  currencies used for  interventions
have  the  possibility  of  refusing 
the  continued  use  of  their
currency  if  this  causes problems for  their  internal  monetary
policy.  Nevertheless, the  dollar  will  continue to be  used for
intra-marginal  interventions  in  cases  where,  by  use  of  this
currency,  the cohesion of  the EMS  can be maintained and,  at

the  same  time, an  undesirable  movement of the  dollar in

4.5.  The central banks of countries which seek  to have special
economic  and financial  ties  with  the  European  Communities
will be able to obtain ECU,  either by acquiring them from the
participating  central banks, or against  transfers  of reserves, in
the form  of  swaps, from  the EMCF.

5.  Further  procedure

5.1.  So as to implement  the provisions of point 2.2. above, the
Council  notes the  Commission's  intention to  submit, to the
extent  this is  necessary, the  appropriate  modifications 
Regulation  (EEC) No 3180/78.

to

5.2.  The  Council  invites  the  central  banks  to  modify 
their
agreement  of  13 March  1979  laying  down  the  operating
procedures for the European Monetary  System to take account
of points 2.1.1., 4.4.  and 4.5.  above.

5.3.  The Council invites the Commission, in close cooperation
with  the  Monetary  Committee  and  the  Committee  of
Governors, to  report in  time for 
its  July  meeting on the
implementation  of  the  measures  and  procedures  set  out  in
paragraphs 3 and 4 above.

Commission proposals for a non-institutional development of the  EMS

Section 2 —  Discussion of  some of the

proposals

into  consideration in the  present  transitional  stage,  where

ECU are  created  precariously  through a  system of  swaps

under which the EMCF does not have unrestricted freedom

The  Commission's  suggestions  formally  presented  in  the
above draft  Resolution were discussed in detail, first  by the
specialist  committees  (the Monetary  Committee  and  the
Committee of Governors: see Annex E and  Annex F),  and
then by the  Council  (Economic and  Financial  Affairs)
meeting in February and  April  1982.

to use the  reserves  against  which the ECU are  created. In

these  circumstances, it is  both  legally and  technically
impossible for the EMCF to guarantee the convertibility of
the ECU.

This section summarizes the discussions and deals with the
main  objections to the Commission's proposals.

in ECU at the settlement date for drawings on the very short-

1.  Must greater convergence precede any development of the

system ?

Some  governments  believe  that  the  lack  of  convergence
between the Community economies poses the main threat to
the  EMS. The  most  pressing  requirement is  therefore for
policies  that  will  increase  convergence  rather  than for
technical  improvements  that  would—however  desirable in
themselves—distract attention  from  the  real  problem.

The  Commission,  too, thinks  that the  achievement of a
satisfactory degree of convergence is essential to prevent an
undesirable change in the character of the EMS. Indeed, its
proposals  are  largely  concerned  with  this  matter.  But  the
Commission feels that convergence and the development of
the  system  must  be  pursued  simultaneously  because  each
reinforces the  other. The EMS has  undeniably  helped to
stabilize  exchange  rates and has  supported the  anti-
inflationary policies implemented in several countries. There
is little doubt that, without the EMS, divergence would have
been even greater. Consequently, it is desirable to strengthen
all aspects of the EMS; this would provide the markets with
tangible proof of the monetary authorities' commitment  to
the  system, and by  this  very  fact  would exert a  stabilizing
influence.

2.  Link  between  the  acceptability  and  convertibility  of  the

ECU

Secondly,  there  is  little  evidence  from  past  experience  to
support the fear of an excessive accumulation of ECU. Such
accumulation could  only derive from  settlement operations

term financing  facility,  as this is the only  instance in which
central banks are entitled to use ECU (up to a limit of 50%) to
discharge  their  debt.  All  other  transfers  of  ECU  must  be
made by mutual agreement. In the three years of existence of

the  EMS, total  repayments of  very  short-term  financing
amounted to the equivalent of 7 300 million ECU, only 9% of
which (660 million ECU) was actually settled in ECU. This
was because debtors preferred, and still prefer, to discharge
as much as possible of their debt by purchasing the creditor's
currency (80 % in this instance) on the market, rather than to
lose reserves, whether ECU  or  dollars.

Nevertheless, the Commission is aware that future develop-
ments are not necessarily a continuation of past experience,
and it has attached several other suggestions to its proposal
that  the  ECU  be  made  fully  acceptable:  control  of  ECU
creation so as to reduce the risk of an inflationary expansion

of the volume; increase in the remuneration on the ECU in

order to enhance its attractiveness to creditors; and the right
to mobilize ECU when the outstanding amount of ECU held
by a participant exceeds a certain ceiling (exercise of this right
being perhaps  subject  to  some  monitoring  of  the need  for
convertible reserves).

All in all, the proposed  system seems all the more balanced
since in the present system the 50% acceptance limit applies
to each claim and not to  the total amount  of ECU held by
each  participant.  Assuming  that, in  order to  defend  their
currencies, several Community countries became debtors of

the same Community central bank under the very short-term

Some  Member  States  link  unlimited  acceptability  with
institutional convertibility of the ECU. Their main argument
is that the ECU  is only a regional instrument of settlement,
while the international role of certain Community currencies
means  that  the authorities issuing these currencies  need  to
have a  stock of  reserve assets  that  will be  accepted by all
countries. If acceptability is increased, there is a greater risk
that quantities of ECU will be accumulated. These Member
States  do  not  therefore  think  that  any  increase  in  accept-
ability can be considered unless the ECU  is fully convertible
into  other assets.

This argument  calls for two remarks:

First, the requirement for a convertible ECU cannot be taken

financing  facility,  that  bank  would,  according  to  present
rules, have to accept settlement in ECU for 50% of each of its
claims.  Contrary  to  what  one might  think,  the acceptance
limit therefore  offers  no real guarantee against the accumu-
lation by a central bank of a relatively large amount of ECU
relative to the  initial  stock of ECU  acquired  against the
transfer  of reserves.

The  Commission's  proposal  would  change the  present
situation  by  offering  potential  creditor  countries  an
assurance that the net ECU credit positions which they might
build up could be mobilized  beyond a certain threshold; at
present,  the system's creditors can  trade  in their  ECU  for
other  exchange  assets  only  through  mutually  agreed
transactions.

55

The  development of the  European  Monetary  System in its present  institutional  framework

In the  debate,  some  countries  moreover  considered the

amendment proposed by the Commission too favourable to
the  system's potential creditors.

3.  Reservations about  extending the  private use of  the  ECU

In  principle,  the  Member  States are  in favour  of  extending
the private use of the ECU, but not all are prepared to follow
the  Commission's  proposals:  these  aim  at  promoting  and
giving a framework to such use by the means of a single basic
text giving an official basis to the private use and prescribing
methods  of use.

The basic text would stipulate, among other things, that the
ECU should have the status of a foreign currency. This status
is  in  fact  already  largely  granted  to  it  by  the  monetary
authorities in most of the Member States which, dejure or de
facto,  treat  transactions in ECU as  foreign  currency
transactions for the purposes of their exchange regulations.
These regulations authorize resident banks to use ECU for a
wide  range  of  transactions,  comparable  with those  usually
carried  out  in foreign  currency.

The absence of a genuine European  capital market (one of
the  objectives of economic and  monetary  union), has been
partly compensated by the development of the Euromarket.
However,  this  is  not  enough.  So,  in  order  to  facilitate  the
emergence  of  a  European  capital  market,  the  Commission
has proposed establishing the principle of the free movement,
within the  Community, of  ECU-denominated  capital.

The Member States with exchange controls find it difficult to
accept  this  principle,  which  could  breach  their  systems of
protection; for it  would be  easy to get  round the  rules
forbidding  certain  exports of  capital by  denominating
transactions  in  ECU. However,  it  seems  that  agreement
might be possible on progressive liberalization, starting with
the  financial  operations  of  the  Community  institutions,
which are already exempt from  exchange controls in most of

the Member States. It would also be conceivable to free ECU

issues for Community residents within an annual ceiling that
could  be  raised  periodically.

The  Commission's proposals on  developing the use of the
ECU  for  the  Community  institutions'  borrowing  and
lending  activities  have  been  well  received.  However, its

suggestions for the ECU to be  used,  first for  keeping the

Commission's accounts with the financial institutions of the
Member States and  second for denominating the rights and
obligations which the Commission contracts met with some
misgiving.

Modelling itself  on the rules in force in some countries (e.g.
Germany)  for  claims  and  prices  expressed  in  national
currencies, the Commission has proposed that claims, values
and  prices  expressed in ECU may not,  except by way of
derogation,  carry  indexation  clauses; it  feels  that  such

56

clauses could damage the good reputation of the ECU, which
is  intended  to  be  an  instrument  of  stability  and  should
therefore  be  based  on  solid  foundations.  Discussion  has
shown  that  formulation  of  such  a  principle  applying
specifically to the ECU did not seem essential to a number of
Member States which felt  that the treatment of the  ECU  in
this respect should conform to the general rules applicable in
those countries.
4.  Objections to the organization of intra-marginal interven-

tions

In  the  present  system,  intra-marginal  interventions  in  an

EMS  currency,  like the  acquisition of an EMS  currency

through  the  very short-term  financing  facility,  requires  the
prior agreement of the issuing bank. For  some of the central
banks,  the  Commission's  proposals  for  improving  the
organization of these transactions are unacceptable, as they
could interfere with national autonomy as regards monetary
policy. The strong-currency countries, i.e. those likely to be
supplying the intervention currencies, point out- that the use
of  the VSTF facility  for intra-marginal interventions would
be inflationary in that it would increase the volume of money
supply  during the  facility's  period of  activation.

The same central banks also feel it undesirable to embark on

the de facto  reduction of the 2,25% fluctuation margins since
this  would  mean  a  systemization  of  procedures  relating  to
intra-marginal interventions.

The  Commission  supports  its  position  by  pointing  to  two
facts.  First,  since the EMS was  introduced  central  banks
have intervened within margins, mainly in order to keep the
overall cost of intervention down; second, the present prior
agreement procedure has frequently turned out in practice to
be  too  lengthy  in  view  of  the  requirements  of  rapidly
changing markets, so that monetary authorities have tended
to  save  time  by  intervening  in  dollars  rather  than  in  the
Community  currencies.
Consequently, the  Commission  thinks the  intervention
procedure should be improved by giving the central banks a
limited  power of  initiative,  while  ensuring  that  there is no
adverse effect  on the conduct of internal monetary policy in
the country whose currency is used. The  implementation  of
the  Commission's  proposals  could  lead to  better  balance
between interventions  in Community  currencies and  inter-
ventions  in  dollars,  allowing  the  choice  to  depend  on  the
respective  movements  of  the  currencies  in  question.  This
would  prevent  dollar  interventions  being used to  maintain
the  cohesion of the  EMS, when  such  intervention  would
move the  dollar  in an  undesired  direction.  Conversely, the
dollar, and not Community currencies, would be used when
use of the dollar would help both  the cohesion of the EMS
and the stabilization of its exchange rate. In concrete terms,
this  would  mean  that  weakening  Community  currencies
would  be  supported  by  the  sale  of  other  Community
currencies rather than dollars when it was obvious that the
exchange  rate of the  dollar  ought not to  fall  further.

Commission proposals for a non-institutional development of  the EMS

However,  if  the  dollar  exchange  rate  was  too  high,  weak
Community  currencies  would  have to be  supported,
primarily by  sales of  dollars.  This  improvement in the
coordination of interventions as a whole would not interfere
with the requirements of national monetary policies since the
amounts of national currency automatically available would

be small, and since the central banks involved would be able
to  suspend  recourse to  their  currencies.

5.  External  aspects: acquisition of  ECU  by third  countries

Most  of  the  Community  countries  think  that,  in  the non-
institutional  stage,  the  use  of  the  ECU  can  be  extended
beyond the Community frontiers only with great caution. It
would be  advisable, in  particular, to  authorize  only the
transfer to  third  countries of  pre-existing ECU by the
Community  central  banks. For so  long as the  system for
creating the ECU makes it a precarious asset which cannot
be converted through the EMCF, any creation of new ECU
for  non-Community countries is out of the  question.

Although its own proposal goes further, the Commission is
prepared to accept this argument, which  would enable the
area of use of the ECU  to be extended and would therefore
constitute some progress.

6.  Legal problems raised by the non-institutional development

of the EMS

The  Commission  considers that  the changes to  the  present
system  could  be  made  on  the  basis  of  Article 235  of  the
Treaty  of  Rome,'  and  by  amending  the  Agreement  of
13 March  1979 between  the  central  banks:  numerous
Council  statements  have  clearly  established  that the
development  of  the  EMS  is  necessary  to  achieve  the
Community's  objectives of  promoting  continuous and
balanced  expansion, an  increase in  stability and  closer
relations  between  the  Member  States  (see Article 2  of  the
EEC Treaty). Furthermore the substance of the Commission
proposals is in keeping with the logic of  the Resolutions of
the  Bremen  and  Brussels  European  Councils  which  are
themselves the basis  of  the present  system.

Although  most of the  Community Member  States take the
same view  as  the  Commission, there is not  unanimity.

Article 235 of  the Treaty of  Rome:
'If  action by the  Community  should  prove  necessary to  attain, in the
course of the operation of the common market, one of the objectives of the
Community and this Treaty has not provided the necessary powers, the
Council shall,  acting  unanimously  on  a  proposal  from  the  Commission
and  after  consulting the Assembly, take the appropriate measures.'

The need to resort to Article 2362 (i.e. to amend the Treaty)
is upheld by the countries in which domestic monetary order
is  based on the  Constitution and the  central  bank's
independence from government. In these circumstances, and
given the  effects of the  Commission's  proposals on the
domestic monetary policies in Member States, they feel that
successive changes to the EMS based on Article 235 would
gradually  undermine the  sovereignty  Member  States  have
over monetary matters without  there having been a debate
beforehand in  national  parliaments.  Such a  debate—and
with it recourse to Article 236—is thought to be essential, as
is detailed consideration of the development of the  EMS by
the legislative  authorities  would  provide the  system  with a
clear  legal  basis  and  place  it  firmly  on  democratic  found-
ations.

Although aware of the validity of the arguments put forward
by the supporters of recourse to Article 236, the Commission
feels that a revision of the Treaty would not be essential for
the development of the EMS in the way in which'it proposes.
Recourse to Article 235, can,  at this stage of the discussion,
provide  an  adequate  legal  basis  for  making  technical
improvements to a  system  itself based on  that  Article.

Conclusion

After  a series of discussions during the  first  four  months of
1982, the Monetary Committee, which concentrated initially
on the  system's mechanisms, tried to  devise a compromise
which  might  be based  on  the  following  points:

(i)  raising  the  acceptance limit  of  the  ECU  from  50%  to

60%  or  70%  (instead  of  100%,  as  suggested  by  the
Commission);

(ii)  allowing the VSTF facility  to be used  to  finance  intra-
marginal  interventions,  while  maintaining,  under
certain  conditions, the  right of  veto of the  creditor
central bank; (the Commission had proposed automatic
access to  the VSTF facility  for intra-marginal interven-
tion,  unless  the  central  banks  issuing  the  intervention
currencies  proved  that the use of  their  currencies
impeded the conduct of domestic monetary policy);

Article 236 of  the Treaty  of  Rome:
"The government of any Member State or the Commission may submit to

the Council proposals for the amendment of  this Treaty.

If the Council, after consulting the Assembly and, where appropriate, the
Commission,  delivers  an  opinion  in  favour  of  calling  a  conference  of
representatives of the governments of the Member States, the conference
shall be  convened by the  President of the  Council for the  purpose of
determining by  common  accord the  amendments to be  made to  this
Treaty.
The  amendments  shall  enter  into  force  after  being  ratified  by  all  the
Member  States  in  accordance  with  their  respective  constitutional
requirements.'

57

The  development  of the European Monetary  System  in its present institutional framework

(iii)  lengthening  the  reference  period  to  be  used  for  the
valuation  of  gold  from  six  months  to  one  year;  (the
Commission had proposed an extension to two years);

However, a  consensus  could not be  reached on  these
proposals, chiefly because it was impossible to overcome the
objections to the proposals concerning the  acceptability of
the ECU and  intra-marginal interventions.

(iv)  opening  up  the  System  to  the  outside  world  by
authorizing  the  central  banks  of  European  countries
having particularly close links with the Community to
acquire ECU  from EEC  issuing  institutions;  (the
Commission  had  proposed  that  third  countries  would
also be able to acquire ECU against transfers of reserves
in  the form  of  swaps with  the  EMCF).

The  difficulties  in  reaching  a  technical  consensus  were
compounded  by the prevailing feeling, expressed in the oral
statements of the Chairmen of the Monetary Committee and
of the  Committee of  Governors on 17 May  1982  (see
Annexes E and  F),  that  given  the economic  and monetary
situation  in  the  Community,  absolute  priority  should  be
given  to  improving the  convergence of economic policies.

58

PART  THREE

Preliminary synthesis of ideas on the institutional stage of the European
Monetary  System

Transition to the final stage of the EMS,  which will be a decisive step in the progress towards
economic and monetary union in the Community, will be achieved only if sustained efforts

are made to promote economic convergence (cf.  Part One) and if a genuine political resolve

is forthcoming.  By definition,  final  consolidation of  the  EMS  means that  Member States
must relinquish at least some of their national policy-making powers and that there must be
an active search for common solutions to the main problems with which the Community is
generally  confronted.

Consequently, this European construction would have to have a tangible effect  at the day-
to-day  operational  level,  and  have to  make its  impact  felt  as  a  means  of creating at  the
Community  level broader and  more  effective  potential for action  than in each  individual
Member  State.  The  interdependence  of  Member  States,  which  is  already  a  fact  of  life,
should be positively exploited as a source of strength and so as to enable the Community to
become a  pole of monetary  attraction  in its own  right  in international  relations.

If  there  were  a  real  desire  to  make  headway,  the  legal  problems  would  not  be  an
insurmountable obstacle, and a start could be made in the process of monetary integration
involving the  transfer to the  Community of  prerogatives  hitherto  exercised by  each
individual country's monetary  authorities.

In  March  1980 the  Commission  sent to the  European  Council a  report  concerning the

European Monetary Fund.  l All the subsequent work up until now has been inspired by the
ideas in that document. During  1980 and  1981, the Commission prepared for the Monetary
Committee a number of working papers which examined direct transition from the initial
stage to the institutional stage of the EMS,  and did not envisage any intermediate stage for
developing the system (cf.  Part Two).  Although these papers no longer necessarily reflect, in
all their points, the arguments that could currently be developed,  nevertheless, it was  felt
useful to  attach  them as an  annex.

The  crucial  feature of the  institutional  phase is the  establishment of a  decision-making
body, the  European  Monetary  Fund,  which is entrusted and  empowered to  pursue the
objective of  creating a  stable  European  monetary  standard. As the way in  which  this
objective  is  achieved  will  depend  upon  the  Fund s  decisions  in  response  to  prevailing
conditions, it is neither necessary nor  possible to lay down in detail a specification  for the
institutional phase of the EMS. It is, however, necessary and possible to specify a number of
preconditions and likely features. This is done below through some brief considerations on:

(i) the  ECU;

(ii)  the Fund;
(iii) the  exterior  aspects of the  EMS;

(iv)  institutional  questions.

1 

See  Annex  H.

59

Preliminary  synthesis  of the ideas on  the institutional stage  of the European  Monetary  System

Section  1 —  The  ECU

The ECU  will be the sight liability of the Fund and as such

will be used by the participating central banks. It will also be

used  progressively  by  the  private  sector  to  denominate  the
whole  range  of  financial  transactions.  The  conditions

surrounding the use of the  Fund's sight  liability  within the

system is a matter between the participants; they may have
conventions, rules and ad hoc agreements as discussed below.

position of ECU  use will only gradually be achieved, but an
obvious first step is the removal of the 50% acceptance limit.

The purpose is to ensure that there is a demand for the asset

which  is  under  the  control  of  the  system  and  which  can
therefore exert a disciplinary effect.  The  more it is used, the
more  other  instruments  are  effectively  demonetized  within
the  system.  At  present  the  relatively  easy  availability  of
settlement  instruments,  especially the  dollar,  through the
international  markets  allow  countries to  delay  necessary
adjustments to  external  imbalances. In the  institutional

phase of the  EMS, the ECU  will play an  important  role in

transactions cannot be forced upon parties to contracts but it
can  be  permitted  and  encouraged  by  legislation  and  more
importantly by ensuring that the ECU is attractive. For  both
the official and the private roles, it is essential that the ECU's
fundamental  characteristics allow the Fund to  develop it in
such a way that it is associated  with  stability.

and in the  light of its use by the participants.

ensuring that timely adjustments are made. For  cases where
additional financing is needed the credit mechanisms will be
consolidated in the Fund. Decisions on credit will therefore
be made as a complement to the decisions on ECU creation

The use of the ECU to  denominate  private  financial

The present definition  of the ECU  as a  basket  ties it to the
national  currencies. It can be  neither  more nor  less  stable
than the best or worst of them. This is a prudent formula and
gives support  to the  ECU  in its formative  stage. It  uses the
joint  identity of the  component  currencies  while it is
acquiring its own. The purpose of the EMS is to ensure that
the component currencies are stable; and as it succeeds, the
ECU,  defined in terms of them, will also become more stable.
It  might  also  however be  desirable at  some  stage  that it is
more  stable  than  their  average,  in  which  case  the  existing
basket  definition  would  have to be  modified.  Eventually
when a  single  stable  monetary  standard is  achieved the
definition  becomes  irrelevant  as  there  will  then  be  no
fundamental  difference  between the  national  currencies or
between  them and the ECU.

Within the system the supply and demand conditions for the
ECU  should be developed in such a way as to be conducive to
stability. The  method chosen  for ECU  creation must reflect
the fact  that  any money  can  only  exert  a disciplinary effect
through  scarcity. The  present  method of ECU  creation
against a swap of gold and dollars suffers  from the overriding
disadvantage that the decision on the quantity of ECU in the
system  has  been  abandoned  to  a  formula  based  on  the
market price of two assets which are not in the control of the
participants. In the institutional phase, the Fund should have
the power to control the quantity of ECU and should do so in
the  interests  of  the  aims  of  the  system.  This  has  clear
implications  for  the  way  in  which  gold  and  dollars  are
transferred to the  system as  will be  discussed  below. The
transfers  must allow  the creation  of a  permanent  ECU  and
full  control  over  the  quantity.

As  well as  being the  system's  settlement  instrument, the
ECU's qualities as a reserve asset must be ensured. It must be
as attractive as other assets held  as reserves, i.e. as dollars,

gold, SDR  etc.  Given the very different  qualities of each of

these,  the  implications  for  the  ECU  are  not  immediately

clear, but it is true that special measures for the ECU may be

necessary because its use is confined  to a regional block. The
participants  will  continue  to  need  and  hold  other  reserve
assets and it is important to consider how one asset can be
transformed into another, and especially how dollars may be
acquired  with  ECU.  Two  complementary  procedures  are
necessary.  The  ECU  should  be  both  negotiable  and
convertible.

Negotiability is the  regulated  possibility to  exchange ECU
for  dollars  with  other  participants of the  system. The
possibility already exists in the present phase of the EMS and

has been used to a limited extent. Although the transactions

may  be  recorded  by  the  Fund  they  essentially  involve  a
voluntary  agreement  of two  central  banks. There is now  a
provision that such transactions shall not be done for the sole
purpose  of  reserve  diversification.  Potential  net  ECU
accumulators may  fear  that  even if  this  provision was
removed their access to dollars would be too limited given the
small  number  of  ECU  holders.  It  would  be  possible  to
supplement  the  voluntary  negotiability  with  a  designation
scheme.  This  would  involve  some  participants  being
designated  to supply dollars to another participant in given
circumstances  determined  by  the  Fund.  They  would  then
have to supply dollars either according to a pre-arranged key
or according to  their ability as judged by the Fund. Such a
scheme has  great  similarities with  the short-term  monetary
support  and  is a  form  of  credit  arrangement.

All  settlements  between  participating central  banks  would
normally be made fully and  exclusively in ECU. Changes in
the amount of other  reserve assets held by the  participants
and  the  Fund  would  occur  only  in  relation  to  exterior
imbalances  which  will  be  discussed  below.  Moving  to  this

Convertibility is  also  necessary.  Institutional  convertibility
means that under certain circumstances the Fund would be
obliged to  provide  dollars to  members in return for ECU
which  should  thus be destroyed. The  main questions posed
by  convertibility are  associated  with the  circumstances in

60

Preliminary  synthesis of the ideas on the  institutional stage of the European  Monetary  System

which, and the price at which these operations would be done
and the possible effect  on the Fund's liquidity. The degree to
which institutional convertibility is necessary depends upon
the size of the potential imbalances within the system and the
resultant net ECU positions as well as on the extent to which
participants  need  other  reserve  assets. The  Fund  must be
given powers to  influence  these factors  as well as being in a
position  to  use  the dollars  that  have  been  transferred,  or
other  assets, to  acquire  dollars, to the extent  necessary to
ensure  the required  degree of  institutional  convertibility.

The  major  difference  between  convertibility  and  negoti-
ability  is that  the  former  involves the  destruction  of  ECU
whereas the  latter  only  involves a  redistribution  between
participants.  It  is therefore  natural  that  whereas  the  Fund
must  be  directly  involved  in  convertibility  it  need  not
necessarily be  involved in  negotiability,  although  there
would be  cases in  which it was  desirable  that it  should be
because  the  distribution  of  ECU  could  be  an  important
element in overall  control.

When reserve assets are being held in considerable amounts

and for long periods of time, a supplementary factor to their

characteristics as a  store of value is any  income that can be
earned. The  growth of  dollar  holdings  during the  Bretton
Woods System was certainly associated with the fact  that it
was better than gold in that it could be converted  into gold
and held in a form which carried an interest payment. Given
the very different proportions in which its central banks hold
gold  and  dollars  it  is  clear  either  that  they  do  not  decide
reserve composition using portfolio optimizing techniques or
that  they  have  very  different  views  about  the  future.
Considering  this  and  the  fact  that  interest  payments  have
often  been swamped by capital movements, the importance
of  interest-type  payments on ECU  should not be  exag-
gerated. A  return is  available on  dollars  because  central
banks hold their dollars in the form of bonds and obligations
mainly  of  the US  Government. The  same procedure is not
available  for  official  ECU  as  long  as  no  official  authority
issues ECU-denominated securities, but the  Fund  will have
some  income  from  its  assets  which  could  be  used  to
remunerate ECU. The  remuneration per ECU  will  depend
upon the quantity of ECU created on the income available to
the Fund. This latter is based on the actual income on dollars,
any  income available on  gold, and any income from  credit.

Section 2 — The  Fund

To  ensure  the  development  of  a  common  and  stable
monetary  standard for the  Community, the  Fund  will
eventually  have  to  make decisions over  the  whole range  of
monetary  policy  dimensions:  exchange  rates,  external
financing,  domestic  monetary  developments. The  instru-

ments  which it can use  will  depend  upon its  power to

influence the  monetary  policy in  Member  States.  Initially,
the Fund will concentrate on the exchange rate and financing
dimensions of  monetary  policy  while the  adjustment
dimensions  will  remain  primarily the  responsibility of
national  authorities.

Exchange rates

The  exchange  rate  mechanism  includes  both  day-to-day
interventions and  changes in  central  rates. The  exterior
aspects of  the system  are  examined below  and  so  here only
interventions in  Community  currencies are  considered.
Without  large  quantities  of  national  currencies  the  Fund
could  not  itself  undertake  interventions.  Member  central
banks have both the market size and the skills to be the active
operators in this area for their own currencies. There is no
need to change  this  situation in the institutional  phase.

The  very  short-term  financing  facility  has  proved  a  useful

addition to the  intervention  mechanisms, and the  Fund

would  continue to  play its  accounting  role for  these
operations. However,  the mechanisms would  also be made
less rigid by making: (i) the financing period variable below
a  maximum  rather  than  fixed;  (ii) the  interest  rate  set
discretionally,  and  (iii) credit  available  also  for  intra-
marginal interventions under circumstances and  conditions
to be determined. The  Fund would have to make decisions
on  these  questions  in  the  light  of  the  prevailing  circum-
stances.

Parity  changes are  already  decided by  mutual  agreement
through  a common procedure. In the institutional phase, it
would  be  natural  to  incorporate  realignments  into  the
Fund's  decision-making  structure.  No  rules  about  the
appropriate size or  time of  parity changes can  be prespeci-
fied, but  guidelines may  help  both  technical judgment and
policy  decisions. In  this sense, the divergence indicator can
continue to be used as a method of monitoring developments
on  the  exchange  markets,  but  other  monetary  markets
should also be followed, as well as the underlying economic
developments.  The  Fund  will  have  to  develop  extensive
technical  capacities  in these  fields  so  that  it  can  provide  a
major  input  into the  overall decision-making process.

Although  they are the necessary  final  point of a  process of
monetary  integration,  irreversibly  fixed  parities should  not
be rigidly planned in advance. As long as central rates are the
result of a  common  decision  through the  Fund  they could
continue  to  be  adjustable  after  the  establishment  of  the
institutional  phase  without  undermining the  objective of
stability.

The  Fund's balance  sheet

The  Fund's  decisions  will  be  reflected  in  its  balance  sheet,

and to a considerable extent its powers are determined by its

61

Preliminary  synthesis of the ideas on the  institutional stage of the  European Monetary  System

asset  transformation  ability  within  the  balance  sheet.  The
liability  side  of  the  ECU  was  discussed  above;  it  is  now
necessary to consider the asset  side.

(a)  Initial  transfer

The present swap system has various defects: the number of
ECU created is mechanically determined by the transfer; this
number is unstable, depending upon the price of gold and the
dollar exchange rate; and it is unrelated to the needs of either
the  system as a  whole or of  individual  participants.
Furthermore, as the participants have the right to the return
of exactly the gold and dollars which they transfer, the ECU
created  are  nothing more than  a transient denomination  of
the particular gold and dollars transferred by each individual
participant. The  transfer of assets in the institutional phase
should  avoid  these problems.

Along with delicate political questions, the definitive  transfer
of  reserves  poses  economic  problems  because  gold and
dollars  have  very  different  characteristics  and  a  highly
volatile price relationship,  which makes the decision on the
initial price or valuation method difficult. It would be wise to
separate the problem of transfer of assets as much as possible
from  that of the  initial  volume of ECU and its distribution
between  participants.  Through  their  transfer  of  gold  and
dollars, the members of the system  would participate in the
Fund.  As  a  separate  action  the  Fund  would  then  issue  an
initial quantity of ECU  without specifying an ECU  price for
the two  assets. The  total  amount of  gold and  dollars
transferred  would  then  take  into  account the  need for the

Fund to be a credible financial  institution and its potential

operational  role  inside  and  outside  the  system.  The  gold
proportion  of  this  total  amount  would  depend  upon  the
extent to  which it is thought  desirable to  mobilize gold.

(b)  Subsequent  operations

Once the Fund is established with an initial quantity of assets
and a set of decision-making procedures, its main task, apart

from  exchange  rate  policy,  will be to  control the  total
quantity of ECU  consistently with its policy objectives. It will
do  so  by exchanging assets against  ECU,  such  assets being
'external'  (gold  and  dollars)  or  'internal'  ones  (credit).

ECU  creation (or  destruction)  against  other  reserve  assets

will occur through  the obligation  of participants  to  hold  in

ECU not less than a given percentage of their reserves and/or

through  conversion  permitted  under  certain  circumstances.

For the latter  case possibilities  will depend not  only on the

extent of  institutional  convertibility as  discussed  above but
also  on  dispositions  enabling  members  to  obtain  ECU
against  dollars.

As to credit, the present mechanisms have been largely taken
over  from  pre-EMS  arrangements and do not  necessarily

62

and the  foreign  exchange needed for intervention  purposes

give rise to ECU creation or assets in ECU except in the case
of the  very  short-term  financing  facility.  Instead, ECU

(created from gold or dollars) are partly used for reimburse-
ment. At  present,  although the  short-term  mechanism is
meant to be a mechanism of  'first  resort' it has hardly  been
used, simply because access to international capital markets

has  been so  free. In the  next  stage,  private  access  would
remain unchanged but  official  access would be less as ECU
rather  than  dollars  would be  needed for  Community
settlements.  Credit  could  then  become a  significant  policy
instrument  in the hands  of the Fund.

The  establishment  of  the  institutional  stage  would  un-
doubtedly  imply  consolidation  within  the  EMS  of  the
existing Community credit mechanisms: the very short-term
financing, 
medium-term  financial  mechanism.

the  short-term  monetary  support and the

Consolidation  of  the  VSTF  facility  raises  two  issues:
provision of the currency  requested and the settlement and
financing procedures. As for the first point, there is room for
improvement  on  two  fronts:  intra-marginal  interventions
could,  if not  already eligible,  qualify  for  the  VSTF facility,

could be supplied by the European Monetary Fund and not,
as at present, on a bilateral basis by the banks participating in
the exchange-rate mechanism. An  innovation could  also be
introduced  in  the  settlement  procedures  under  the  VSTF
facility  whereby  the  creditor  central  bank  could  have  its
debts  settled  immediately in ECU  created by the Fund. In
return, the latter would acquire a claim, also in ECU,  on the
debtor bank. As concerns the consolidation of the STMS and
MTFA it would have to be accompanied by a revision of the
amount of credit available and  of the conditionality both in
the  light  of  the  Fund's  responsibilities  in  the  adjustment
process.

The credit instruments available in the Fund would probably

not be the same as those now in existence which are largely
automatic  and  which  are  separated  by  duration.  It  is
necessary to consider credit generally from a functional point
of  view and ask  what  overall  limitations on  amount and
duration are  necessary.  Within any  such  limits, the  Fund
should  make  discretionary  decisions  about  whether  credit
should be granted in a particular instance or not,  and if so on
what conditions as to duration, interest rate, etc.  A decision
to  grant  credit  would  thus  be parallel  to  one  on  exchange
rates. It would be natural in both cases that general policies
of the member countries are reviewed and recommendations
made.

Situations may arise when there are too many ECU,  with the
result that credit becomes an irrelevant policy instrument. In
these  circumstances,  the  Fund  would  be  incapable  of
pursuing its  objectives if it  could not  take  measures to
decrease the amount of liquid ECU.  This could be done by a

Preliminary synthesis  of the ideas on  the institutional  stage of the  European  Monetary  System

ratio type method which would require members (a member)
under certain circumstances to hold a given percentage of its
total  ECU  in  a  term  deposit  rather  than  as  sight  ECU.
Alternatively the Fund could vary the attractiveness of term
deposits  relative  to  sight  ECU  through  the  interest  rate.
Normally only a low interest rate at most would be payable
on sight ECU and participants could be encouraged to hold
less sight ECU and more term deposits through an increase in
the interest  rate on  the latter.

repartition of the  change in  reserves  among the  member
central  banks.  From an  operational  point of  view  there
would be no need for the Fund itself to undertake the task of
intervening on the exchange markets. This could continue to
be done by member central banks, once they act in execution
of  a  commonly  defined  policy  line.  Such  a  common  dollar
policy would be consistent with the idea outlined above that
settlements within  the system would  be made exclusively in
ECU,  and hence that  dollars would  have a purely  external
role.

Section 3 — Exterior  aspects of the EMS

In its institutional stage, the EMS will have to develop in a
way  consistent  with  the  main  features  of  the  post-Bretton
Woods  era. International  monetary  relationships  are  no
longer  organized by one  dominant  currency.  Various new
reserve centres have emerged. Managed floating has become
the  prevailing  exchange  rate  regime.  Private  financial
institutions have largely outgrown official  ones in the role of
creating  international  liquidity and of  intermediating
between  surplus  and  deficit  countries.  Domestic monetary
targets have to a large extent replaced gold as the anchor of
the money creation process.

The  institutional  phase  must  satisfy  three  requirements.
First, it must help the effective conduct of external monetary
policy  by  the  Community.  Second,  it  must  promote
cooperation  with  outside  monetary  authorities.  Third, it
must  contribute  to  the  evolution  towards  a  new  world
monetary  order.

Regardless of the attitude of the American authorities vis-a-
vis their exchange rates and  intervention, member countries
of  the  Community  have  since  1971 always  individually
followed a policy of managed floating  vis-d-vis the dollar but
have  never  accepted  common  management.  This  is  inef-
ficient  because  it  allows  internal  policy  differences  to  be
concealed; it  lets the  dollar/German  mark  relationship
magnify  the  EMS/dollar  relationship,  with  the  result  of
sometimes  reducing  and  sometimes  amplifying  the  intra-
EMS tensions generated by internal factors; and it may lead
to  contradictory  actions on the  exchanges  such as  simul-
taneous  buying and  selling of  dollars by  different  particip-

ants. For the  institutional  phase, a  truly  'common  dollar

policy'  should  consist  in  handling  dollar  interventions  by
common decision through the Fund. Collective decisions on

the necessary amount of intervention would, like individual
decisions  taken  today, be  based on a judgment  about the
desirable combination of exchange rate and  reserve object-
ives. There is no technical difficulty  in stating such objectives
in terms of an ECU/dollar exchange rate and of the desirable
change of dollar  reserves for the system as a whole.

In  contrast  to  intervention  policy,  monetary  cooperation
with  other authorities  outside the  EMS  requires agreement
and participation by other parties. Such parties are not only
the  US  authorities,  but  also  the  authorities  of  other
important  monetary  centres,  such as  Japan and the  oil-
producing  countries.  Monetary  cooperation may  take
several forms in the areas of exchange rate management and
of financing  payments imbalances. The  common definition
of  some  kind of  exchange  rate  target  among key  world

currencies  seems  unlikely  today, but  could be  considered
again in the  future.  Actions are  possible in the  field of
financing, such as activation of swap lines between monetary
authorities or  official  borrowing or  lending like the 'Carter
Bonds'  as  in  1978.  A  well  developed  EMS  could  have
considered an equivalent action in 1981, when exchange rates
clearly moved out of line but when market pressures were too
strong for interventions alone to be effective.  Similarly, the
Community could finance protracted oil deficits with its own
liability, thus also meeting the desire of OPEC countries to
hold non-dollar denominated assets. A  full  development of
both common intervention policy and of a common policy of
financing  payments imbalances by  the EMS  would  require
that  ECU-denominated  assets of  different  maturities be
issued to  non-members of the system.

Finally, the European Monetary  System  will have a role in
promoting the  evolution of the  international  monetary
system. If the ECU and the EMS  were fully  developed, the
natural  consequence  would be for  them to  replace the
existing  currencies  and  their  authorities  in  international
monetary relationships. The ECU would have a larger role to
play than  the sum  of  national currencies would  have in its
absence. The ECU would thus be one of the few currencies of
which  the  multi-reserve  currency  system  was  composed.
Such a system would be simpler and less difficult  to manage
than one in which the European pole had  failed to give itself
the necessary  organization.

Section 4 — Institutional questions

The  difficulty is much more the political one of defining an

appropriate  decision-making  procedure  and  a  key  for  the

The problem of the institutional phase has three facets: the
functional,  the  institutional,  and  the  legal.  The  functional

63

Preliminary  synthesis  of the  ideas on  the institutional stage of  the  European Monetary System

facet, to  which  most of the above has  been  devoted, is the
basis  for  identifying  institutional  and  legal  arrangements.
The institutional aspect essentially consists of defining  the
appropriate  charter  of  the  Fund.  The  legal  aspect  is  the
problem of  approving the  charter by a  satisfactory  pro-
cedure. These three facets are  different but  related, and the
system  will  be able to  achieve its objectives  only if  efficient

and  mutually consistent solutions are  found for all of them.

from  majority  decisions  which are in  fact the  rule in all
multilateral monetary and  financial  institutions, whether at
world  or  at  Community level.  In  designing  the details of
voting procedures careful  consideration should be given  to
possible  formulae  such  as:  the  number  of board  members
determined by the importance of the country; voting powers
proportional  to  the capital-quota  position;  voting  powers
dependent to some extent on credit positions. Some of these
formulae are used in existing institutions e.g. EIB and IMF.

The heart of the institutional problem is giving the Fund the

instrument and organization that are necessary to assure that
it not  only can but  also  that it is  obliged to  pursue the
necessary policies to reach the objective of'creating a zone of
monetary stability in Europe1 in the sense of both prices and
exchange rates. In a world in which floating is managed and
conditions  are  continuously  and  unpredictably  changing,
this  requires the possibility to  take  decisions  that are  both
discretionary and rapid. In the monetary field there can be no
'stopping the clock' or  'delaying the campaign year'.

An  important  question  is the interdependence  between  the
Fund  and  other national and  Community  institutions. It  is
generally  agreed  that a  money-creating  institution  must
benefit from a certain degree of independence if it is to be able
to resist pressures for excessive liquidity creation that would
inevitably lead  to  inflation.  Independence  has  its basis  not
only on  legal provisions, but also  on prestige and  tradition.
In member countries institutional arrangements vary widely
from  great to very limited independence of the central bank,
although in no country is independence pushed to the point
of permitting the central bank to overtly oppose the general
policy  orientation  of  the  elected  government.  At  the
Community level it is of the greatest importance to properly
formulate  the terms  of the  problem.

the  general  objective of

Independence means that the power to create money should
be  sufficiently  separated  from the power to  spend so as to
ensure  that  decisions  satisfy 
monetary  stability  rather  than  the  particular  needs  of
individual  spenders.  In  today's  national  contexts,  this
essentially means the autonomy of the central bank from the
budgetary  authority,  which is at the  same  time the  largest
spender and the interpreter of popular will. In a Community
context,  the  budgetary  authority  (the Commission,  the
Council and  the European Parliament) is unlikely to be the
major source of inflationary pressures, as the budget is small

and  balanced by law.

The  'money spenders' are not only the budgetary  authority

but  also,  and  perhaps  more,  deficit  countries.  Seen  in  this
light,  the  issue  of  independence  is  not  so  much  one  of
determining  which  authorities  will sit in the  organs of the
Fund, as one of defining  the decision-making rules, such as
majority  rules, within such  organs. In an  institution like the
EMF,  which  will  have to  take decisions, and  often to  take
them  very  quickly, it is hard to  imagine  anything  different

64

A further category of problems concerns the structure of the
Fund.  Different  types of  institutions have been outlined in
the  studies  discussed  by  the  Alternates  of  the  Monetary
Committee:  an  accounting  type,  a  central  bank  type,  a
regional IMF type and a suigeneris institution. This typology
results from different hypotheses about the attribution to the
Fund of functions  that in the present  arrangements belong
alternatively to central banks, ministers, etc. This distinction
is useful but it should not be carried too far. It is clear from
the discussion of the functional  aspects that the Fund would
be  incapable of  pursuing its objectives  if its responsibilities
did  not  envelop  the  three  dimensions  of  monetary  policy:
exchange  rates,  financing  and  adjustment.  These  three
dimensions  are  part  of  a  whole  and  yet, in  the  existing
national  arrangements,  they  are  split  between  different
authorities  (central  banks,  treasury,  other  organs  and
agencies)  and  split  in  a  way  that  differs  from  country  to
country.

A  last  aspect of the  institutional  problem is  related to the
evolutionary character of the institutional phase. Although
the full potential of the EMS will be realized in a gradual way,
the  fundamental  characteristics  of  the  final  form  of  the
system should be defined from the outset. In other words, the
direction  of  the  movement  should  be  stated  without
ambiguity from the beginning, but the movement would then
be gradual.  If this is so,  provisions will be needed to  assure
that the  dynamic  process  will  actually  occur. The  Com-
munity  knows  this kind  of  problem  being itself  a  dynamic
institutional system. Indeed it has always needed 'a motor',
although through the years  this function has been  success-
ively  performed in very  different  ways.

satisfy different  requirements: the need for discretionary and
rapid decisions; autonomy from actual and potential money-
spenders ; competence over  the full  range of dimensions  of
monetary policy; clearly defined position in the constellation
of  national and  Community  institutions;  provisions to
assure the evolution of the system. In practice, if the political
will  develops for a  transition to the  institutional phase, all
these problems may prove less difficult to solve than might at
first sight appear. Existing Community and non-Community
institutions offer a wealth of suggestions to the ingenuity of
legislators.

To sum up, an appropriate institutional setting will have to

Annexes

ANNEX A

The  system narrowing the margins of  fluctuation
between the currencies of  the European Economic  Community
from  April 1971  to March 1979

Such  possible  variations  (9%)  between the  Community
currencies were incompatible with the Werner Plan  object-
ives.  So,  after  a  Council  resolution  of  21 March  1972,  the
Community  central  banks  agreed, in the  Basle  Agreement
signed on  10 April 1972 which entered into force on 24 April
1972, to  reduce the  margins of  fluctuation of  Community
currencies around their reciprocal parities to + 2,25%, i.e. to
the  same level as the  margins applicable to the US dollar.

So  that  these  new  margins  could  be  respected  (they
denoted—and  still  do—the  points for  interventions in
Community  currencies), the  Community's  issuing  insti-
tutions agreed (the agreement is still in force)  to grant each
other an  unlimited  amount of  very  short-term  financing
facilities  (VSTF)  in  their  currencies;  these  facilities  are
administered by the European Monetary Cooperation Fund
(EMCF).

2.  Participating  countries and functioning  of  the snake in the

tunnel

The  system  for  narrowing the  fluctuation  margins between
the currencies of the European Economic Community from
April  1972  to March  1979  (the  'snake') was the precursor to
the  European  Monetary  System,  which  retains some  of  its
features.

The history of the snake can be split into two periods: April
1972  to  February  1973  and  March  1973  to  March  1979.

I.  April  1972 to February  1973: the narrowing

of  margins between the European currencies
in a system of  fixed  parities (the  snake in the
tunnel)

1.  Origin: the Basle Agreement

The  main  achievement of the  Community's  first ten  years

was the establishment of a customs union; at the start of its
second  decade the  Werner  Plan was the  first  step in an
attempt to achieve economic and monetary union by stages.
In compliance with this plan, the Council, on 22 March 1971,

invited the  central  banks of the  Member  States  'from the
beginning of the first stage, and on an experimental basis, to
hold  exchange  rate  fluctuations  between the  currencies of
Member States within margins narrower than those resulting
from  the  application  of  the  margins  in  force  for  the  US
dollar, by  means of  concerted  action  with  respect to  that
currency'.

At the end of May  1972, ten  countries  implemented the

Agreement to  reduce margins: the six founder  members of

the EEC  (Belgium, the  Federal  Republic of  Germany,

France, Italy, Luxembourg and The Netherlands), the three
countries which were to accede on 1 January 1973 (Denmark,
Ireland and  the United  Kingdom) and  Norway (see below;

Chronology of the  'snake1).

The  Basle  Agreement, as  it  functioned  from  April  1972  to
February 1973,  is generally known from the way it looks on a
graph,  as  the  'snake in  the  tunnel' (see  Graph  1).

The  axis of  the tunnel  was represented  by the parity  of the
Community  currencies  against  the  US  dollar  and  its  two
outer extremes were formed by the  fluctuation  limits (i.e. a

Nevertheless, speculation against the US dollar in May  1971
and the deepening crisis culminating in the suspension of the
dollar's convertibility into gold on 15 August  1971  ' meant
that the  European  monetary  authorities  were  unable to
implement  these provisions.

ceiling of + 2,25% and a floor of -  2,25%) against the dollar

parity.

After the Washington Agreement of  18 December 1971,2 the

maximum  spot  spread  of  the  EEC  currencies  around  their
parities,  expressed  in  dollars,  were  in  fact  widened  to
±2,25% (as  against  ±0,75%  previously).  Over  time, the
maximum fluctuation  margins of these currencies were thus
increased to 4,50%  vis-a-vis the dollar and to 9% vis-a-vis any
other  currency.

Within  the  tunnel—which  therefore  had  a  diameter  of
4,50%—the  European  currencies  participating in the  Basle
Agreement  moved  within a  Community  band—usually
called  the  'Community  snake'—which  was  necessarily
narrower than the tunnel since the maximum spread of rates
which two  European  currencies  could  show in  relation to
their  reciprocal  parity was limited to  2,25%.

The  suspension of the  dollar's  convertibility  into  gold  transformed the
international  monetary system  from an  exchange rate  system  pegged to
gold (nevertheless a  somewhat  hybrid  system  since  only the dollar was
convertible  into  gold)  into an  exchange  rate  system  pegged to the US
dollar.

The  main  points of the Agreement  were:

(i)  a general realignment of parities and notably a  7,89%  devaluation of
the US dollar against gold, the official  gold price rising from  USD  35

the  'snake  in  the  tunnel'  worked

Up  to  the  start  of  1973, 
relatively  well  apart  from  three  exceptions.  Three  Com-
munity currencies had to withdraw from the snake and allow
their exchange rates to float: the pound sterling and the Irish
pound, on 23 June  1972,  and the Italian lira at the beginning
of  1973.

to USD 38 per ounce;

(ii) a  widening of the  fluctuation  margins  from 1% (0,75% for the EEC

currencies) to  2,25%.

The  1972  Basle Agreement remained in force until the implementation of

the European  Monetary  System  on  13 March  1979.

67

3

Documents relating  to  the European  Monetary  System

II.  March  1973 to  March  1979: the joint

floating  of  the European currencies (the
'snake outside the tunnel')

1. The abolition of the  tunnel and the start of joint floating of

the  European  currencies

At the  beginning of  1973, developments on the  foreign

exchange market showed that the general parity realignment
decided in December 1971 had not ushered in a new period of
stability  for  the  international  monetary  system.

In fact, February 1973 saw an increase in speculation against
the US dollar to the benefit of the German mark and the yen.
On  12 February  1973 the dollar was devalued for the second
time (10% against the  official  price of gold which rose from
USD  38 to  USD  42,22 per  ounce).  But  despite the dollar's
devaluation, the  foreign  exchange markets remained  unset-
tled  and  had  to  be closed  at  the beginning  of March  1973.

In  this  crisis  situation,  the  Community  Finance  Ministers

met in Brussels on  11 and 12 March  1973 and decided among

other  things to  keep the  maximum  spread  between six
Community  currencies at  2,25% (see below) and to  cease
their  systematic  intervention at the  maximum  fluctuation
margins  of the  United  States dollar.

For the European currencies these arrangements marked the

end of the system of fixed parities and the birth of the system

of the  joint  float,  which has  been in  existence  ever  since

(though in a  modified  form  since the  establishment of the
European  Monetary  System on 13 March  1979).

To  use  a  metaphor,  it  can  be  said  that  the  decision  of
12 March  did  away  with  the  'tunnel'—since  the  maximum
margins  of  fluctuation  against  the  dollar  were  no  longer
defended—but retained the snake since the maximum spread
between  Community  currencies  remained  fixed  at  2,25%.

2.  The functioning  of  the joint float

Eight currencies were originally involved in the joint  float:
six EEC currencies (the Danish krone, the Dutch guilder, the
French  franc,  the  Belgian  and  Luxembourg francs,  and  the
German  mark) and two  other  currencies  (the Norwegian
krone which had  been associated since 23 May  1972 and the
Swedish  krona  which had  entered the  joint  float on
19  March  1973).

68

The  six years from  March  1973 to  March  1979 saw a  fall  in

the  number of  currencies  participating in the  joint  float

mainly  because of tensions due to the oil price  shocks, the
variety  of  responses  to  the  energy  crisis  and  the  lack  of
success of  Community  policies to  reduce  economic and
monetary  divergences.

Apart  from  numerous  adjustments of  central  rates  (see
chronology), the  following  were the  main  events:

(i)  the French franc,  which had withdrawn from  the snake
on  19 January  1974, re-entered the joint float  system on
10 July  1975  only  to  leave it again  on  15 March  1976;

(ii) the  Swedish  krona  ceased to be  associated  with the

snake on 28 August  1977;

(iii)  shortly  after  the  conclusion  of  negotiations  on  the
European  Monetary  System  which  provided  for  the
implementation  of  a  new  exchange  rate  mechanism,
Norway,  on  12 December  1978,  announced 
its
withdrawal  from  the  snake.

Thus by  the  beginning of  1979, only a  mini-snake was left,
containing  five  Community  currencies:  the  Danish  krone,
which had  maintained its participation in the joint float at
the  cost  of  several  devaluations,  and  four  'stronger'
currencies (the Dutch guilder, the Belgian and  Luxembourg
francs and the German  mark).

The  other  European  currencies  (French  franc,  Italian  lira,
pound  sterling and  Irish pound) practised a  'dirty'  float.

*

* 

*

The  European  Councils  in  1978 (Copenhagen  on  7  and  8

April,  Bremen on 6 and 7 July and  Brussels on 4 and

5 December) were to reintroduce into the EEC a unified joint
float system vis-a-vis other countries, grouping together eight
of the EEC countries within the framework  of the European
Monetary  System  (see Annex  B).

The  effective  implementation of the  EMS, on 13 March

1979,  was  accompanied  by  the  abrogation  of  the  Basle
Agreement signed in 1972 and by the implementation of new
provisions.1

1  Basle  Agreement of  13  March  1979 between the  central  banks of the

Member States of the EEC laying down the operating procedures for the
European  Monetary  System.

Annex A

Chronology  of  the 'snake'

1974

(April  1972 to  March  1979)

7972

24 April 

Entry into force of the Basle Agreement of  10
April  1972 establishing a  fluctuation  system
limited  to  2,25%  between  Community  cur-
rencies (the snake in the tunnel). The countries
taking part were Belgium, France, the Federal
Republic of  Germany,  Italy,  Luxembourg
and The Netherlands

19  January 

The  French  franc  leaves the  snake

1975

10  July 

The  French  franc  rejoins  the snake

1976

15 March 

The  French  franc  again  leaves the  snake

1 May 

The  pound  sterling, the  Irish pound  and  the
Danish  krone join  the  snake

17  October 

The  Norwegian krone is associated  with the

23 May 

snake

'Frankfurt  realignment' of  exchange  rates
against  the  EMUA,  with  the German  mark
being revalued by 2%, the Danish krone being
devalued by 4% and the Norwegian krone and
Swedish krona being devalued by 1%

23 June 

The pound sterling and  the Irish pound leave
the  snake

7977

27 June 

The  Danish krone leaves the snake

10  October The Danish krone rejoins the snake

7973

13 February The  Italian lira leaves the snake

12 March 

3% revaluation of the German mark against

the  EMUA1 and  announcement by the

Council  of  a  joint  float  of  EEC  currencies
within  margins of  fluctuation of  2,25%
against one another, with the exception of the
pound sterling, the Irish pound and the Italian
lira,  which continue to  float  independently

14  March 

The  Swedish  krona  is  associated  with  the
snake

29 June 

5,5% revaluation of the German mark against

the EMUA

1  April 

6% devaluation of the Swedish krona and  3%
devaluation  of  both  the  Danish  and  the
Norwegian kroner  against  the EMUA

28 August 

The  Swedish  krona  leaves  the  snake,  5%
devaluation  of  both  the  Danish  and  the
Norwegian kroner  against the EMUA

1978

13 February  8%  devaluation  of  the  Norwegian  krone

against the EMUA

17  October 

4% revaluation of the German mark and 2%

revaluation of both the Dutch guilder and the
Belgian  franc  against  the  EMUA

4-5 December  European Council in Brussels: adoption of a

resolution  on  the  establishment  of  the  Eu-
ropean  Monetary System

77 September  5% revaluation  of the  Dutch guilder  against

the  EMUA

12 December The  Norwegian  krone leaves the  snake

16  November  5%  revaluation  of  the  Norwegian  krone

against  the EMUA

7979

' 

EMUA: European monetary unit of account created on 3 April  1973 and
defined by a weight of  fine  gold (1 EMUA =  0,88867088 grams of  fine
gold, i.e. the gold parity of the dollar from  1934 to  1971). The EMUA was
the European Monetary Cooperation Fund's unit of account from 3 April
1973 (the date on which this body was established) to 31 December 1978.

13  March 
and by the members of the  Board of Gover-

Signing by the Governors of the central banks

nors of the EMCF of instruments relating to
the  implementation  of the EMS

69

ANNEX  B

Main features of the European Monetary  System
in its present phase

The  European  Monetary System (EMS) was established by

the  Resolution  of  the  Brussels  European  Council  of
5 December  1978  and  implemented  on  13 March  1979  after
the  conclusion of an  arrangement on the  progressive
reduction  of  the  monetary  compensatory amounts.

Table  1

Composition  of the  ECU

The ECU is at  present  equal to the sum of the  following  amounts

The Brussels Resolution provided for an initial phase, which
originally was to  have  lasted two  years, but  which was
prolonged. In due  course, on  transition to the  definitive
phase, all the elements of the system will be consolidated, and
the  European  Monetary  Fund  (EMF)  will  be  set  up.

All the EEC countries, at the different levels of responsibility
concerned, are signatories of the instruments constituting the
EMS.  However, the  United  Kingdom and  Greece do not
participate in the  system's  exchange  rate  mechanism and
Italy's  currency  benefits  from  special  arrangements  which
will  be  described  below.

Since its  creation,  numerous  commentaries  have  been
devoted to the EMS, including one in particular in European
Economy. ' The system will  therefore not be described again
here;  instead  a  simple  reminder  of  its main  features  at  the
present time is given below in two sections — one relating to

the ECU and the  other to the  exchange  rate and  credit
mechanisms.

I.  The  ECU

The  ECU  is at  the centre of  the  EMS.

Its definition,  the  way  in  which  it  is issued  and  its  use  are
described  below.

A.  Definition

The ECU is defined as a 'currency basket' type of numeraire.

A  procedure  exists  for  periodically  re-examining  its  com-
position and for  revising the latter, if necessary.

1.  Present  situation

The composition of the ECU and the way in which its value is
determined  are  identical  to  those  of  the  European  unit  of
account (EUA)  created in March  1975.

The  ECU  is therefore  equal  to  the sum  of fixed  amounts of
nine  Community  currencies  (see Table  1).  The  tenth  EEC
currency — the Greek drachma — is, according to the Greek
Treaty of Accession, due to be introduced  into the ECU by
31 December  1985 at the latest.

See  European  Economy. No 3.  July  1979.

70

of  the currencies of  the  EEC  Member  Slates
(except  Greece):

0,828
0,0885
1,15

109

0,286
3,66
0,14
0,217
0,00759

German  mark
pound  sterling
French  francs
Italian  lire
Dutch  guilder
Belgian  francs
Luxembourg  franc
Danish  krone
Irish  pound

Because each  currency  accounts  for  a  fixed  amount  in  the
composition  of  the  ECU, the  relationship  between  these
amounts and  the value of  the  ECU  or,  in  other words,  the
respective weight of each of the currencies in the ECU,  varies
in  line  with  exchange  rate  movements  between the  Com-
munity currencies. These weights have changed appreciably
since  1975  (see Table 2).

2.  Revision  of  the ECU's  composition

The  Brussels  Resolution  laid  down  that  the weights  of  the
currencies in the ECU  would be re-examined and if necessary
revised  'every  five years or, on  request, if the  weight of any
currency  has changed  by 25%'.

'Revisions  have to be  mutually  accepted;  they  will, by
themselves, not modify the external value of the ECU. They
will'be made in  line with  underlying economic criteria.'

The circumstances in which the ECU's composition can be
altered  must be  laid  down by the  Council,  acting  unani-
mously on a  proposal  from the  Commission and  after an
opinion  from the  Monetary  Committee and the  EMCF's
Board of Governors.

B.  Issue  of  ECU  reserves

ECU reserves are created by the EMCF for the EEC central

banks  against  the  transfer,  by  these  banks,  in  the  form  of
three-month revolving swaps, of 20% of their gold assets and
20%  of  their  dollar  reserves;  under  the  present  provisions,
the swaps are to be unwound in March 1983, save in the event
of a unanimous decision to the contrary by the Governors of
the central  banks.

Annex B

Table 2

Weighting of the various currencies in the ECU

the currencies

Reminder of

the initial

weightings of

in the  EUA
(March  1975)

Weightings on the basis of  the ECU central  rates

in  force on

13
March
1979

24
September
1979

30
November
1979

23
March
1981

5 
October 
1981 

22
February

1982

14
June
1982

Belgian and  Luxembourg  francs
Danish krone
German  mark
French  franc
Irish pound
Italian  lira
Dutch  guilder
Pound  sterling

8,2
3-
27,3
19,5
1,5
14-
9 -
17^5

9,63
3,06
32,98
19,83
1,15
9,50
10,51
13,34

9,54
2,95
33,31
19,64
1,13
9,40
10,41
13,62

9,55
2,81
33,36
19,67
1,14
9,41
10,42
13,64

9,31
2,74
32,54
19,18
1,11
8,63
10,17
16,32

9,32
2,74
34,36
18,63
1,11
8,38
10,74
14,72

8,50
2,65
34,24
18,56
1,11
8,35
10,70
15,89

8,45
2,63
35,48
17,39
1,10
8,07
11,09
15,79

Total

100-

100— 

100— 100— 100— 100— 100— 100 —

Entry into  force of the EMS on 13 March  1979.

On 30 November  1979, the  Danish  krone was devalued by 5% against the other EEC  currencies participating in the EMS exchange rate  mechanism.

On 22 March  1961  (with  effect  from 23 March),  ihe Italian  lira was devalued by 6%  against the other EEC  currencies participating in the EMS  exchange  rate  mechanism.

On 24 September  1979, the German mark was revalued by 5% againstthe Danish krone and by 2% against the other EEC currencies participating in the EMS exchange rate mechanism.

On 4 October  1981 (with effect  from  5 October), the German mark and  the Dutch guilder were revalued by 5,5% against the Danish krone, the Belgian  franc,  the Luxembourg franc and
(he  Irish  pound; the  French  franc  and  the Italian  lira were devalued  by  3% against  these same  currencies.

On 21 February  1982 (with effect  from 22 February), the Belgian franc and the Luxembourg franc were each devalued by 8,5% and  the Danish krone by 3% against the other currencies

participating  in the  EMS  exchange rate  mechanism.
On  12 June 1982 (with effect  from 14 June), the German mark and the Dutch guilder were revalued by 4,25%  against the Belgian franc, the Luxembourg franc, the Danish krone and the
Irish pound; the  French  franc and  the  Italian  lira  were  devalued by  5,75% and  2,75%  respectively  against  the same currencies.

Table 3

The  creation of ECU by swap operations

starting in

Swap operations

April  1979
July  19791
October  1979
January  1980
April  1980
July  1980
October  1980
January  1981
April  1981
July  1981
October  1981
January  1982
April  1982

US dollar
Gold
transfers
(million
ounces)

transfers
('000-
million)

Gold
price
(ECU  per
ounce)

USD1  =
...  ECU

Counterpart in ECU

('000 million)

Gold

US dollars

80,7
85,3
85,3
85,5
85,6
85,6
85,6
85,6
85,7
85,7
85,7
85,7
85,7

13,4
15,9
16,0
15,5
14,4
13,7
13,9
14,5
14,2
12,7
11,5
11,7
10,5

165
185
211
259
370
419
425
447
440
406
402
368
327

0,75
0,73
0,70
0,69
0,77
0,70
0,71
0,75
0,84
0,97
0,91
0,92
I _

13,3
15,8
18,0
22,2
31,7
35,9
36,4
38,3
37,7
34,8
34,5
31,6
28,1

10,0
11,6
11,3
10,7
11,1
9,6
9,9
10,9
12,0
12,3
10,5
10,7
10,5

1 
The  Bank of  England  transferred 20% of its gold and  dollar  reserves  from  July  1979. The  Bank of  Greece has  made no  transfer.
Source.-  Monthly  reports of the agent of the EMCF.

Total

23,3
27,4
29,3
32,9
42,8
45,5
46,3
49,2
49,7
47,1
45,0
42,3
38,6

71

Documents relating to  the European  Monetary  System

As a result, at present, the creation of ECUs is not definitive.

Furthermore, the  amount of  ECUs  issued — at  present
38 600 million (see Table 3) — varies every three months for
two  reasons:

(i) first, the swap system itself means that the volume of gold

and  dollar  transfers  made by the  issuing  institutions

fluctuates  in  line  with  the  volume  of  official  gold  and
dollar  reserves  held by  these institutions;

(ii)  second,  the  rates  at  which  the  transfers  are  valued  are
themselves  fluctuating.  The  conversion  rate  for  gold  is
equal to the average of the prices recorded daily at the two
London fixings during the previous six calendar months

but not exceeding the average price of the two  fixings on

the penultimate working day of the period; the rate used
for the dollar is the market rate two working days prior to
the  value date  of the  swap  operation.

C.  Use  of  the  ECU

The use of the ECU by the official  authorities—national or

Community—and by the private  sector, is now examined.

from  April 1979, the ECU was introduced into the common
agricultural policy, but with specific conversion rates ('green
rates'). Lastly, since January  1981, the ECU has replaced the
EUA in all the sectors in which the latter had been used and
has  thus  become  the  sole  unit  of  account  used  by  the
Community  authorities.

As a general rule, two principles, whose degree of application
depends on the sectors concerned, govern the use of the ECU
for the  administrative  needs of the  Community: the  first
concerns  the  recording  in  ECU  of  operations  in  national
currencies; the  second  aims at the denomination, wherever
possible, of claims and debts of the Community authorities in
ECUs.

2. The private use of the ECU

Before examining the expansion in the use of the ECU by the
private  sector,  it  must  be  pointed  out  that  there  is  no
connection  (except for the  ECU's  definition and the use of
identical exchange rates — the latter being determined by the
foreign exchange market) between the use of the ECU  within
the official  framework  of the EMS and  its use by the private
sector; in the former  case, we are referring  to an agreement
between the  authorities of the  Member  States and to
Community decisions; in the latter, each operation gives rise

to a contract  under private law.

1.  The  'official'  use  of  the  ECU

This  said, the use of the ECU by the  private  sector,  after

(a) The use of ECU  reserves is specified in one case only: a

getting off  to  a  fairly  slow start,  is now  expanding.

debtor  is entitled  to  use the  ECU  in  order  to  repay  at  the
settlement  date  a debt  under  the very  short-term  financing
arrangement.  However,  the  creditor  central  bank  is  not
obliged to accept settlement by means of ECUs of an amount
more than 50% of its claim. In other cases, the use of the ECU
between  central  banks takes  place by mutual  agreement.

(b)  Apart  from its role as a  reserve asset, the ECU is also
used as a numeraire for the exchange rate mechanism, as the
basis for  establishing the  divergence  indicator, and as the
denominator for operations in both the intervention and  the
credit  mechanisms.

(c)  Lastly,  as  a  unit  of  account,  the  ECU  has  been
progressively  introduced  into all the Community's areas of
activity.

From  1975  to  1978,  it was used  first  of  all —in  the  initial

EUA  form — by  various  institutions  (the EIB  since

18 March  1975; the EOF — under the Lome Convention —
since 21 April  1975; the ECSC since 24 April 1975) and for a
variety of purposes (the general budget since 21 April 1978;
in  customs  matters  since 23 November  1978).  With  effect

72

(a) The  first  operations in  EUA, the  initial  form of the

Community's currency unit, were chiefly concerned with the
keeping of current accounts opened mainly on  behalf of the
Community authorities. However, the ECU  really started to
be  introduced  into  private  contracts  as  a  monetary
instrument  only  from  1979 onwards,  when  it  became  a
currency of  settlement  for operations within  the EMS, and
operations  did  not  really  start  until  April  1981  with  the
launching of  the  first  public  ECU  issue.  Since then several
issues  have  followed  and, at  the  end  of  June  1982, they
totalled  some  1 000  million  ECU.

(b)  At  present,  the  private  use  of  the  ECU  is  expanding
significantly for two main reasons. First, the majority of the
Community's  issuing  institutions  now  grant  the  ECU, de
facto or dejure, the status of a currency, and second, since the
start  of  their  ECU  operations,  the  banks  themselves  have
used the ECU not only as a simple unit of account, the use of
which would have required a currency of settlement, but also
as  an  instrument  of  settlement,  at  least  between  final
operators. This approach has led the banks to extend all the
services normally available on convertible currencies to  the
ECU.

Annex  B

adequate measures even before the compulsory intervention
points  are  reached.  These  measures  may  be  diversified
intervention, measures  of economic or monetary  policy, or
changes in central  rates.

2.  The  adjustments

The inadequacy of economic policy convergence means that
adjustments of  central  rates are  inevitable  with  varying
frequency.  Adjustments  were made even  under  the  Bretton
Woods  system  which  is  sometimes  called  —not  quite
accurately — a system of  fixed  parities.

The  originality  of  the  EMS  is  that  it  organizes  the
adjustments to  take  place in the  best  possible conditions.

Thus the Brussels Resolution states: 'Adjustments of central
rates  will be  subject to  mutual  agreement by a  common
procedure which  will comprise all countries participating in

the  exchange  rate  mechanism and the  Commission.  There

will be reciprocal consultation in the Community framework
about important decisions concerning exchange rate policy
between  countries  participating and any  country not
participating in  the  system.'

Since  the  entry  into  force  of  the  EMS,  six adjustments  of
central rates have taken place (see Table 2, notes 2 to 7); the
changes  in  bilateral  central  rates,  resulting  from  these
realignments, are  indicated in Table 5.

B.  The  credit  mechanisms

The  existing  credit  mechanisms  — which  are  to  be  con-
solidated into a single fund, in the final phase of the EMS —
have been reinforced and supplemented by measures to assist

the less prosperous countries of the Community.

At  present,  the  ECU  is  thus  dealt-in  in  on-the-spot  and
forward  foreign markets (up to one year); it can also be kept
in an interest-earning current account or be placed on a time
deposit. There are also short-term overdrafts and syndicated
bank  loans  for up  to  seven  years.

In  future, the  establishment of a  clearing  house  should
facilitate  operations  for  small  and  medium-sized  banks
which will thus operate directly on an ECU  market without
any  longer having  to  break  down their  operations into  the
different  component  currencies.

II. The  exchange rate and credit mechanisms

A. The exchange  rate  mechanism

The EMS exchange rate mechanism organizes exchange rate
relationships between the Community currencies according

to a system of stable, but adjustable when necessary, parities.

1.  The  stability  of  exchange  rates

With the exception of the United Kingdom and Greece, the
other  EEC  countries  have joined  or  rejoined  a  system  of
stable  parities, consisting  of  limited  margins of  fluctuation
based  on  a  common  numeraire  — the  ECU —  and  on
intervention  rules.

All  the currencies participating in the  EMS  have an  ECU-
related  central  rate. The  central  rates as a  whole  serve to
determine the  grid  of  bilateral  central  rates (see Table 4).
Fluctuation margins of  ± 2,25% are established around the
bilateral  central  rates,  except  for  the  Italian  lira  which
temporarily  observes  ±6% margins.

Once a  currency  reaches its  lower or  upper  bilateral
intervention  point  vis-a-vis  another  currency, the  central
banks of the countries concerned are required to intervene.
Interventions at the margins must be made in the currency at

1. The  reinforcement of the  credit  mechanisms

the  opposite bilateral  limit.

These intervention  rules, which are  similar to  those used  in

the snake, have been supplemented in the EMS by an original

mechanism: the 'divergence indicator'. As its name indicates,
the  divergence  indicator,  which  is  based  on  the  ECU,
identifies the  currencies whose exchange  rate  performance
diverges  from  the  'Community  average'.  A  'threshold  of
divergence' is  fixed at 75% of the  maximum  spread of
divergence for each currency and when a currency crosses the
threshold,  this  results  in  a  presumption  that  the  country
concerned  will act.

We shall  consider  in  turn  very  short-term  financing,  short-
term  monetary  support  and  medium-term  financial  assist-
ance.

(a)  Very  short-term  financing  (VSTF) is  designed to
facilitate respect of the maximum margins of fluctuation. All
the  central  banks  of  the  countries  belonging  to  the  EMS
exchange rate mechanism are  eligible for it.

Under  the  VSTF  arrangement,  the  participating  central
banks open for each other unlimited credit facilities through

The indicator in fact works as an early warning system and is
designed  to  encourage  the  monetary  authorities  to  take

the  EMCF in  their  respective  currencies for a  very  short

period.

73

Documents  relating to  the  European  Monetary  System

With the establishment of the EMS, the VSTF arrangement
was  changed  in  two  important  respects:  the  initial  credit
period was extended  from  30 to 45 days from  the end  of the
month in which the debt was incurred, and the debtor central

bank was enabled to make settlement by transferring ECUs,

with the proviso that the creditor central bank is not obliged
to accept a settlement by means of ECUs of an amount more
than 50% of its claim. The balance of the debt is settled by the
transfer of  other  reserve components.

(b)  Like the VSTF, the short-term monetary support system
(STMS) is an  agreement between central banks. Unlike the
VSTF, reserved  solely for participants in the exchange rate
mechanism  of  the  EMS,  all  EEC  countries  may  request
short-term  monetary  support.

The granting of short-term monetary support is linked to the
need for  short-term  financing  caused by a  temporary
balance-of-payments  deficit.

Table 4

Bilateral  central  rates and  intervention  margins for currencies  participating  in the  EMS  exchange rate  mechanism

Amsterdam
in  HFL

Brussels
in  BFR/LFR

Frankfurt
in  DM

Copenhagen
in  DKR

London 
in  UKL 

Dublin
in  IRL

Paris
in  FF

Rome
in  LIT

(rales  in force  as from  14 June  1982)

HFL 100

BFR/LFR  100

DM  100

DKR  100

+ f>25"/
~  *•**••*  /a
central  rate
-2,25%

+ 2,25%
central  rate
-2,25%

+ 2,25%
central  rate
-2,25%

+ 2,25%
central  rate
-2,25%

100

I  782,85
1  743,23
1  704,45

92,525
90,4673
88,455

326,45
319,183
312,08

5,8670
5,73646
5,6090

100

5,308
5,18961
5,074

18,726
18,3098
17,903

113,05
110,537
108,0775

1  970,85
1  926,93
1  884,00

100

360,83
352,817
344,97

32,0425
31,33
30,6325

558,60
546,154
534,00

28,990
28,3433
27,715

100

i 

' 

1 

' 

27,3975
26,7864
26,1915

262,21
256,380
250,67

55  577,0
52341,9
42 296,0

1,57155
1,53659
1,50241

15,042
14,7072
14,380

3  188,0
3 002,58
2  828,0

30,2845
29,6090
28,9520

289,85
283,396
277,09

61  433,0
57  857,4
54 490,0

8,58300
8,39216
8,20550

82,150
80,3239
78,535

17412,0
16  398,7
15444,0

UKL

central  rate

I RL  1

FF  100

LIT  1 000

+ 2,25%
central  rate
-2,25%

+ 2,25 %
central  rate
-  2,25 %

+ 6%
central  rate
-6%

3,8180
3,73324
3,6500

66,56
65,0792
63,6315

3,454
3,37736
3,302

12,187
11,9159
1 1 ,6509

1 

1

2 074,80

9,7890 
9,57129 1 954,05
1 840,32
9,3585 

39,8925
39,0045
38,1375

695,40
679,941
664,80

36,090
35,2863
34,500

127,33
124,496
121,73

2.02850
1,91051
1,79925

35,360
33,3047
31,365

1,835
1,72839
1,628

6,475
6,09804
5,743

1 

' 

10,6855
10,4479
10,2155

100 

21  677,0
20415,7
19  227,0

0,54338
0,511758
0,48197

5,2010
4,89818 
4,6130

I  000

1  ECU

central  rate

2,57971 

44,9704 

2,33379 

8,234 

(0,560453) 

0,691011 

6,61387  1 350,27

Doe*, no!  participate  in the exchange  mechanism.

74

Annex  B

Table 5

Appreciation or depreciation of  the bilateral central  rates of  EMS  participant currencies from  13 March  1979 to  14 June  1982'

Belgian  and  Luxembourg  francs
Danish  krone
German  mark
French  franc
Irish  pound
Italian  lira
Dutch  guilder

Belgian and
Luxembourg
franc

—
-1,9
+ 22,6
-0,1
+ 9,3
-3,1
+ 20,2

Danish
krone

German
mack

French
franc

Irish
pound

Italian
lira

+ 2-
—
+ 25,-l
+ 1,9
+  11,4
-1,2
+ 22,6

-18,4
-20-
—
-18,5
-10,9
-21-
— 2  —

+ 0,1
-1,8
+ 22,7
—
+ 9,4
-3-
+ 20,3

-8,5
-10,3
+ 12,2
-8,6
—
-11,3
+ 10,-

+ 3,2
+ 1,2
+ 26,5
+ 3,1
+ 12,8
—
+ 24,-

Dutch
guilder

-16,8
-18,4
+ 2-
-16,9
-9,1
-19,4
—

The table  reads horizontally {for  example, the Belgian  franc has appreciated 2 % against the  Danish  krone and the  Danish  krone has depreciated  1,9% against the Belgian  franc).

The  amount  actually  available for  short-term  monetary

2.-  Transfers  of  resources  to  less prosperous  countries

support has been more than doubled and increased to  14 000
million  ECU. In  addition, the  duration of the  facility,
previously  fixed  at  six  months  (three  months,  renewable
once) was extended to nine months (three months, renewable
twice).

The less prosperous countries of the Community which do in
fact  participate in the  exchange  rate and  intervention
mechanism — at present, Italy and  Ireland — are eligible for
loans  on special  terms.

(c)  Medium-term financial assistance (MTFA) is granted by
the Member States of the EEC, for a period of between two

The Community  institutions and the  European  Investment

and  five  years, where a Member State is in serious balance-
of-payments  difficulties.

The credit amount actually available was more than doubled

at the start of the EMS and at present stands at  11 000 million

ECU.

Bank are empowered to make available to them, for a period
of five years with effect  from  the establishment of the EMS,
loans of  up to  1 000 million  ECU  per  year; these loans are
eligible for an  interest  rate  subsidy of 3%,  limited to an
annual cost of 200 million  ECU.

75

ANNEX  C

Examination by the Monetary  Committee
of  some  aspects of  the non-institutional development

of the  European Monetary System

At the end of  1981, it was clear that the introduction of the

The  first  report  (Annex C-2)  examines  four  questions:

institutional  phase  would  take  some  time,  and  a  relatively
long time at that.

(i) how to  break the  link  between the  volume of  ECUs

The Monetary Committee therefore felt it useful to pin-point

the areas in which progress could be made in the less distant

future.

issued and the price of gold and the exchange rate for the
dollar;

(ii)  the  eligibility  of  intra-marginal  interventions  for  the

very short-term  financing  facility;

In this connection, the Chairman of the Monetary Commit-
tee, at the Council (Economic and Financial Affairs) held on
14 December  1981,  suggested a  number of  points for
consideration (see Annex C-l).

(iii) the external  role of the  ECU;

(iv) the  minting of an ECU  coin.

In  addition,  the  Alternates  of  the  Monetary  Committee
— on  a  mandate  from  the  Committee  and  in  the  reports
which follow — studied some of the problems posed by the
non-institutional  development of the EMS.

The  supplementary  report  (Annex  C-3) examines  the
problem of the mobilization of net ECU  credit positions.

76

ANNEX  C-l

Statement by Mr Jean-Yves Haberer,  Chairman of the Monetary Committee,

to the Economic and Financial  Affairs  Council of 14 December  1981,

on the European Monetary System

I.  Progress report on the  work  assigned to the

experts

II. The successes of the EMS

On  13  March  1982 
celebrate  three years of  official  existence.

the  European  Monetary  System  will

The  Monetary  Committee  has  complied  with  the  wish
expressed  on several occasions by  the  European  Council and

the  Council of  Ministers for  Economic and Financial  Affairs,

and  in  1980  and  1981  devoted  numerous  studies  to  the
reinforcement  of  the  EMS  until  its  transition,  at  the
appropriate 
time,  to  the  institutional  phase.  With  the
invaluable assistance  of  its  alternates, a report  was produced
containing six  documents  prepared by  Commission  depart-
ments  and  revised  after  discussions  with  the  experts  of  the
Monetary  Committee.  The  report  was  submitted  to  the
Monetary  Committee  which  took  it  into  consideration  in
presenting  the  broad  options  which  I am  about  to mention.

the  technical

the  renewal  and  reinforcement  of  the  credit  arrange-

In  accordance  with  the  guidelines  laid  down  by  the  Luxem-
bourg  European  Council of 2  December  1980, 
work  centred on the  gradual  development of the use of the
ECU, 
ments, and the coordination of monetary policies and exchange
rate policies pursued in relation to third countries. In the course
of 
documents I have mentioned, brought out the importance of the
problems and options  connected  with :

their  work on  these  subjects, the  experts, in the six

(i)  the status of  the ECU  and its acceptability  as a means of

settlement;

As the European Council has several times noted, theEMShas

worked  remarkably  successfully  for  three years.

1.  First, it has provided a satisfactory  response to the central
problem  of  a  common market, i.e.  of  a  zone  the purpose  of
which  is  to promote  the  interdependence  of  its  economies  by
trade, the  movement of  capital and  individuals, and  free
competition; this problem is the stabilization of exchange rates
without  which it  becomes far 
too  hazardous to  calculate
profitability  and to  devise  marketing  strategies.

Despite the existence of a wide fluctuation  margin and the four

—  albeit  moderate —  realignments  which  have  taken place

within the  EMS, 

trade  between the countries participating in

the  exchange  rate  and  intervention mechanism  has benefited
greatly  from 
the  security  of  transactions  created  by  the
foreseeable  nature  of  exchange  rates.  By  reducing  the
uncertainties involved in intra-Community  trading operations,
the EMS  has thus made it possible to cut their  cost and speed
their development.

2.  This success has been confirmed  despite the turmoil in the
international  environment: the  three years of the  European
Monetary  System's  existence have seen a very serious oil price
shock  succeeded  by  a  monetary  shock  which  was  no  less
disruptive  because of  the sudden  and  erratic  variations  in  the
dollar  interest rate and exchange rate. During  this period, the
interest  rate on the major  international currency  doubled and
its exchange rate appreciated by  over  40% against the  major

European  currencies,  but  without  any  lasting  effect  on  the
internal  cohesiveness of the  EMS.

(ii) the  liquidity of the  central  monetary  institution;

(in)  the  arrangements  for 

European  Monetary  Fund;

transferring  reserves  to  the

3. The four  currency  realignments  which occurred during the

(iv) 

the  consolidation  of  Community  credits  in  the EMF;

(v)  the external  role  of  the ECU;

(vi)  and lastly,  the institutional aspects  of  the  EMF.

It is certainly  true that, when the time comes, certain points will
have to be examined in even greater detail.  These  include, for
example, the questions of the return paid on the ECU and the
legal status  which  the period of  transition  to  the institutional
phase of the EMS  will have by reference to the Treaty  of Rome
and the member countries'constitutional rules. Nevertheless, it
seems to me  that the  detailed and  comprehensive  technical
studies already  made provide, as from  now,  a sufficient  basis
for  exploring  the directions in which the EMS  can go forward,
and in particular for  responding  to the call of the recent London
European  Council. I  therefore  have the  honour of  asking the
Council to  recognize  that  we have  acquitted  ourselves  of  the
preliminary  work  carried out at its  request.

period, among which the only real general realignment was that
of  October  1981,  were carried out calmly  and remained within
reasonable  limits.  They  showed the  ability of the  countries
participating  in the EMS  to anticipate market movements and
to  regulate  them  without  allowing  undue  disruption  of  the
foreign  exchange  markets  to  develop.  In  this  respect,
interventions were clearly  consistent with their natural purpose
since  they  were for  the most part  reversible. Net  transfers  of
reserves between participants  remained limited.

4.  Contrary to the fears  expressed by some at the moment of

the establishment of the system, the mechanisms providing for
a  very  large amount  of  credit  (a  total of  25 000  million ECU
for  medium-term financial assistance and short-term monetary
support)  did not have to be activated. The corrective measures
which were needed were taken early enough for  any momentary
divergences on the foreign  exchange  markets to be  amply
covered  by  very  short-term financing  between  central  banks.
But  the  credibility  of  the  EMS  was greatly  enhanced  by  the
existence of a generously  endowed  credit  system.

77

Documents relating to  the European  Monetary  System

5.  Even  if  the  economic policies  of  the  Member  States  are
often  very  diverse, the  constraint of  having to  respect the
central rates established  within the EMS has been important
and  has favoured  the'convergence  of  monetary  policies, and
through them, of economic policies: the general rejection  of a
permissive interpretation of the European  monetary  rules has
been an  active  element in  bringing  economic policies  closer
together, and a number of  Member  States are a  well-known
demonstration  of  this development.

2.  Improved  technical cooperation  between the central banks
participating in the exchange rate and intervention mechanism.
Thus, very short-term financing  could be activated not only for
obligatory  interventions  at  the  bilateral  limits,  but  also for
preventive  intra-marginal  interventions  designed to promote
the stability of the system; the divergence indicator mechanism
could be improved;  and acceptance of  the ECU  as a means of
settlement  between  the participating  central  banks  could  be
increased from  50%  to  100%

6.  The success of the EMS has been assisted by the prospects it

offers for  Europe's  progress  towards  genuine  economic and

monetary union, and by the technical and political rendez-vous
which it has set  itself  from the  outset. The  existence of the
European  Economic Community's  monetary  ambition has, in

its  way,  been  crucial for the  credibility of the EMS and has

3.  Greater  credibility for  the ECU.  The ECU's success must
first be  ensured in the  Community  itself; 
institutions should set an example by using it for  their accounts
and for  their  market  borrowings.  The  central  banks  of  the
European countries with an exchange rate policy linked to the

the  Community

EMS  could be  authorized to  hold  ECUs  obtained  either by

aroused manifest  interest from  the banks and the international
markets.

deposits of  reserves  with the  EMCF or by  settlements  with

III.  Scope for a non-institutional development of

the EMS

In  line with the conclusions of the recent European  Council in

London, I believe it is essential to mark the third anniversary of
the EMS  by real and meaningful  progress. In  this area, as in

any other, but perhaps even more so in view of the momentum
created and the expectations inherent in the system, we cannot

afford 
to stand still, for  fear of  losing  what we have  already
achieved.  Nevertheless, we  must not be  unrealistic. My
colleagues and I myself feel  that  it  would be inappropriate,  in
the present circumstances, to embark on the final phase, which,
because of its scale, would require ratification by the national
parliaments in long and complex procedures. It therefore  seems
that at  this stage we must set on one side the question of the
institutional framework of the  EMS, 
fundamental  questions  which  also  involve  parliamentary
procedures,  e.g.  the  definitive 
transfer  of foreign  exchange
reserves to a European  Monetary  Fund.

together  with  other

That  said, I  have  made use of the  opportunities for  personal
diplomacy  enjoyed  by  the  Chairman  of  the  Monetary
Committee  to form  a personal  opinion,  which  reflects  many

others, on the points  which  could permit, with a satisfactory

degree  of  coherence,  a  non-institutional  development  of  the
if this were to find favour  with the political authorities of
EMS, 

the Community.  These points are the following, in increasing

order  of  importance :

EMS  central  banks. The  central  banks of oil  exporting

countries  which had  agreed  to financial  cooperation  with  the
borrowing  Community  institutions  could  also  be  allowed  to
hold  ECUs  on  the same  terms.

4.  The regrouping  of the credit mechanisms. The present short
or medium-term mechanisms  would be  incorporated  into  the
EMCF  itself  where  they  would  become  credit  lines, and  this
would  confirm the  Community's  ultimate  intention of  setting
up  a genuine European  Monetary  Fund.

5.  Stabilization of the  volume of  ECUs  issued. A re-
examination might concentrate on the relationship between the
volume of ECUs,  which deserves  to be under control, and  the
gold and  dollar  prices,  which  have the  disadvantage of
continually fluctuating.

6.  Closer  convergence  of  monetary  policies.  Interest  rate
policies in particular  could be  concerted more frequently.

7.  The determination of  a  'zone  of probability'for 
There is a clear need for a common approach to third currencies
and to the dollar in particular. An  attempt  should be made to
determine a zone of probability for  European  exchange rates
vis-a-vis the dollar, in consultation  with the US  authorities.

the dollar.

I have ventured on a list which is in no way restrictive: in taking
advantage  of  the  opportunity  provided  by my presentation to

the Council of the Monetary  Committee's  work on the EMS,

my  purpose  is  none  other  than  to  express  the feeling  that
progress is possible in certain areas which are consistent  with
each other, and hence necessarily  interconnected.

The Council of Ministers may call on the Monetary  Committee

1.  A  signal  to public opinion:  each of  the member  countries,
following  its  customary  national procedure,  should  mint  an
ECU-denominatedmetal  coin of'standarddesign,  which would
circulate freely  in  the  Community.

at any time to translate the guidelines of the London European

Council  into  concrete proposals.

78

ANNEX C-2

Report on some aspects of the non-institutional development
of  the  European Monetary System  presented  on 3 February  1982
by the Alternates of the Monetary  Committee

A i its meeting of  13 January  1982, the Monetary  Committee
discussed  various proposals for the non-institutional develop-
ment of the European Monetary  System  (EMS)  and requested
the  Alternates  to  examine  and  report  on  the  following
questions :

(i) How can the volume ofECUs  issued be divorced from the

two widely fluctuating  variables, the market price of gold
and the  exchange  rate for the US  dollar?

(ii) How is the extension of the very-short  term facility to the

financing of  intra-marginal  interventions to be  circum-
scribed  (either  by  attaching  conditions,  imposing  a
ceiling, or limiting its duration) ?

(Hi)  How can the option  open  to non-Community  institutions

to hold  ECUs  be organized?

(iv) How  would the problems of legal tender arise in relation

to the free  circulation of an ECU  coin minted according
to national procedures ?

their  examination to the  feasibility,

The  Alternates accordingly  met  on  25-26  January  and  on  3
February  1982  and  herewith  submit  their  report 
to  the
Committee.  In  conformity  with  the  mandate  received,  the
Alternates  confined 
technical implementation and implications of  the four  courses
of  action mentioned above, without  taking a position on their
o verall merits or otherwise; nor did they examine the links with
other proposals  affecting 
related  aspects  of  the  system  (e.g.
ECU  acceptability,  remuneration, etc.). Finally,  their exami-
nation  remained  within the  confines of a  non-institutional
development  of  the  EMS,  although  views  as  to  the  precise
limits of  such a development  differed.

peak  of  almost  50000  million  ECU  in  April  1981,  with  a
subsequent fall  to 42 000 million ECU  at present.  The key  to
these  developments  lies  almost  exclusively in  changes in the
price of  gold. The  volume of  ECUs  created  against  gold
transfers  rose from  16 000  million  ECU  at  the  start  of  the
system to 32 000 million ECU at present (i.e. from 58% to 75%
of  total ECU  creation).  The amount  of  ECUs  issued against
the transfer  of dollars has, on the contrary, remained generally
stable, ranging between 10 000 and 12 000 million ECU  since
the  start of the  system,  because  o/  volume  declines  which
almost  totally  offset 
ation.

the  rise  caused  by  the  dollar's  appreci-

2.  Before  examining automatic formulae  acting either on the
valuation  rules or on the  volume of  reserves  transferred, the
Alternates considered an alternative approach:  endowing the
Board of  Governors of the  EMCF  with  some  discretionary
powers over the adjustments  to be made on the occasion of the
swap renewals. These powers could be limited to the possibility
of  overriding the agreed rule under  well-defined  circumstances

1979 were left to an agreement between central banks). Such a
step could be justified  by the consideration that, in the existing
system, there is an over-reliance on automatisms, which always
risk producing unforeseen  results, and an insufficient  scope for
stability-oriented  discretionary decisions.  Under  these circum-
stances, the growth in ECU  volume and its distribution between
participants  cannot be expected to  always  reflect the  overall
objectives  of the system. Such a step is, however, generally seen
as moving  into  institutional ground;  one should furthermore
not  underestimate  the  contribution  that  automatic  and  clear
rules  have  made to the  overall  credibility of the  system,
avoiding potentially  difficult  discussions at periodic intervals.

and on  specific  items  (e.g.  valuation  rules,  which  already in

3. The  Alternates  examined the possibility of  reducing the

volatility of ECU  creation by  acting  through the  valuation

rules.  Central  banks  would  still  swap 20% of  their gold and
dollar  reserves,  but  the  valuation  method  would  be  changed
and/or,  in the same line of thinking, the duration of each swap
would be extended.  In  this respect, the Alternates agreed that

any solution which would lead to disregarding the market price

of the reserve assets for any extended period of time would be

I. How can the volume of  ECUs issued be

divorced  from the two widely fluctuating
variables, the  market  price  of  gold  and the
exchange  rate for the dollar?

/.  Since the inception of the EMS, the rules governing ECU
creation against swaps  of gold and dollars have led to marked
fluctuations in the  total  volume of  ECUs  issued. The amount
rose from  an  initial  27 000 million  ECU  in July  1979 '  to  a

undesirable. Renewing swaps at unchanged prices would mean
that  over  time  the  value  of  the  ECU  issued  could  diverge
markedly from  the current  value of the underlying  assets, with
the  ECU  assets  thus becoming much more  (or  less)  valuable
than their backing, which could in either case adversely  affect
the use of the ECU. ft  could furthermore give the impression of
an  attempt  to  peg  the  price  for  gold,  in  contrast  to
commitments  under  the  IMF  Articles of  Agreement.

On  the  above  grounds,  the  Alternates  would  tend  to  reject
proposals aimed at stabilizing ECU  creation through a 'freeze'
on  the gold and  dollar price for  future  swap  renewals.

1 

July  1979 is taken as (he point of departure for comparisons as it is the date
at which (he IJniled Kingdom joined other members in transferring 20% of
iis  gold and US  dollar  holdings (o the  EMCF.

3.1. The Alternates did,  however, consider  three possibilities

for  moderating  the  effects  of  erratic price movements:

79

Documents relating to the European Monetary System

(i)  a  lengthening  of  the  duration  of  the  swaps  from  the

(i)  a  'uniform  shares'  rule:  central  banks  would  transfer

gold and dollars according to a uniform  proportion, say

20% of  their holdings of  each asset. At  subsequent swap

present 3 months to say 6 or 12 months.  This  would
reduce  the frequency  of  the  adjustments  and  therefore
somewhat  dampen the  short-term  volatility in ECU
creation, but would not avoid large movements when the
adjustments  eventually 
encounter legal difficulties 

in certain member countries;

took  place, and  would  also

(ii)  a lengthening of  the reference  period for  the  valuation of
gold, with the existing caveat of  using whichever is lower
between the average price and the  latest  market price.
This would of  course moderate  the growth ofECUs  in a
period of  rapid  gold price  increases, albeit to a  limited
extent  (see  attached graph)  ;  the  effect  could be  more
significant  only  if  the  reference  period were much longer
than 12 months;

(Hi) an alternative proposal is to value gold conservatively by

comparison  with present  market  rates, for  example by
applying  a discount of 10 or 20% in the current price. This
would  have  a  once-and-for-all  effect 
in  reducing  the
volume of  ECUs  created, but  would not  eliminate
subsequent  volatility,  unless  the  discount  varied  pro-
portionately to price movements.

3.2.  The above methods  are not mutually  exclusive and could
perhaps be combined. In all cases, to the extent to which they
succeed in dampening the  effects of  unstable market  variables
on ECU  supply,  they necessarily  lead to a divergence between
the  internal  and  the  market's  valuation  of  the  underlying
reserve  assets.  These  methods  would  thus  all  require  a
compromise between the objective  of moderating the  volatility
in ECU creation and the principle, stated in point 3 above, that
any prolonged or marked departure from  market rates should
be  avoided.

4.  The  Alternates  finally  examined  various 
'closed  pool'
systems for  controlling  the  volume  of  ECUs  issued.  In  such
systems  the quantity  ofECUs  would in principle be fixed  and
the  volume  of  reserves  transferred  by  each participant  at  a
swap  renewal  would be  adjusted in accordance  with the price
evolution of the assets. The percentage of  reserves transferred
would accordingly change at each swap, i.e. the 20% rule would
no  longer  be  applicable.

4.1.  The first  issue  arising  in  this  context  relates  to  the
decision-making process for fixing the initial volume ofECUs
to be created and for  subsequent periodic  reviews  (annual  or
biennial). The Alternates did not discuss this point as it falls
beyond  their mandate.

renewals,  the  adjustments 
changes (while maintaining constant the total volume of
ECUs created)  would be made in such a way as to ensure
that  each  central  bank  continued  to  transfer  an  equal

to  take  account  of  price

proportion of its holdings of the two  reserve assets, e.g.

18% of each if  the price of  the reserve assets had risen or
22% of each if it had fallen. The current proportion under
this system (if  ECU creation had been kept at its original
level)  would be  12% of central banks' gold holdings and
12%  of  their  dollar  reserves, instead  of  the  initial  20%
(see  Table  1).  This  system  would,  however,  have  the
drawback  of making the amount of dollar  transfers  vary
also  in relation  to the gold price;

(ii)  an alternative system  would be one where gold  transfers

inversely  to  movements  in  the  dollar

would  vary  inversely to movements in the gold price and
dollar  transfers 
exchange  rate.  This  system  could  work as follows: to
establish the initial quantity  of ECUs, a given proportion
of gold and dollars  would be  transferred.  At subsequent
swap  renewals, gold or dollars  would be  returned to or
requiredfrom  each participant in proportion to price rises
or falls of  these  assets in  terms of the ECU. With  this
system,  the  total  amount  of  ECUs  created  remains
constant, as does the share of  this total allocated to each
participant,  whereas  under the  present  arrangements
these factors  vary in relation both to market prices and to
volume  changes.  The  system  would  in fact  function  as
though a constant ECU allocation had been made to each
participant  until a new decision was taken. Its operation
could possibly have adverse  effects on liquidity for  dollar
holders.  Had  such  a  system  been  applied  during  the
period since July  1979, the subsequent price movements
in  gold and  dollars  would  have  resulted in  sizeable
reductions  in the  share  of gold  deposited  and  increases,
. for  most members, in the share of dollars deposited  (as a
proportion  of  their holdings of  these assets —  see  Table
2);

(Hi)  given  that the  main  cause of the fluctuations in ECU

creation has  been  changes in  the price  of gold,  another
possibility  would be to maintain the 20% rule for  dollar
the  volume  of  gold  transfers
transfers  but  to  adjust 
inversely  to  movements  in  the price  of  gold  and  in  the

ECU  creation  against  dollars, so as to  keep the  total

volume of ECU  supply  constant  (see Table 3).  This
would,  however, mean  that  the  two  assets  were  treated
very  differently 

in the process of  ECU  creation;

4.2.  The second point relates to the technical functioning  of a
'closed  pool'  mechanism.  Various  possibilities  were  con-
sidered:

(iv) 

80

the two latter systems could be modified  to take account
also of  volume changes in participants'  reserves, with a
country  which had  used  some of its  dollar  reserves
decreasing  proportionately 

the  dollars 

transferred.

Annex  C-2

Table  1

Share of  assets transferred to the EMCF in % of  gold and dollar  holdings
under a 'uniform  shares' rule

HI-1979

11-1980

1-1981

I-I9B2

Gold  Dollars  Total

Gold  Dollars  Total

Gold  Dollars  Total

Gold  Dollars  Total

20

20

20

128 

128 

12

12,9 

129 

129

20

20

20

12,8  12,8  12,8 11,1  11,1 11,1

12,9  12,9  12,9

27,3
15,8
11,6

185,064

1,37653

27,3
20,3
7,1

370,546

1,29517

27,3
21,3
6,1

446,958

1,33166

27,3
20,4
6,9

368,025

1,08806

Belgium
Denmark
FR of  Germany
France
Ireland
Italy
The  Netherlands
United  Kingdom

Amount of  ECUs created

(thousand  millions)
against  gold
against  dollars

Conversion  rates

ECU/ounce of  gold
USD/ ECU

Table 2

Share of  assets transferred  to the EMCF in % of gold  and dollar holdings
under  the 'rule of  proportionate  volume  adjustments for gold  and dollars1

Belgium 
Denmark
FR  of  Germany
France
Ireland
Italy
The  Netherlands
United  Kingdom 

Amount of  ECUs created

(thousand  millions) 
against  gold 
against  dollars 

Conversion  rates

ECU/ounce of gold 
USD/ECU 

111-1979 

11-1980

1-1981

1-1982

Gold  Dollars  Total 

Gold  Dollars

Total

Gold

Dollars

Total

Gold

Dollars

Total

9,7  54,2

19,7
18,2

10,0 
10,0 
10,6  19,7
10,0  23,7
10,0  22,4
9,8  19,2

27,3
15,8
11,6

370,546

1,29517

20 

20 

20 

27,3
15,8
1 1,6

185,064 

1,37653 

11,4
32,8
13,6
11,3
17,7
12,7
11,3
14,7

8,3
8,1
8,3
8,3
8,8
8,3
8,3
8,1

15,3
26,6
21,5
16,8
12,5
26,9
21,3
21,2

9,1
20,0
12,4
9,5
11,8
11,2
9,5
14,0

10,0
9,8
10,0
10,0
10,6
10,0
10,0
9,7

12,5
29,8
20,5
20,2
15,5
22,6
21,1
29,0

10,4
23,0
13,8
11,5
14,6
12,7
11,3
17,7

27,3
15,8
11,6

446,958

1,33166

27,3
15,8
11,6

368,025

1,08806

Unlike the adjustments  made in relation to price changes,
these  adjustments  would  change  the  total  quantity  of
ECUs  created  (except  in  the  unlikely  case  of  precisely
offsetting 
volume  movements  in  the  participants'  re-
serves) . The system  would thus reduce  volatility in ECU
creation but  would not  operate as a pure  'closed pool'.

4.3.  A  third  issue  is  whether  in  all  the  above systems  there
should be a fixed  rule regarding the proportion of reserves to be
swapped or whether, given that  each country may  differ 
appreciation  of  what  constitutes  the  most  appropriately
balanced portfolio  of gold and dollar  reserves, countries could
be  given  some  latitude  (e.g. ±5%)  in  the  distribution  as

in its

81

20 

20 

10,0 28,1

20 

Documents relating to the European Monetary System

20  13,7  10,5

10,2 20 

8,6 

20 

20 

15,3 

20 

Table 3

Share of assets transferred  to the EMCF in % of  gold and dollar holdings
under the 'role of  volume adjustments of  gold only*

Belgium 
Denmark 

FR of Germany 
France 
Ireland 
Italy 
The  Netherlands 
United  Kingdom 

Amount  of  ECUs created
(thousand  millions) 
against gold 
against dollars 

Conversion  rates

ECU/ounce of gold 
USD/ECU 

III-1979

II-1980

1-1981

1-1982

Gold  Dollars  Total

Gold  Dollars  Total

Gold  Dollars  Total

Gold  Dollars  Total

20 

20 

20 

10,2 20  11,0 

1 5,3

13,9

1 1 ,8
17,9
12,2
11,3

86 

20 

9,9 

15,9
12,1
10,2
18,0
10,4
9,6

10,5

20  12,0
16,8
14,0
11,9
18,3
12,5
11,6
20  14,5

27,3 
15,8 
11,6 

27,3 
16,2 
11,1 

27,3 
16,4
10,9

185,064 

1,37653 

370,546 

1,29517 

446,958 

1,33166

27,3
6,6
0,7

368,025

1,08806

ECU/GOLD  RATES  (ECU per  fine  ounce)

520

480

440

400

360

320

280

240

200

160

82

Rate  used  for  swap
operations  with  Ihe  EMCF

Price on  penultimate working
day of  previous  monlh

Average price  over
six  previous  months
Average  price  over 
twelve  previous  months

.

M  A  M  J

J  A
1979

S O N DJ  F M AM

J

J 

A S  O N DJ  F M AM

J

J 

A  S  O  N  D

1980

1981

Annex C-2

between gold and dollars, which would help to overcome some
technical difficulties for the monetary  authorities. This  would
introduce an element of flexibility,  but also of arbitrariness, in
the system.

rigid rules, there should be a presumption that the financing of
intra-marginal  interventions  through the  VSTF  would be
justified, for  example,  when a given bilateral spread  (say 2%)
is reached  or  when the divergence  threshold is crossed.

4.4.  In  conclusion, a  'closed pool'  system  would  allow  ECU
creation to be controlled and divorced from  market  variables.
It  would, however, mean departing from the 20% rule set out in
the  European  Council  Resolution  of  5  December  1978,  and
though market  variables would no longer influence  the volume
the  volume  of  reserves
of  ECUs  created,  they  would  affect 
transferred.  In some cases, the different 
treatment of gold and
dollar  assets  would  be accentuated.

II.  How  is  the  extension of  the  very  short-term
facility to the  financing of  infra-marginal

interventions to  be circumscribed (either  by
attaching conditions, imposing a ceiling, or
limiting its  duration)?

5. The  Brussels  Resolution  states  that in principle  interven-

tions in the EMS  will be made  in participating  currencies and
provides for  diversified  interventions  when a currency  crosses
its  divergence  threshold.  The  Agreement  of  13  March  1979
between  the  central  banks,  however,  makes  no  specific
arrangements  for 
intra-marginal  interventions  or  their
financing; such interventions are carried out on an ad hoc basis
within  the framework  of  concertation  among  EEC  central
then  depends  on  bilateral
banks.  Currency  availability 
agreements  on  either  credit  lines  or  using  working  balances
(limited  in  principle  by  Article  15  of  the  central  banks'
Agreement).  Intra-marginal 
interventions  in  Community
currencies have nevertheless been considerable, amounting to
over 20 000 million dollars or some 55% of  total interventions
in  Community  currencies since the  inception of the system. '
No  intra-marginal  intervention sales in EMS  currencies  were
covered by  very  short-term financing  through the  EMCF.

The Alternates have confined  their examination to the general
orientations  which might govern  the possible extension of  the
VSTF to intra-marginal interventions; it  would be the task of
central bank  experts  to eventually  define the  technical details
of  its  implementation.

6. It is the general  view that, if  access to the  VSTFfor 
marginal  interventions  were to be  made  automatic or  semi-
automatic  as  discussed  below,  such  access  could  be  made
subject  to  a  trigger  related  to  the situation  on  the  exchange
markets  (a presomption de declenchementj.  Without fixing

intra-

The  significance of  this figure  should, however, be qualified: it includes
repurchases of  the currency previously sold as well as the sale of proceeds
of  official  borrowing.

7.  The  Alternates felt  that  the  extension  of  very  short-term
financing  to intra-marginal interventions should in any event, if
they  were  to  be  automatic, be  circumscribed  by  imposing  a
ceiling for  each participating currency. It would be necessary to
fix  rules determining the amount of  this ceiling  (e.g.  related to
quotas in the  short-term  monetary  support  mechanism), on
how it would apply  to debtor and creditor central banks, on how
a ceiling would be reopened, etc.  Within such a ceiling, cover of
intra-marginal  interventions by means of the  VSTF  could be
either  completely  automatic or  semi-automatic, in the  sense
that the central bank issuing the currency of intervention could
object  only in the  case of  special and  concrete  circumstances
(such  as conditions on  the exchange markets  or on domestic
monetary markets)  which it  would be required to illustrate  to
the other authorities in the framework  of concertation or in the
appropriate  Community  bodies.  The  making  available  of
amounts  in  excess  of  the  ceiling  to finance  intra-marginal
intervention  would  continue to be a  matter for  concertation

between  central banks on an ad hoc  basis.

8.  Apart from fixing a ceiling, one could envisage altering the

other elements of the  VSTF  (duration,  interest rate, means of
settlement, etc.)  when extending  the facility to intra-marginal
interventions. This  would, however, be tantamount to creating
a new facility  and could not be described as an 'extension' of the
existing  VSTF.

9.  In  this  context the  question  arises  whether the  conditions

under which intra-marginal interventions can take place should
be  altered. The  Alternates  agree  that it is  of fundamental
importance for the proper functioning of the  exchange  rate
mechanism  that  intra-marginal  interventions should  continue

This being said, it has been suggested that central banks should
be  given  more  leeway in  their  on-the-spot  decisions for
interventions in participating currencies, by making available a
limited amount  of  individual  Community  currencies for  intra-
marginal  interventions.  This amount  could be used automati-
cally, in case of emergencies, on the intervening central bank's
own initiative and on the understanding  that the issuing central
bank and the other central banks should be informed  without
delay.  This proposal relates to the availability of currencies for
interventions and does not touch upon the question of financing.

10.  Some  Alternates  consider  that  if  automatic facilities for
limited  amounts  were  accepted, 
currency  was being used might be expected  to discourage intra-
marginal  interventions  beyond  those  limits;  thus  the present
flexibility  would  be  reduced  rather  than  increased.  These
Alternates are furthermore of the  opinion  that the use of the

the  central  bank  whose

83

to be the  subject of  close  concertation  among  central banks.

Documents relating  to  the European  Monetary  System

VSTF  for  intra-marginal  interventions  is justifiable  only  if
there is a  sufficient  probability  that  these  interventions  will
reduce  the  total  of  interventions  otherwise  needed.  Thus,  the
presumption  should  not  relate  to  a  currency  becoming
divergent but  rather to the  causes of the  imbalance and the
measures being  taken to remedy it.

In  the  view of  the other Alternates however, the application  of
such principles  would  not  represent  a  significant  departure
from  present practices.

III. How can the option open to  non-Community

institutions to  hold ECUs be organized?

11.  The Alternates examined the above question in relation to

the  external use of  ECUs. issued by the  EMCF,  i.e. not in

relation to ECU-denominated paper  which might be issued by
other  Community  entities or by private financial  institutions.
The possible interest of  third parties in holding ECUs has also
not  been examined.

12. A general principle governing the external role of the ECU
should  be  that  third  holders  of  ECUs  should  be  subject  to
substantially  the  same  rights  and  obligations  concerning  the

ECU  (use, remuneration, etc.) as those of participant  central

banks:  the  single  nature  of  the  ECU  should  not  be
compromised in extending its role beyond the Community.  The
conditions for  acquiring  ECUs  will  accordingly  also  have  to
reflect  the ECU's present precarious existence.

13. A first  possibility  would be to permit  designated  third
holders  to freely  acquire  existing  ECU  assets from  EMS
members. ' For example, a member  central bank  could swap
ECUs for  dollars  with a third country central bank in order  to
mobilize its ECU  holdings.  This swap could not be allowed to
overlap the  underlying  swap of the member central bank  with

the EMCF.  Such  transactions  would not  imply an increase in

surrender its ECU assets, if necessary, to allow EEC  members
to settle their obligations at the swap  renewals and in (he event
of  a  definitive  unwinding  of  the  swap  mechanisms.

14. A second possibility  would be for the EMCF to issue ECUs
to third countries against  the contribution of reserve assets, as
it  does  with  member  central  banks.  The present  legal  texts
empower  the  EMCF  to  issue  ECUs  against  the  transfer  of
reserves  by  the  monetary  authorities  of  the  Member  States
alone. To authorize it to issue newly-created ECUs against the
contribution of  reserve assets by  non-Community  institutions
would 
the  relevant
Regulation  (EEC  No  3181/78).  Unlike  the first  case,  new
ECUs  would be created by  this operation  and third countries
would furthermore be given the possibility  of mobilizing part of
their  gold  holdings  through the  Fund,  thereby  increasing
mobilizable  international  liquidity.

require  a  modification  of 

therefore 

This  formula  would  seem  particularly,  if  not  exclusively,
suitable for  those  European  countries  with particularly  close
economic and financial  ties with the Community  wishing to be

associated to the EMS  exchange  rate and  intervention

mechanism. The  association agreement  would have to set out
the  conditions  for  acquiring  and  using  ECUs  on  terms
analogous to  those  applied to  member  central  banks. It is
doubtful  thai such an extension  of  the  ECU  would  appeal  to
third countries unless the ECU  were established as a full means
of  settlement  within the system.

15. In a  broader  perspective, an  external  role for the ECU
could  be  envisaged  as  a  reflection  of  a  demand for  reserve
diversification  by non-Community  institutions. A possibility of
this  kind is  examined in  more  detail in the  note by the
Commission  departments on the  external  role of the ECU, 2
already  discussed  in depth  by  the Alternates. In  the majority
view of  the Alternates, such a development  would presuppose
inter alia, that the ECU  were already a fully-fledged  means of
settlement and reserve asset for  EMS  participants, that it had a
less precarious existence  than  that  deriving from  the present
revolving  swap  mechanisms, and  that 
transformed  into  an  institution  able  to  support  an  exchange

the  EMCF  were

rate  risk and to  offer  real  possibilities of  substitution. The

'substitution

the total volume of ECUs in circulation; there would merely be
contrary  view is  that one  could  envisage a 
a transfer,  in the EMCF's  books, of ECUs held by members to
third holders. Such a transfer  could also take the form
official 
of  a  sale  rather  than  a  swap,  provided  a prior  'third  holder
arrangement' had been concluded between the EMCF and the
third  party  concerned,  setting  out  in  detail  the  terms  and
conditions for  acquiring,  mobilizing and  restituting ECU
assets.  The  third  holder  would  in  particular  be  required  to

account' without institutional convertibility:  its attractiveness
would obviously be reduced, but the conversion of  ECUs  into
third  currencies  could be  ensured at a  market  rate, in the
framework  of a negotiability formula  between member central
banks and  third holders.  There is  therefore  scope for a non-
institutional development  in this regard and, according  to this
view, the matter  deserves to be studied further.

Allowing  third  parties  to  acquire  ECUs  in  this  way  would  entail  a
modification of the composition of their reserves as well as of those of the
member central banks concerned. This would run counter to the limitation
of  Article  18(4) of  the  13  March  1979  Agreement  which  rules  out
operations having the sole purpose of altering the composition of a central
bank's reserves. The question of lifting  this limitation for third holders or
of abolishing it altogether would need to be further  examined.

84

See Annex I -5: Preparatory studies on the European  Monetary Fund -

External role of  Ihe ECU.

Annex  C-2

IV.  How  would the  problems of  legal  tender

arise in relation to  the  free  circulation of  an
ECU  coin minted  according to  national
procedures?

would be of  negligible  size  vis-a-vis the  Community  money
supply and as such  would not  raise significant  problems  with
respect  to the likelihood of additional infra-Community  capital
flows.

16. The Alternates examined this question in full  awareness of

the limits of  their competence as regards the legal implications
of such a step and the more technical aspects  of the mint. These
aspects, whose importance and potential difficulties  should not
be underestimated,  would haw to be studied by the competent
experts  at  the  appropriate  time.

value to be set at the  level of the  participating  currencies'

17.  From a legal point of  view, it  appears  that  adaptation of

national legislation  concerning the minting and circulation of
coins will be required in most or all countries, whether the ECU
coin is granted full  legal tender  (i.e.  compulsory  acceptability
by  all  economic  agents  within  a  certain  amount,  as  with
national  coins) or  whether it  enjoys  voluntary  acceptability
between  agents.  The  question  of  the  issuing  authorities'
commitment to repurchase the coins at a given rate would arise
in both  cases.

19.  Doubts were raised as to whether the coin would effectively
remain  in circulation, given also past experience  with  certain
national  coinages  issued in small  amounts.  Doubts  were  also
expressed as to whether the coin would be used in transactions.
The rules governing its conversion rate into national currencies
would  be  an  important  element  in  determining  its  effective
circulation.  A first  possibility  would  be for  the  ECU  coin's

central rates, rounded off to an appropriate figure.  This  would
confer  a certain stability  to its value between two realignments,
but  would raise a number of  difficulties: 
the  central rate rule
could not be applied for  conversion into pounds sterling or into
Greek drachmas, nor into Belgian francs, given the existence of
a  dual  exchange  market;  it  would  introduce  a  distinction
between the ECU  coin converted at the central rate and ECU-
denominated  deposits  to  which  market rates  are  applied;  it
would  create  arbitrage  possibilities,  in  so  far  as  national
currencies could be exchanged at their central rates through the

ECU  coin. It  should be  noted,  however,  that the practical

18. As to the amount of the issue, the Alternates suggested that

a global ceiling should be fixed for the Community as a whole,
with  quotas per  member  country  based on some  appropriate

key  (weight in the  ECU, quota in the  STMS,  etc.). If the

amount  were a modest proportion of  total coin circulation, it

significance of  these difficulties  would be limited by the small
denomination of  the coin  (which s'muldbe  of  I  ECU)  and  the
modest amount of  the issue in relai  n to total coin circulation.

A  second  possibility  would be  for 

the ECU  coin to be

exchanged at market rates, though  this  would raise practical
difficulties 

in transactions given the fluctuations in daily  rates.

85

ANNEX C-3

Supplementary  report on some aspects of the non-institutional development

of the European Monetary  System presented on 26 February 1982

by the Alternates of the Monetary Committee

At the Monetary  Committee meeting of 11 February 1982, the
Alternates were  invited to examine the following  question:

'In the context of the abolition of the ECV's acceptance limit,

II.  Mobilization through the EMCF

3.  The technical considerations concerning a scheme by which

what technical arrangements could ensure that holders of ECU
net credit positions could mobilize such positions against other
assets?'

ECU  mobilization is  assured by the  EMCF are  mainly

The Alternates met on 23 February  1982 and herewith submit
their report to the Committee. As in their previous report, the
Alternates  refrained  from  discussing  the  desirability  of
amending  the  existing provisions of  the system  and  confined
their examination to technical aspects  in the context of a non-
institutional development of the EMS.

The first  section of this report recalls the existing provisions for
mobilizing  ECUs  and  their limitations.  The second and third
sections  discuss  possible  new  schemes  for  ensuring  such
mobilization. The  last  section  offers  some  concluding  com-
ments  regarding,  inter  alia,  the  difference 
schemes and full  institutional  convertibility.1

between  such

I.  Preliminary  remarks

1.  According  to  the  existing provisions  of  the  Agreement  of
13 March  1979, a  central  bank may  acquire  dollars  against
ECUs  either  from 
the  EMCF,  by  unwinding  a  swap
transaction, or from  another  central bank.  In  the first  case,
mobilization can in practice only  be used in the case afafall 
in
dollar reserves; it does not  apply to the mobilization of ECU
net  credit  positions.  In  the  second  case,  the  transaction  is
subject to mutual agreement. In both cases, mobilization is at
present  restricted  by  Article  I8(4)of 
the  Agreement  stating
thai  the operations  referred  to above  'shall not  be carried out

for the  sole purpose of  altering the  composition of a  central
bank's  reserves'.

2.  Although mobilization  could  conceivably be allowed more
freely by  removing  this provision, it  would not  ensure  that
holders of ECU net credit positions could at any time mobilize
such positions. Therefore, two  types  of schemes are examined
below, which could be devised to offer  this possibility, subject  to
amendments  in the present arrangements.

Under  both schemes, the right to mobilize an ECU net  credit
position might  either be unconditional, or be subject  to some
requirement of  need, or be  restricted to net  credit positions
exceeding  a  specified 
threshold.  Any  limitation  on  ECU
mobilization wouldlessen liquidity problems for  the system but
would  on  the  other  hand  restrict  the  degree  of  effective
convertibility  of  net  credit positions.

circumscribed by the swap system through which reserve assets

are  transferred.

4.  ECUs  are  created  against  both  gold  and  dollars  but
mobilization  would  presumably  only be  against  dollars.
Depending  therefore on the stringency of the conditions under
which mobilization is possible and/or on the possible ability of
the Fund to acquire currencies from  outside  the system, there
could be a liquidity problem  if  large net  credit positions arose
and the  central  banks  concerned  sought to  mobilize  them,
especially as the majority of  ECUs are created against gold.

5. The swap method of  transfer  limits the way in which dollars

can  be made  available  through  the  EMCF  and mobilization
could  only be  accomplished  through a  swap in the  other
direction  between the  Fund and the  central  bank  concerned,
thereby  temporarily  destroying  ECUs.  Such a  swap  would
initially  have to match the duration of the swap in force and
would from  then on be open for  renewal on a quarterly  basis
under  the same  conditions  as  the  original mobilization.

6. The  EMCF  under  existing  arrangements  returns the

management of  transferred  assets to the participating  central
banks.  These  dollars  are  invested  in  various  maturities
according to the central bank's preferences, and the remuner-
ation is retained by  them. It  would .therefore be necessary to
specify  criteria  under  which the  dollar  assets to be  used for
mobilization  would be selected, and provide  compensation for

the  loss of  remuneration,  including the  possible  costs of

unwinding  investments  before  maturity.  These  costs  would
have to be charged to the  central bank  mobilizing  ECUs.

III.  Mobilization  with the other participants in

the system

7.  This  scheme  provides  for  mobilization  with  the  other
participants according to a designation plan. It would allow the
ECU  to be mobilized not only  into dollars but also into SDKs.
Mobilization in Community  currencies could also be envisaged
but  this  possibility  should  be  assessed  in  the  context  of
enhancing the  scope for  intra-marginal  intervention or for
reimbursement  before  maturity of ECU  debts in the  VSTF.

The  convertibility issue was discussed by the Alternates in the context of
the institutional phase of the system when assisting the Commission in its

studies for  the  European  Monetary  Fund (see Annex  1-5).

(a)  criteriafor  the designation of the potential ECU  recipients.

Possible  criteria are the following :

86

8. The scheme  raises the following  issues:

Annex  C-3

(i) 

the  balance  of  payments  and  the foreign  reserves
situation ;

IV.  Concluding  remarks

(ii) the  composition of  reserves;

(Hi) 

the  credit  or debit position  in ECUs  in the  VSTF;

(iv)  some  quota  system  such as that in the STMS;

(b)  the mobilization  technique: the actual mobilization  could
either take the form  of a swap  transaction or of a straight
transfer;

(c)  constraints on the  operation of the  scheme: a  major

constraint  would arise  when all or most participants  were
simultaneously  in  a  deficit  position  with  the  rest  of  the
world. A possible solution to  this problem might be found

by the  EMCF  borrowing  currencies  outside the  Com-

munity  under  conditions consistent  with its present status,
e.g. borrowing  with the BIS.

9. It was observed that, given its basic regional character, this

scheme  differs  from the SDK  designation  system: first of all
the present  method of ECU  creation  implies  that the ECU
system  is not  a zero-sum mechanism, as  is  the SDK  scheme.
Moreover,  the  EMCF—unlike  the  IMF  with  the  SDRs—
cannot  become  a holder  of  net  creditor positions in  ECUs.

10. The  view was expressed  that, irrespective of the mainten-

ance or abolition of the 50% rule, a designation scheme would

imply  another  acceptance  limit  beyond  which a  central bank
would  not  be  obliged  to  accumulate  ECUs  by  virtue  of
designation.

from  a  technical  point  of  view  from  full

11. The  Alternates  examined the extent to  which the  above
formulae  differ 
institutional convertibility for net ECU credit positions. In the
first place, unless there were recourse to assets from  outside the
system,  the  potential  of  mobilization  would  be  limited,
according  to  the formulae,  either  by  the  size  of  the  Fund's
dollar  holdings or by the  volume of  assets  which  could be
activated under a designation scheme. Secondly, the formula of
mobilization with the EMCF  would satisfy  short-term liquidity
needs, but would still leave the central bank  with a net forward

ECU  position.  Thirdly,  mobilization  with  other participants

through a designation scheme would,  if  done by  transfer,  have
the same  immediate result for  the mobilizing  central bank  as
institutional  convertibility.  However,  the  central  bank  con-
cerned might  at  a later stage find  itself  subject  to obligations
under  the designation  scheme. Furthermore, given the limited
number of participants, the operation of such a scheme could be
constrained if all  members  were in  balance-of-payments

deficit. For  designated  central  banks  with ECU net  debtor

positions it would be tantamount to a reconstitution obligation.

12. In  conclusion, none of the above formulae  would seem to
pose insurmountable technical difficulties.  They  are, from  this
point  of  view, feasible.  They  would,  however,  require  rather
elaborate rules and procedures, which could give the impression
that  there is some unwillingness to keep  or acquire ECUs  and
might do a disservice to a system  which should remain largely
based on mutual cooperation  and flexibility.  Against this, the
schemes described could go some way to increase possibilities

for  central  banks  accumulating  large ECU net  creditor

positions  to mobilize  these positions.

87

ANNEX  D

Commission communication to  the Economic and Financial Affairs  Council

of 15 March 1982 on the development of the European  Monetary System

Consideration of the system's future  began in May  1979. The
subject was taken up by the Commission in dose  consultation
with the  Monetary  Committee and the  Committee of
Governors.  The  discussions  took  into  consideration  and  were
modified  by  developments 
in  the  Community's  economic
situation  and by  upheavals  in  the  international  environment.
On  several  occasions  there  were  Council declarations  on  the
subject and in  March  1980 the  Commission  presented the
European  Council  with a  report on the  European  Monetary
Fund.

before  and generally adapted  to the requirements of the system,
even  though  hindered  by  the  steep  rise  in  US  interest  rates,
which  led  to  a  level  of  interest  rates  in  Europe  incompatible
with the low economic activity  and the scale of unemployment.
The system, however, has not led to a sufficient  convergence of
inflation  rates: from  1979  to  1981, the inflation  rate average
rose, and the spread widened under the combined impact  of the
second oil  price  shock, the  soaring  dollar and  insufficient
internal  discipline as  regards  costs and public finance.

At  its  meeting  on  15  February  1982,  at  the  end  of  a  wide-
ranging debate, the  Council found  that a number of  measures
could be taken to develop the EMS  in the following four  areas :
improving  (he system's  mechanisms, opening  up  the  EMS  to
the  exterior,  promoting  the  private  use  of  the  ECU  and
reinforcing  convergence.  On  this occasion,  the  Council  took

note of the  Commission's  intention to put  forward  specific

proposals,  in good  time for  its meeting  on  15 March.

The present communication is in response to that undertaking.
In  it,  the  Commission proposes  the  adoption  of  a  group  of
measures to  consolidate and develop the system; it insists on
their importance by recalling the actual words of  the foreword

to the  draft  fifth  medium-term economic policy programme:
'With the  European  Monetary  System, the  Community has

embarked on an ambitious, albeit gradualist, venture aimed at
stabilization  and  convergence.  The  contribution made  by  the
system  —greater  certainty in  economic  activity, a  strong
incentive  to keep  the  key  economic  aggregates  in balance, a
stimulus to policy convergence and the added  weight it gives to
Europe in international monetary  cooperation —  should be a
major factor  in the success of  the  strategy  set  out  in  the fifth
programme.' In  other  words, the  Commission  considers its
proposed measures for  developing  the system  to be a necessary
and  realistic  step  towards the  institutional and final  phase,
which is still the ultimate objective  of  the European  monetary
edifice.

A. The ECU

The  successes attributable to the EMS are  therefore  fragile,

and the object  of the Commission proposals is to strengthen and

consolidate the system from  within so that its contribution to
stability and its ability to resist  outside shocks are increased.

the  EMS  do  not 

impinge  on  the  re-

The following proposals, which are expressed in a text based on
the  format of the  resolution of 5 December  1978 on the
establishment  of 
sponsibilities of the  various  Member  States,  over  their
monetary  policies.  Their  implementation  will  stimulate the
system  towards  its  objectives  and  increase  its  contribution
towards  improving  the general economic situation in Europe,
since monetary stability, more certain prospects and increased
employment  are  closely  linked.  The  proposals  respect  the
existing  institutional framework  and form  a balanced  whole,
both from  the  viewpoint  of  creditors'  and debtors'  rights  and

obligations and of the elements of  solidarity and strictness on

which the system has been based. Further, as demonstrated by
the work  undertaken  in close consultation with the competent
committees, their  adoption  is technically possible.

The  role of  the  official  ECU  as  the  very  centre of  the system
should be reinforced.  Also the current extension of  the private
use  of  the  ECU  should be facilitated  and  organized.

(a) ECU  creation and use in the system

The  purpose of the  system,  clearly  defined  when it was

launched, is to establish  'closer monetary  cooperation  leading
to a  zone  of .monetary  stability in  Europe'.  Three  years of
operation  have  shown  that  the  EMS  has  succeeded  in

stabilizing the exchange rate relationships  of the participating

The monetary nature of the ECU flows from its characteristics
concerning: method of  issue, convertibility and acceptability.

currencies,  whereas the  exchange  rates of the  major  third
currencies (the dollar and the yen)  and of the non-participating
Community  currencies  have  been  very  unstable.  Altogether,
five  realignments of central rates have taken place, but two of
them have involved one currency  only;  all have been made by
mutual agreement in orderly market conditions, on the basis of
a  common procedure  which has  avoided  competitive  devalu-
ations. Throughout  these three years, exchange rate manage-
ment  has  drawn  heavily  on  the  possibilities  offered  by  the
system's  exchange rate and intervention mechanism; national
monetary  policies  have  been  more  closely  coordinated  than

for the ECU in the EMS. The widest acceptability for the ECU

In  this  respect  the present  system  is  less  than  satisfactory.
Experience has proved the method of issuing the ECU not to be
fully  rational, and its  convertibility  has remained embryonic.
Thus  the  limits  imposed  on  its acceptability  have, somewhat
paradoxically, looked like a protective measure. The perspect-
ive must be reversed, so that it conforms  with the role planned

must  be  sought,  and  the  corollary  must  be  some  degree  of
control over the process of creating ECUs and the organization
of  arrangements for  mobilizing it.

88

Annex  D

The creation of  ECUs against  transfers  of  reserves has in fact
been disorderly and potentially  inflationary: as a result of the
quarterly  swaps, the 27 000  million ECU  created in  March
1979  became almost  50 000  million in April  1981; the figure
has now fallen  to 42 000 million. Although these variations are
primarily  linked to the  variations in the  price of  gold, the
volume of ECUs issued should be divorced from the two widely
fluctuating  variables, the price of gold and the dollar exchange
rale, so  (hat ECU  creation  can be  controlled.  At  present, at
each quarterly  swap  renewal, volume adjustments are made to
lake account of the variations in reserves held by  each central
bank, and  value adjustments  are made  to take account  of  the
variations in the ECU  price of the  assets  transferred. The
Commission proposes  that ECU  creation  should be  brought
under control by retaining the same volume adjustments, but by
applying the  value  adjustments to the  quantities of  gold and
dollars  transferred to the EMCF by the central banks, instead
of to the  outstanding  amount of  ECUs  issued.

Another  less  satisfactory  possibility  would  be  to  dampen  the
effects of  erratic  gold  price  movements on the  quantity of
ECUs by lengthening the reference  period used to calculate the
average gold price from  six months to two years.  This  would,
however,  entail  the  disadvantage  of  a  difference  between  the
price  of gold  on  the market  and  that  used  within  the system.

importance  of proposals  designed to  supplement the existing
provisions and to encourage and control the use of the ECU on
the markets.

It  is important  to define  a sort of  'ECU  trademark' so that the
term  and  the  instrument  'ECU'  is  used  correctly  by  the
markets.  The  necessary  Community 
legislation  should
therefore be adopted to protect the ECU  'trademark' and to
define it.  Such legislation  would also have to set out the rules
for  its use,  in order  to ensure  that  the  ECU  is not  deflected:
thus, for  example, prohibiting  the attaching  of  an indexation
clause  to  an  ECU-denominated  pecuniary  liability  would
ensure that the ECU remained the instrument of stability  which
is its purpose. In  this way the  wider private use of the ECU

would  be solidly  based.

The various Community institutions and the EIB  would have to
promote the  widest  possible use of the ECU for 
their
accounting  and  their  operations.  Further,  they  should  set  an
example  by  developing  the use of  the  ECU  in their borrowing
and  lending  operations to the full  extent  compatible  with the
ECU's proper  establishment on the financial  markets. Greater
use of  the ECU  by issues which each represent  another facet  of
the  Community's  institutional  edifice  would  strengthen  the
ECU's  role  on the markets.

would be set by the  Governors of the  central banks at a level

With the inflationary  danger  involved in the present method of
ECU  creation  eliminated,  the  use  of  the  ECU  should  be
encouraged.  The  abolition  of  the  ECU's  present  acceptance
limit for  settlement  of  operations  covered  by  the  very  short-
term financing  would enable the debtor  to clear his debt  in full

by  using  ECUs. In return, the creditor should receive a higher

remuneration on his net ECU  position  (the rate of  interest

derived from the market levels)  and be authorized to mobilize a
net  ECU  credit position beyond  50% of  its allocation, on  the
understanding  that  this mobilization possibility  would not  be
used for  the  sole purpose  of  changing  the  composition  of  its
reserves.

Other  steps  should be  taken to promote the  wider use of the

ECU and to make it a factor in the integration of the financial

markets  in  Europe.  First,  the  discriminations  currently
applying  to the ECU  in national regulations should be removed
(being neither a national nor a foreign  currency, it is subject to
any regulation applying to either). In the Community countries

the ECU  should be given the status of a foreign  currency and

even a privileged one. The principle  of free  movement, within

the  Community, of  ECU-denominated  capital  should  also be

established.  Finally,  the  EMCF  should  be  empowered  to
monitor ECU  operations and issues.

The  above  modifications to the  existing  rules  together  with
those  proposed  concerning  intra-marginal  interventions  (see
point  C(d)  below)  make  up,  in  the  Commission's  view,  a
balanced package  which  would ensure a larger  circulation for
the  ECU  while,  respecting  the  interests  of  both  debtors  and
creditors.

(b)  Private  use of  the  ECU

Alongside the  official ECU  circuit and  unconnected with it, a
private  ECU  circuit  is  now  developing.  It  is  natural  for
operators and  markets to be  interested in the  monetary
expression  of  a  vast  economic  area  in  the  process  of
integration. The  Community  should take care of  its monetary
image; it should not only promote, but also monitor, and even
guide  this  expanding  private  use  of  the  ECU. Whence  the

B.  Convergence

On an annual average over the last  three years, and expressed
in  national  currencies, movements  of  costs  and prices  in  the
countries  participating in the EMS  have  diverged  substan-
tially :  consumer  price  rises  range from  5,6% to  16,3% and
variations in the  relative  unit  costs of  labour  range from
— 14,5% to  +32,7%.  What  is more, the  deviations from  the
mean are increasing, ft is true that these movements would have
been  even  more  unfavourable  without the  EMS, but the
persistence of  these divergences imperils  the  very nature of  the
system. The  measures to  strengthen the  system  would be
useless if  they too did not  contribute to the  convergence of
economic and monetary policies.

89

Documents relating to  the  European Monetary  System

All dimensions of economic policy should be reconsidered from

the  viewpoint of  their  contribution to  convergence  towards

stability.  It  is clearly  a  long  and  difficult  exercise.  This goal
should  always be  borne in mind  when  economic policies are
formulated.  Some  concrete  decisions  should be  taken at
Community  level  and  be  implemented  rapidly.  The  main
objective  would be to arrange for policies to be concerted more
actively:

(a) by the  regular  discussion of the  national  intermediate

monetary policy  targets, and the level of  interest rates, in
relation  to  their  compatibility  with  the  economic policy
objectives pursued in common, without  however  affecting
essential  national  responsibilities,  especially  those of the
central banks;

(b)  by  enumerating  the  economic  and  monetary  policy

measures and instruments which are incompatible  with the
proper functioning  of  the EMS;  the use of  these should be
avoided;

(c) by establishing the principle  of the free  movement ofECU-
denominated capital, and by reconsidering the restrictions

on  movements of  capital  currently  authorized  under

safeguard  clauses;

(d)  by 

improving 

the  effectiveness 

of 

the  monitoring  of

to a set of

Member  States'  economic  policies.  Their  results and
methods  will be  assessed by  reference 
comparative  indicators and to  objectives  laid  down by
common agreement.  Once  they  started to diverge  signifi-
cantly, the Commission would have to make full  use of  the
existing  consultation and recommendation procedures;

(e)  by  establishing  a  mutual  information  and  monitoring

procedure on the  balance-of-payments  situation and the
external  indebtedness of the  Member  States; in  this
context, an assessment could be made of the desirability  of
early  recourse to  Community financing.

C.  External relations of the system

In the field of  international  monetary  relations, the  Com-
munity  lacks the  organization  needed for it to play the  role
asked of it as one of  the poles of the developing multiple reserve
currency system. As a result, it is handicapped in the dialogue
with the authorities responsible for the major  third currencies,

the US  dollar and the yen, at a  time  when such a dialogue is

essential  in  order  to  promote  the  orderly  evolution  of  the
international monetary  system.

The  cohesion of the system might not  withstand the repetition
of shocks comparable to those caused, in the last two years, by
the sudden and erratic changes in US interest rates (whichhave
doubled) and the dollar exchange rate  (which has appreciated

90

by  over  50%  against  the  major  European  currencies).
Circumstances demand  a common attitude  to third currencies
—particularly the  dollar— and an  expression of  this by
Community  bodies.

Actions in four  areas  could  be foreseen:

(a)  Reinforcing  the regular consultations should  be proposed
to  the  US  and  Japanese  authorities.  The  various  Com-
munity  bodies  (Council,  Commission and  specialist
committees)  should take part in these consultations. These
would  provide a  regular  forum,  with  periodicity to be
decided,  for  an  exchange  of  views  on  financial  and
monetary  problems  of  common  interest.  The  procedure
should also be able to be activated at  the request of  one of
the parties  when the  situation on the foreign  exchange
market  appeared 
to  be  unrelated  to  the  underlying
economic  data  —  i.e. manifestly  outside  the  limits  that
economic likelihood would suggest — or when interest rate
differentials  caused  excessive and  undesirable  strains on
the  Community's  money and financial  markets.

(b)  The  Community  monetary  authorities  should  encourage

the  American and  Japanese  monetary  authorities to
participate in  meaningful  cooperation on  exchange and
interest rates.  The  US  authorities in particular should  be
invited to  abandon  their  laissez-aller  exchange  rate and
interest  rate  policy.  Also  discussions  with  the  US
authorities should be started  with a  view to  replacing the
existing  network  of  swaps  between  certain  Community
central banks and the Federal  Reserve Bank  of New  York

by a single  credit  line between the latter and the EMCF.

This  would  provide  tangible  evidence  of  European
determination  to  avoid  appearing  disunited  from 
the
United  States point  of  view.

(c) The  coordination of  Community  central banks'  interven-

tions in  third  currencies should be  improved. The  central
banks should  make regular  and frequent  common assess-
ments of the ECU's exchange relationships, paying  regard
to  the  average  level  of  interest  rates  desirable  in  the
Community.  Their  intervention policy  should be based on
this assessment.

(d)  With the same objective in view, it is important  to organize

the use of  Community  currencies in  intra-marginal

interventions.  At  present,  a  central  bank's  use  of  a
Community  currency for  intervention inside the margins is
subject  to the good will of  the central bank whose currency
is requested. Interventions are instead made in dollars  and
this  often  has  the  effect  of  emphasizing  an  undesired
movement of the US  currency or of  undermining the
coherence of the  participating  central  banks'  attitudes
towards  that  currency. Alternatively,  if  no  intervention  is
made  inside  the margins, the currency  under  threat slides
until it  reaches its  bilateral  margin, at  which  point the
intervention  amounts  may  be far  greater  than  those  that
would earlier  have been necessary  to  reverse  the  trend.

Annex  D

The  use of Community  currencies for  intra-marginal interven-
tions  would  conform 
to  the  spirit  of  the  system  if  it  were
specified  that a central bank intervening inside the margins was
presumed to be able  to do so in  Community  currencies  with
access  to  the  very  short-term financing  when  its  currency
crossed  the  divergence  threshold  (lowered  to  50% for  wider
band currencies) or when the difference  of its bilateral rate vis-
a-vis another participant was more than 85% of the permitted
fluctuation  margin.  The  central  banks  of  currencies  used for
interventions would for  their part have the right of  refusing  the
continued  use  of  their  currencies  if  such  use  were  causing
problems for  their internal monetary policy. Nevertheless, the
dollar  would  continue to be  used for  intra-marginal  interven-
tions in cases where, by use of this currency, the cohesion of  the
EMS  could  be  maintained  and, at  the  same  time,  an
undesirable  movement  of  the  dollar  in  relation  to  the  EMS
could be acted  upon.

Determined  action in  line  with the  above  could  allow the
Community  the degree of autonomy necessary for  it to be able
to  react,  in a  unified  and  coherent  way, to  tensions from  the
outside  which  have  a  large  and  excessive  effect  on  European
interest  rates.

The EMS  is at present a closed system in which only the central
banks  of  certain  Member  States  participate,  whereas  the
Community  is open  to  the  outside  world.  Opening  it  to  third
countries in the spirit  of  the European  Council of Brussels and
giving them access to ECUs  would extend the system's zone of
stability and increase the possibilities for  using and mobilizing
ECUs.

Central banks of countries which seek to have special economic
and financial  ties  with  the  European  Communities should  be
authorized to  acquire  existing  ECUs  freely  from 
participating  central  banks, and the  EMCF  should be
empowered  to create ECUs for  them on the same conditions as
those for  the participants,  i.e.  against  reserve  transfers  in the
form  of  swaps.  But  first,  agreements  would  have  to  be
concluded  specifying 
the  terms and  conditions for  acquiring,
mobilizing and restituting  ECUs.

the

The  adoption  of  the  measures  proposed  above  to  develop,
strengthen  and  consolidate  the  EMS  is  technically feasible.
While  they respect the institutional framework,  they represent
a necessary step forward for  the system. In devising them, care
has been taken to preserve the balance between the principles of
strictness  and  solidarity 
inherent  in  the  system,  and  the
measures form a whole in which the component parts reinforce
each  other.

Following the method employed  when the EMS was set up in
December 1978 the Council decisions or guidelines could be the
subject  of  a  resolution.  A  draft  resolution  based  on  the
suggestions  of  this communication  is attached. '

1  The  draft  resolution  can  be  found  in Chapter VI.

91

ANNEXE

Statement by the  Chairman of  the Monetary  Committee
on the non-institutional  development of the EMS to the Council
(Economic  and Financial  Affairs)  of  15 March  1972

Following the request of the Council of  15  February  1982, the
Monetary  Committee  continued  its  work  on  the  non-
institutional development of the European  Monetary  System.
Its work centred on the four  areas indicated by the Council, i.e.

the mechanisms of the system, the private use of the ECU, the

strengthening of  convergence and the  system's  external
relations.

The  Committee  concentrated  in  the  first  instance  on  the
technical  aspects of the  system, in the  expectation  that if
agreement could be reached on these, agreement might well be
attainable on  the other points also. It  therefore  attempted  to
assemble the elements of a package on the technical aspects  to
see  whether  these  could  command  general  acceptance.  The
proposals discussed in detail in the Committee were as follows :

(i)  raising  the acceptance  limit  to a figure  between 60 and

70% and improving ECU  remuneration by  relating it to

market  interest  rates for future  debtor positions;

(ii)  supplementing  the current possibilities for  intra-marginal
interventions  in  Community  currencies  by  means  of  a
presumption  that such interventions  would be generally
justified, and  access to the  very  short-term  facility
possible, when a given bilateral spread  were  reached or
when  the  divergence  threshold  were  crossed,  while
maintaining—under  certain  conditions—a  right  of  veto
for  the  creditor  central  bank ;

(Hi) 

lengthening the reference  period for  gold valuation from
the present six months to one year, in order to dampen the
effects  of an unstable gold price on ECU  supply.  Changes
in the gold price have been the main cause of  the marked
growth  and fluctuations in ECU  volume;

(iv)  giving the  system an  external  dimension by  allowing

central  banks  of  European  countries  with  particularly
close  economic  and financial  ties  with  the  European
Community to  obtain  ECUs by  acquiring  them from
participant  central banks.

It was recognized that any set of proposals would have to strike

a balance between the interests of potential creditor and debtor

countries in the system. However, no general agreement proved
possible  on  this  group  of  proposals  as  a  result  of 
the
Committee's discussion.

Moving  to another  area  indicated  by  the  Council, that  of  the
private  use  of  the  ECU, the  Committee  agreed  that  an
exemplary  use  of  the  ECU  in  the  borrowing  and  lending
activities of the Community institutions should  continue and be

expanded as far as  market  conditions  permit.  ECU-de-
nominated  issues  by  Community  institutions  should  con-
sequently  be exempt from  exchange controls where these exist.
The  Committee  also  supported  the  general  direction  of  the
other proposals regarding the private use of the ECU, but noted
that  these are largely  a matter for  the private sector itself  and
that the ECU  has already  come to be used substantially  in the
private  sector  without the  need for  official 
Committee  has furthermore  not  examined  the  technical  and
legal questions which might arise from  the implementation  of
the  various proposals  on  the private  use of  the ECU.

intervention. The

As regards the strengthening of convergence, I already  stressed

at  the  last  Council  meeting  the  top  priority  which  the
Committee considers should be given  to achieving progress in
this area, both in terms of economic policies and performances
and of  rectifying  existing  imbalances  between  member
countries.  The  Committee  therefore  welcomes  the  Com-
mission 's intention to make full  use of  the existing consultation
and recommendation procedures. Although the Committee has
not  addressed  itself in full on the subject of  convergence since
the Council's last meeting, it has placed the issue at the centre
of its work programme. It has agreed, for  example, to regularly
prepare  and  update  a  dossier  on  the  'fundamentals'  of  our
economies, which would allow a better appraisal  of the conduct
of  economic policies and performances and  also be  useful for
realignment discussions. I already  stressed the importance of a
greater freedom  of  capital  movements in my  statement to the
last Council meeting: in this regard the Committee will explore
the scope for  action, keeping  in mind the interrelation between

the  advancement of  convergence and the  liberalization of

capital  movements.

As  regards the final  chapter  indicated by the Council, that of

the system's  external relations, I have already  mentioned one
technical aspect, i.e.  that  of  allowing  central banks of  certain
European countries to acquire ECUs from participants. On the
more general point of the system's relations with the dollar and
other major  currencies, the Committee—while acknowledging
that our own policies have an important part to play in  these
relations—considers  that it is also  necessary to  convince the
US authorities to pursue policies which take full  account of the
importance of the US economy and of the dollar at  world level.
The Monetary  Committee has on several occasions formulated
a  Community  position  on  these  issues and keeps  the matter
under  constant  review.  During its  meeting of 5  March, for
example,  members  agreed  to  pass  on  to  their  national
authorities a note by the Commission departments, prepared  in
response 
to a  ministerial  request, on the  international
implications  of  US fiscal  and  monetary  policies.

92

ANNEX  F  —  Statement  and  letter  from  the Committee of  Governors on the future  of the

EMS

ANNEX F-l

Oral  statement  from  the  Committee  of  Governors  of  the  central  banks  of  the
Member States of the European Economic  Community to the Council
(Economic and Financial  Affairs) of 15 March  1982 on the  future of the EMS

I.  Following  the meeting on 15 February  1982 of  the  Council
of 
the  European  Communities  (Economic and  Financial
Affairs) 
the Committee of  Governors has continued its studies
on the future  development of the EMS and has examined in
particular  the four  areas  which have  been  enumerated  in  the
conclusions of  that  Council session, i.e.

(i)  the mechanisms of  the system,

(ii)  opening  the system  to  the outside  world,

(Hi)  private  use  of  the  ECU,

(iv)  strengthening  convergence.

The  Committee of  Governors  wishes to  reiterate  that the

system so far has  worked  well; it  must  nevertheless be

recognized that this was partly due to the realistic central rates
selected at  the start  of  the system  and  to  the  weakness of  the
German  mark  over  prolonged  periods.  More  generally, the
good functioning  owed much to the high degree of  cooperation
between  central  banks in managing the  system. The  lack of
con vergence of economic policies and of fundamental  economic
variables in participating  countries means, however,  that, at
present, conditions are not appropriate for  major  institutional
changes in the  EMS.

the  strengthening  of  convergence  is  a

2.  Accordingly, 
prerequisite for any  significant  future  development of the
EMS.  Such  strengthening  of  convergence  should  apply  to all
economic policy areas (in particular budgetary policy)  and be
achieved  by  implementing  coordinated  domestic  and  Com-
munity policies designed  to  rectify  existing  imbalances within
and  between EEC  countries. The  ultimate  success of  these
policies  will,  however,  depend  more on the  determination of
national  authorities to  ensure the  attainment of  economic
objectives  than on  consultation procedure.

The EMS  itself can assist  this process because, notably, the
exchange  rate  constraints  which  it  imposes  have  doubtless
influenced  participant countries'monetary and other policies in
the  direction  of greater  discipline.  But  that  is not  enough. If
divergences in  other  areas are  building up,  then  monetary
policies in individual countries ultimately  cannot withstand the
pressure. Nor can exchange rate realignments be counted upon

to relieve the strains: if  they are too frequent or too large they

detract  from 
accentuating  diverging  developments.

the  system's  credibility  and  risk  further

In  these  circumstances,  technical  improvements to particular
elements  of  the  system  cannot  be  regarded  as  a  viable
alternative  to  closer  convergence  of  economic  policies.
Progress in this area is of crucial importance for  the continued
existence of  the EMS.

Concerning  monetary  policies,  the  Committee  of  Governors
will continue to monitor developments in the Member States of

the EEC, as  well as  their compatibility  with one another and

with the objectives  of  achieving greater domestic and external
stability.  To  this end, the  Committee of  Governors evaluates
regularly the  adaptations  that may be required to foster the
cohesion of monetary and exchange rate developments  within
the Community. In particular, the Governors are analysing the
recent growth in borrowing  abroad by  EEC  members  and its
implications for the pursuit  of  monetary policy.

3.  The  Governors  have  carefully  examined  a  number  of
possible adaptations  to the mechanisms of the EMS, which fall
within their sphere of competence. These adjustments  relate to:
(i)  intervention  and financing  within  the  system,  and  (ii)
creation and  acceptability of  ECUs.

The  Governors,  however,  did  not  reach  a  consensus  on  the
introduction  of  amendments  to  existing  arrangements  and
agreements  at  the present  time.  They  wish  to point  out  that
their  in-depth  review  of  the  operation  of  the  EMS  in its first
three  years  has  led  to  the  conclusion  that  the  system  is
functioning  satisfactorily  from  a  technical point  of  view.

The  Committee of  Governors will continue  to monitor closely
the  performance  of  the  EMS  and  stand  ready  to  introduce
those  adaptations 
appropriate  as circumstances develop.

to its  mechanisms  that  might  become

4.  With  regard  to  the relations of  the EMS  with the outside
world, the Committee of Governors focused its attention on the
desirability  of  obtaining  a  higher  degree  of  exchange  rate
stability, in particular  between the EMS and the US  dollar.
However,  this  cannot be  achieved  merely  through  exchange
market intervention. Rather, the solution of present problems
requires increased coordination of economic policies within the
Community  and  also  between  EEC  countries and  the  United
States  of  America.  It  should  be  recalled  in  this  respect  that
EEC  central  banks  already  have  adequate  opportunity  for
constant communication  with their American colleagues both
through the concertation procedure and through their monthly
meetings.

The extension of  the use ofECUs  issued by  the EM CF outside

the circle of EMS  member central banks is difficult 

to envisage,

given the precarious  nature of the ECU and the fact  that its
convertibility  into third currencies has not  been defined.  This
does not  exclude  the possibility  of central banks  of  'European
countries  with particularly  close  economic and financial  ties
with the European Communities' obtaining ECUs by acquiring
them from an EMS  central bank. The legal implications of this
change, however, would have to be examined.

93

Documents relating to the European  Monetary  System

5. EEC  central  banks do not  have  objections to the
development  of  the  use  of  ECUs  in  private  markets,  and,
indeed, progress in this field  is taking place in several countries.
Care must, however, be taken  lo prevent  developments  which
would interfere  with the proper conduct  of domestic monetary
policies.

ments,  this  step  would  create segmentation  within the
national  capital  market as  long as  these  restrictions
persisted; efforts  must therefore  be made to facilitate  the

issue of ECU  loans  through a progressive  removal of

capital  controls.

The  Governors  specifically  wish to  draw  attention to the
following  issues:

(i)  There is a  danger  that, if  Community  institutions  were

forced to borrow in ECUs beyond the possibilities offered

by the developing ECU  market,  these institutions might
suffer  a financial  burden.

(ii)  Although there would be advantages in exempting ECU-
denominated  loans from  restrictions on  capital  move-

By  permitting the  opening of  ECU-denominated  bank

accounts by residents there is the danger of circumventing
exchange control measures where they are still in force.
Difficulties  for  monetary  control  would  also  arise.

The  nature  of  these problems and  their implications for  legal
and structural  conditions in  individual EEC  countries, in the
Governors'  view, mean  that  appropriate  measures fall  to  be
taken by  individual  countries.

94

ANNEX F-2

Letter of 29 April  1982 from  the  Chairman of the Committee of  Governors of
the central banks of  the Member States of the European Economic  Community
to the President of  the  Council of  the European Communities

Dear  Mr  President,

I  refer to my  letter of 30  March in  which I  confirmed
that, in  response to the  Economic and  Financial  Affairs
Council's  request, the  Committee of EEC  Governors  would
undertake discussions in April about the European  Monetary
System.

meeting  of  the  Economic  and  Financial  Affairs  Council.
During  their discussion, the Governors confirmed the position
taken  in the attached  note  verbale '  that  I presented  to  the
Economic and  Financial  Affairs  Council in  March  1982.
Furthermore, developments, and in particular the tensions, of
the past  weeks only  underline further  the need to give priority

to strengthening the convergence of national economic policies

and to  coordinating  these policies with  Community  policies.
Indeed,  action  to  improve  convergence  appears  necessary  to
preserve the  very  viability  of the European Monetary  System.

A t its  meeting of 20  April  1982 the  Committee of

Governors re-examined the question, with particular regard to
the four  areas specified in the conclusions to the February  1982

Yours  sincerely.

1 

See  Annex  F-l.

95

ANNEX G

Oral statement of  the Chairman of  the Monetary  Committee

on the development of the EMS to the informal  meeting

of  Economic  and Finance Ministers on  17 May  1982

/.  On  21  April  and 5  May  1982,  pursuant  to  the  Council's
request,  the  Monetary  Committee  again  examined  the
Commission's proposal for a  draft  Council  resolution on the
development  of the European  Monetary  System. '

exchange rate and  interest  rate developments,  where it insists
on  the  need  to  persevere  in  our  efforts 
to persuade  the  US
authorities to pursue policies which  take full  account  of  their
responsibilities to the world economy.

improvement in  convergence and the  system's  development.

The EMS has in  fact  already  become an  increasingly

4.  There was general agreement within the Committee that the
top  priority  area for our  future  efforts  must be the
strengthening  of  convergence,  both  in  terms  of  economic
policies and performances  and of reducing existing imbalances
between  member  countries.  It  is  clear  that  the  system's
prospects hinge crucially on our ability  to make progress in this
area,  and  that  there  is  thus  a  parallelism  between  an

important part of our economic policy framework.  In its three
years of existence, the coordination and consultation process at
Community  level  has  been  intensified;  at  national  level,  the
system has promoted the adoption of stability-oriented policies
in a number  of member countries, and notably in those where
they  were  most  needed.  But  disappointing  results  in  the
fundamental  areas  of  domestic  cost  and price  trends  and  of
public finances,  underlying 
the  recent  tensions  within  the
system,  indicate  the  urgent  need for  a  renewed  and  incisive
effort.  It  is along this road, in the daily  implementation of  our
economic policies and in our capacity to direct  them  towards
stability,  that the system can continue to give its support and
must progress further.  Such progress is not  a question of new
procedures,  but  of  resolute  and forceful  cooperation  at  all
levels, and  especially 
in the ' bodies  where  views may be
exchanged  most  frankly  and  confidentially. 
intention of members to actively use the forum provided by the
Monetary  Committee to this end,  and to keep matters having a
bearing on convergence at  the centre of our work programme.

It  is  the firm

5.  In conclusion, therefore,  although  the proposals  contained
in the  draft  resolution do not  appear to be acceptable in their
totality  at  the  present  stage,  notably  for 
agreement on a  technical package  which is at the  same  time
significant and balanced,  there are possibilities and scope for
pragmatic progress on a number  of  issues, and  most  notably
that  of  convergence.  It  is  my  intention  that  the  Monetary
Committee play its full part in contributing to such progress.

the  absence  of

interventions and the  external

2.  With  regard  to  the  propositions  covering  the  technical
aspects  of  the  system  (i.e. ECU  creation,  acceptance  and
remuneration,  infra-marginal 
role of the  ECU), the  Committee  continues to find  that no
general  agreement  proves possible  at  present,  either  on  the
proposals  as  they  stand  in  the  draft  resolution  or  on  an
alternative group  of proposals  as set  out, for  example,  in my
previous statement  to the  Council of  15 March  1982. You will
recall  that the  Committee had  attempted to  assemble the
element sofa  package on the technical aspects of the system to
see  whether  these  could  command general  acceptance,  in  the
expectation  that  if  agreement  could  be  reached  on  these,
agreement  might  well be attainable on the other points of  the
draft  resolution as well. That had not been the case at the time,
and today  I cannot but  confirm  thai outcome. The Committee
felt  that  under  these  circumstances  a  continuation  of  the
discussion  would not  alter  the situation.

3. As to the other group  of proposals, covering the private use

of the  ECU, the  measures to  enhance  convergence, and the

external  aspects  of  the  system,  the  Committee's  Alternates
have examined  their technical implications and, although they
found  that  technical  problems  persist  in  some  cases,  the
Committee's view is that  the general direction of several of  the
proposals should be supported  and encouraged.  The Commit-
tee expressed, for  example, its support for the promotion of the

private use of the ECU.  This is an area where developments are

largely  spontaneous  and  can proceed  at  a pace  of  their  own:
thus, for  example,  the  ECU  is  already  treated  as  a foreign

currency in the  majority of  Member  States. The  Committee

also  agreed  that  the  use  of  the  ECU  for  the  borrowing  and
lending  activities of the  Community  institutions  should be
expanded  as far  as  market  conditions  permit.  As  regards
external  relations,  the  Committee  has  often  contributed  to  a
common  Community  position, for  example  in  the field  of

See  Chapter  VI.

96

ANNEX H

Report  from the Commission (of 20 March  1980)
to  the  European  Council  on  the  European Monetary  Fund  V

/. At the Dublin  meeting on 29 and 30 November  1979, the

European  Council  invited the  Commission to submit, for the
meeting in March  1980, a report setting out the progress made
in studying  the establishment of the European Monetary  Fund
and pointing  out  any  difficulties.

The studies on the European  Monetary  Fund  were started by

the  Commission as  early as May  1979.  Since  then, the

Monetary  Committee and the Committee of  Governors have
looked into  this question, and  their  respective  chairmen have
reported to the Council on the progress of work. This work has
not  yet  been  completed;  rather  than  producing  specific
guidelines, it has so far  made  it possible  to  identify  problems
and possible  choices between  solutions. However,  as  can be
seen from the analysis  below, the preliminary  technical  work

has shown that, if it is to make a real extra contribution, the

transition to the institutional stage of the European Monetary

System can be carried out  only  if  certain basic questions have

been resolved  which have not  yet  been fully  clarified.

II.  Current  work is based on  three main elements:

A.  The first  is the desire expressed by the European Council in
Bremen  and  Brussels,  to  transform  the  European  Monetary
System  into a  'durable scheme' guaranteeing the creation of a
zone  of  monetary  stability  in  Europe.  For  the  purpose  of
attaining  this  objective, the  European  Council  defined 
operating  rules of the system in the first  stage and  indicated
certain characteristics of the  'final  stage'.

the

B.  The second is the lessons to be learnt from  the first  year of
operation  of  the  European  Monetary  System  and  from
monetary and exchange-rate developments in the Community
since  13 March  1979.

The  assessment of the  operation of the  European  Monetary
System  in its first  year is largely positive. The procedures for
consultation between the authorities of  the Member  States in
the  various  Community  bodies  have  been  improved.  Despite
sharp  economic  and  monetary  disturbances  which  entailed
interest rate increases ranging from  3 to 5 points according to
the country, the group of participating currencies maintained a
greater degree of cohesion than that recorded since 1972. Two
adjustments  of central rates in September and'November  1979
were carried out in good time and fairly  smoothly.  Lastly,  the
monetary  compensatory  amounts  were  reduced  appreciably,
reflecting  progress towards  the objective  of  uniform  prices on
the  European  agricultural market.

In stressing the positive factors,  the Commission is expressing
its  conviction  that it  would  have been much more  difficult 
achieve these results if  there had been no European Monetary
System. However, between the end of  1978 and the end of 1979,

to

1 

Previously  published in European  Economy  Number 7, November  1980:
Chapter 6 of  the  Annual  Economic  Review  1980-81.

the average rate of  inflation in the Community  rose from  6,9%

to 9,0%, and the spread between the lowest and the highest rate
of inflation in the Member States widened from  10 to 17 points.
Although progress has thus been made towards exchange-rate
stability, the same has not  been the case in the field  of prices.
Consequently,  the  European  Monetary  System  must  be
consolidated and  strengthened so as to  make its own  active
contribution  to  better  economic  equilibrium  in  Europe.
Economic policies for  their part  will  have  to  be brought  to
converge more closely  to ensure the stability  of  the monetary
system.

C.  The  third element  is the  developments  in the international
economic, financial  and  monetary  situation.  In  1978,  the
serious disruption of exchange rates, payments balances, prices
and financial  markets  caused  by  the  1971-74  monetary  and
energy  crises, seemed to be about to ease. Today, the threat of
renewed  disequilibria  in  international payments  relations  is
growing.

The future  development of the  European  Monetary  System
must  therefore  be such as to contribute actively  to the overall
stability  of  the  international financial  and monetary  system
andtomeet  the Community's general interests in the tradeand
financial  fields—both 
its  own  interests  and  those  of  the
countries with  which it has particularly  close  relations.

III.  The  Commission  and  the  committees  concerned  have

organization  of  the  credit  mechanisms  in  the  European
Monetary  Fund. They have examined the institutional aspects,
which will be largely  governed by  the solutions adopted  to the
questions of  substance discussed  above.

1.  The  credit mechanisms

Two features  of  the credits granted under present agreements
should be noted: to a large extent they are bilateral credits, the
accounting procedures for  which are handled by a Community
body, the EMCF; and since the body  which issued the ECUs—
the EMCF—is  only an accounting  intermediary in the credit
operations,  these  do  not  give  rise  to  the  direct  creation  of
ECUs.

Two  problems  have  been  studied  in  particular;  first,  the
consolidation  of  existing  credits  (short-term  and  medium-
term)  and of  very  short-term credit facilities.  It  became clear
that,  whatever  solution  is adopted,  this  is not  a fundamental
problem in the  transition to the  institutional  stage of the
European  Monetary  Fund.

Second, the  EMF's  ability to  create  ECUs  against  credits,
which is a crucial issue. This ability  raises the problem of the
limits and conditions under which these ECUs could be created

97

primarily  concentrated on the  role of the ECU and on the

Documents relating to the European  Monetary  System

or the credits could be granted, and therefore  that of the means
which would be available to the European  Monetary  Fund to
impose  tighter  monetary  discipline  in  the  Community.  The
solutions to this problem will depend  to a large extent on the

role of the ECU in the  institutional  stage of the  European

Monetary  System.

2.  The ECU

(a)  In the present system, the ECV  serves as the numeraire/or
the
the  exchange-rate  mechanism,  as  the  basis  for 
divergence  indicator, as the denominator for  intervention
operations  and  as  a  means  of  settlement  between  the
Community's  monetary  authorities.

However,  the  ECU  lacks  the  principal  features  of  a
currency: it is not an instrument of payment; there can be
no  autonomous  creation  of  ECUs  through  the  credit
operations;  and  though  it  appears  in  the  central bank's
balance-sheets,  this  does  not  mean  that  it  is  a  genuine
reserve instrument, since it is merely  the expression  in the
accounts of the assets  (dollars and gold)  against which it
has been issued and whose movements it reflects  automati-
cally.

(b)  The  decisions  taken  at  Bremen  and  Brussels,  certain

fundamental  considerations and  recent  monetary  trends
together mean that the development  of the ECU  will be the
locomotive for  transition to the institutional stage of the
European Monetary  System:  it is by expanding  the role of

the ECU  that the  Community  will be  able to  organize

internally the  coordinated  action  necessary to  achieve a
greater  degree  of  monetary  stability  and  establish  its
monetary  identity  at  international  level.

(c)  The full  and  complete  use  of  the  ECU  as  a  means  of
payment and the  regulation of the  creation of  ECUs to

serve the objective  of monetary stability  raise the question
whether, to  what  extent and  under  what  conditions the
future  Monetary  Fund could possess an independent power
of  money  creation.

If  it were given such power, the future  European Monetary
Fund  could  create  ECUs 
contribution of  reserves (as is  done  under the  present

in two  ways:  against a

agreements), or  through  credit  operations;  these two

methods  could  even  be combined.

The full use of the ECU as a means of payment or reserve

instrument  within the  Community  would  require  that
several  conditions be met:

(i)  certain  legislative  measures  would  have to be  taken to

abolish the  limits to the  acceptability of  ECUs to the

98

central  banks,  to  provide  that  a  certain  percentage  of
reserves must be held in the form  of ECUs, and possibly to

impose the exclusive use of the ECU as an instrument of

settlement between the Community's  central banks;

(ii)  if the limits to the acceptability  of  the ECU  were abolished,
the  ECUs  inherent  characteristics  (convertibility  and
yield)  would  have  to  be  strengthened  to  make  it  as
attractive  as  the other possible  reserve instruments;

(d)  Apart from the  role to be performed by the ECU in the

areas described above, a secondmajor  decision of principle
will  have to be  taken; this concerns the  wider use of the
ECU outside the system of Community central banks, both
on the private financial  markets and by  the authorities of
non-Community  countries, so as to  ensure the  full
negotiability  of  the ECU  and  to  enhance  its status as  a
reserve  asset.  In  this  context,  the  question  arises  as  to
whether  the  strengthening  of  the  role  of  the  ECU  might
allow it to play a part in recycling the surpluses  of the oil-
producing  countries.

IV.  Once  the  European  Monetary  System  enters  into  its
institutional  stage,  consistency  between  domestic  monetary
policies, credit mechanisms and exchange-rate agreements will
have to be ensured within a single system of procedures, so as to
provide a full and proper basis for the smooth operation of the
system and the  achievement of  monetary  stability.  •

This raises the questions firstly,  of the institutional powers with
which the  Fund  will be  endowed in  order to  administer the
system itself  and, secondly, of the back-up measures which will
have to be  taken so as to  ensure the  smooth  working of the
system,  including  measures  such  as  the  coordination  of
exchange-rate  policies  vis-a-vis  non-Community  currencies
and the achievement of a sufficient  degree of convergence in the
economic and monetary policies pursued in the Member States.

Examination of the institutional aspects has already  begun. It
has  started from  the  principle  that  a  Fund  endowed  with
increased  powers  should be  integrated  into the  institutional
system  of  the  Community  and  of  the  existing  international
monetary  organizations  on  the  basis  of  clear  precise  legal
arrangements. Fuller  examination of the  institutional aspects
must  necessarily  be  carried  out  in  parallel  with  the  basic
questions  raised  above; it  is on  the solutions  arrived  at  with
regard to these basic questions that the powers of the European
Monetary  Fund and the nature of the bodies running it will to a
large extent  depend. It  will at all events be necessary to  work
out a balanced system of tasks, responsibilities and safeguards
for  the  European  Monetary  Fund;  this  is  essential  to  the
exercise  of  any function  of  a  monetary  nature.  A  balanced
system of this kind is, moreover, to be found  in all the Member
States, though the features  of each system  differ 
with  national  legal and institutional  circumstances.

in accordance

Annex H

Some of the  functions or  tasks  allotted to the  European
Monetary  Fund once it is established will probably  have to be
taken up only gradually  depending on how the relevant political
authorities assess the way in which the situation is developing
and on  whether  they find the mechanisms suitable.

In  conclusion, the  Commission proposes  that the  European

Council request the relevant Community bodies to pursue their
work  along  the lines set  out in this report.  The  Commission is
ready  to provide  the  European  Council  with further  inform-
ation on the progress achieved and difficulties  encountered in
setting up the European Monetary  Fund proposed in the texts
that were released after  the meetings of  the European  Council
in July and  December  1978.

99

ANNEX I

Preparatory studies on the European Monetary Fund

Notes  prepared by  Commission departments in  1980 and  1981

The  papers  in  this  annex  were  drafted 
in  execution  of  the 
mandate  given  by  the  Monetary  Committee  on  26  February
1980  on the  study  of  different  aspects  of  the  transition  to  the 
institutional phase of the European Monetary  System.  Though 
they  have  been  discussed  in  depth  by  the  Alternates,  they
remain  technical  notes  of  the  Commission  departments.  In 
accordance with the Committee's request, each topic is treated

in a separate paper  which develops the  different  options  which 
may be envisaged. 

(4)  consolidation of  Community  credits in the  European

The  subjects  studied  are  the following :

t1)  acceptability  and convertibility I negotiability of the ECU;
(2)  (he  Uquidity  or the Fund.

(3)  arrangements for  transferring  reserves to  the EMF;

Monetary  Fund;

(5)  external  role  of  the ECU;

(6) the EMF—institutional  aspects.

100

ANNEX  1-1

Preparatory studies on the European Monetary Fund

— Acceptability and convertibility/negotiability of the ECU

Contents

/.  Introduction

1.  Nature of the paper
2.  Definitions

II. The present situation

1.  Acceptabilityjexclusivity

2.  Convertibility or negotiability

HI. The  institutional stage of the EMS

1.  Acceptabilityjexclusivity

2.  Convertibility  or negotiability

IV.  Implications for the Fund

The findings of  this paper  should be regarded as tentative both
because  the  characteristics examined  are not  exhaustive  and
also  because  existing  currencies and  reserve  assets can  only
shed some light on what qualities should be given to the ECU,
which  will necessarily  be a new  and  to some extent  different
type  of  instrument, issued by  an institution, the  EMF,  whose
role and  characteristics  remain  to  be agreed  upon.

2.  Definitions

Within a currency area transactions are normally denominated

and settled in the national currency, which has the qualities of

both  acceptability  and  exclusivity.  In  general,  the  national
currency is the  only  instrument  recognized by the  law; a
creditor  must  accept it in discharge of a  debt. Although two
parties could in principle  agree on something else, there are in
many  countries restrictions on residents  acquiring  or holding
other currencies. These  concepts  cannot be directly  applied to
the ECU, but it is convenient in what follows  to call the degree
to which creditors are obliged to accept  ECUs  in settlement,
the degree of acceptability;  and to employ  the word exclusive
when a debtor  must use ECUs in settlement.

Between currency areas there is a limited number of settlement
instruments  that  are normally  used.  For  any  transaction  the
denomination and the means of payment are generally part of
the  contract,  and  important  elements  in  the  choice  are  the

convertibility or  negotiability of the  instrument. As the

I.  Introduction

1.  Nature of the paper

The  purpose of  this  paper is to  raise  some  questions for
discussion  of  the  development  of  the  ECU  towards  its full
utilization  as  a  reserve  asset  and  settlement  instrument  as
outlined  in  the  Resolution  of 
the  European  Council  of
5 December  1978.  The  approach  adopted  is  to  consider  in  a
first  section  some  particular  characteristics  of  existing
currencies,  reserve  assets  and settlement  instruments  and  to
consider  whether  implications  can  be  drawn for  the  develop-
ment of the  ECU. The  characteristics  examined are  accept-
ability,  exclusivity,  convertibility  and  negotiability,  chosen
mainly  because it is thought  that  there are limitations on the
ECU  in these areas in  the existing phase of  the EMS.  These
will be examined in the second section of the paper. The third
section will examine possible developments for  the next stage
and the final section attempts to identify  possible links between
the  choices  to be  made  and  the  role  of  the  Fund.

meaning  of  the  term  convertibility  has  changed  along  with
developments  over time in the international monetary system,
some  definitions  are  necessary.  Until  August  1971, the  US
dollar, the major  reserve currency, was said to be convertible
because  it  could  be  officially  converted  through  its  issuing
authority  into  gold at a  known and fixed  price.  Although
neither the dollar nor the European currencies now possess this
quality,'  they are  still  said to be  convertible  because, for
eligible  transactions  with  other  currency  areas,  domestic
nationals may sell their own currency to purchase the necessary
foreign  currency on an organized market but not necessarily at
a fixed  price,  and foreign  nationals  with  balances  in  that
currency may sell these balances on the same market. As these
are  market  rather  than  official 
transactions,  the  currencies
could  be  said  to  be  negotiable  rather  than  convertible.  The

existing currencies. In  transposing  these concepts  to the ECU
in  what follows  the  word  convertibility  will  be  reserved for
transactions through the Fund: and the word negotiability for
transactions  in  ECUs  between participants.

The EMS  to  some extent restores the previous situation for transactions
between the  participating  currencies for  which  price  fluctuations are
limited to a narrow  band.

101

ECU  will not  necessarily  develop  into  either an  instrument
exactly  like the dollar was nor  with all the  characteristics of

Documents relating to the European Monetary System

II.  The  present situation

III.  The institutional stage of  the EMS

1.  Acceptability /exclusivity

1.  Acceptabilityjexclusivity

In  the  present  transitional phase,  as  well  as  being  used  by
agreement  between  participants, the use of the ECU as a
denominator for  claims and  liabilities and its use as a
settlement  and  reserve  instrument  is  prescribed  in  specific
instances. Each central bank must  transfer at  least 20% of its
gold and dollar holdings to the Fund. Against these transfers  it
receives  ECUs  which can be  used as  follows.  When an
intervention  is  made  at  the  margin,  the  debtor  may  choose
whether  or  not  to  activate  the  very  short-time financing
(VSTF).  If  he  chooses  to  do  so,  the  debt  is denominated  in
ECUs but  settlement may be  made at any  time  before the
financing  opera lion falls due in the currency of the creditor. If
there is no  advance  repayment the  creditor is not  obliged to
accept  settlement by means of  ECUs  of  an amount more than
50% of  the claim. In  cases  where the financing  mechanism is
not activated, the transaction is not denominated in ECUs but

the two banks can agree that all or some part of the settlement

should  be  made  in  ECUs.  When  infra-marginal  intervention
takes place, the debtor has no right to the  VSTF,  but it may be
granted  with  the  agreement  of  the  creditor  in  which  case  the
above  settlement  rules  would  again  apply.  These  types of
transactions  give  rise to net ECU  positions, the  interest on
which is fully  settled in ECUs. The settlement  arrangements
using ECUs do not  therefore  involve absolute exclusivity  since
the provisions are  without prejudice  to other mutually  agreed
forms  of  settlement; and  as  indicated  above  acceptability  is
limited to 50%  of a claim at  the end of  the financing period of

the  VSTF.

2.  Convertibility  or negotiability

The present  arrangements for  the transitional period exclude
the possibility  of  ECU  convertibility  by  the  Fund  into  other
reserve  assets,  except 
to  the  extent  that  swaps  may  be
unwound. The initial allocation of  ECU  is made against  three-
month swaps  of gold and reserves.  This system, together with

the arrangement that the management of the assets is entrusted
to the contributing central banks, does not allow the Fund any
discretionary  powers or  control  over 
Moreover,  since  participants may  reobtain  their  assets by
unwinding the  swaps at two  working  days'  notice, it is
impossible for  the  Fund  to  convert  any  net  ECU  position  by
spot  buying  and  selling  operations.

the • reserve  assets.

The  ECU  would  be given  the  characteristics  of  acceptability
and exclusivity  if  debts  and claims between  the central banks
had to be denominated and settled in ECUs. Denomination and
settlement  are closely  linked.  Normally  a  transaction  will  be
settled  in the instrument  in  which it  is denominated,  although
this  is  not  always  true  and  is  not  true  in  the  existing
arrangements  for 
the  VSTF.  These  arrangements  were,
however, substantially  taken over from  the previous system in

which it was not possible for  settlement to be made in EMU As

in which the debts were denominated. In the EMS  however, the

ECU is to be fully  used as a settlement instrument which can be

taken  to imply  that more transactions should be denominated
and  settled  in ECUs.  It  is not foreseen  at  this stage  that  the
ECU  itself  will be used for  interventions but  it  would still be
possible for  these  transactions in  national  currencies to be
denominated  in ECU, as  they  would  be  if  they  were  to pass
through the Fund.

For acceptability,  it is necessary to specify not only the type of
obligation requiring settlement but  also  the extent  to  which a
participating  bank  is  obliged  to  accept  ECU. In  the present
system, as seen above, there is a 50% lower acceptance limit on
each  settlement.  Consideration  could  also be given to  other
percentages or the  abandoning of all  limits as  well as to
different 
acceptance  until  a  central  bank  holds  more  than  a  given
percentage  of  its  reserves  in ECUs.

types of  limits. An  example of the  latter is full

It  is  evident  that  a  monetary  instrument  cannot  usefully  be
given the qualities of exclusivity and acceptability  if its supply
is not  regulated. The  monopoly  power of  central  banks is
closely connected with their responsibilities for  their currency.
The  implication for  the  ECU  is  that  questions  of  exclusivity

and  acceptability  cannot be  determined  without  reference to

the way in  which it is  created, its  supply  regulated and the

the  Fund  or  through  transactions  with  other

facilities by which participants may obtain more either through
credit  from 
participants.  Important  elements in  these  topics are the
convertibility/negotiability  of  the ECU  to which this note now
turns.

2.  Convertibility or negotiability

Subject  to  the  restriction  that  the  transactions should  not  be
made  solely  with  a  purpose  of  altering  the  composition  of
reserves, the ECU is  however  negotiable  between  central
banks.  This  implies that when two central banks agree, ECUs

can be used in spot  transactions to acquire other reserve assets

or Community  currencies, and that these currencies and assets
can  be  used  to  acquire  ECUs.

There are two  basic  approaches to the  questions of how
participants can acquire more ECUs when needed or exchange
ECUs for  other  reserve  assets  when  they  consider  that  they
hold too many ECUs. One is that  these transactions should be
made  mainly  through the  Fund by  emphasizing the  convert-
ibility of the ECU  through its  issuing authority. The other is
that the  transactions  should be  made  mainly  with  other

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Annex  1-1

participants, i.e.  by putting  the emphasison  negotiability.  The
two  approaches  are, however, not  mutually  exclusive. The
following  considerations  should  be  taken  into  account  in
considering  the  correct  balance  between  the approaches.

(i) In the existing system  each participant  acquires an initial

The  negotiability  approach  would  imply  that  participants
would  rely  predominantly  on  each  other  rather  than  on  the
Fund for  acquiring more ECU  or for  disposing  of ECU  in case
it  was  thought  that  net  balances  in either  direction  were  too
large.  With  this approach  considerations of  what assets can be
acquired against a positive position or used to replenish  stocks

of ECU and the rules and conditions under which it can be done

are relatively  unimportant beyond  the parties concerned when
transactions  are  voluntary.  If  there  are  two  central  banks
willing  to  make  the  transaction  there  would  seem  to  be  no
purpose in restricting them. The principal question to be asked
about the approach is whether the 'market', which at this stage
is  composed  only  of  the participating  central banks,  is large
enough relative to the supply  of ECUs to ensure that the ECU
is sufficiently  negotiable to be a fully  usable asset. It is also
worth noting that with this approach the yield characteristics of
the ECU  become  very  important  because, with its  value being
fixed by a formula,  changing its attractiveness depends  upon
varying  the yield. It  will not be used in a negotiability approach

if it is either too attractive or not attractive enough as it will not

be possible to find two  willing  sides to a  transaction.

In the case that it was thought that the 'market'composedonly
of  the participants  was  too  restricted  it  would  be possible  to
supplement  negotiability  with  a  designation  scheme.  In  this
case, when  a participant  required dollars,  it  could  call on  the
Fund to raise them from  the other members. This could be done
through a designation plan. Once a key  had been agreed upon,
participants  would be required to supply  dollars. The key  could
either  be  prespeci/ied  or  determined  on  an  ad  hoc  basis
according  to  circumstances. For  the former,  experience  with
the IMF  would suggest  that  the procedure  risks  being  rather
rigid;  whereas for  the  latter,  the  Fund  would  have  to  have
powers to  impose its  decisions on participants.  This  type of
scheme  would be available in cases  where a participant  could
show that it had a need for  dollars. In a regional scheme, it is
possible  that  the provision of  dollars  under  a designation plan
could pose difficulties  for  the participants  at  a  time  when the
Fund's holdings of dollars had not been tapped. In such cases, it
would then be possible for the Fund to use its own resources to
supply  dollars  on  a  temporary  basis.  In  a  later  stage,  if  the
international  role  of  the  ECU  is  developed,  this possibility
could be  extended  through  operations in  which  non-EEC
monetary  authorities  acquired  ECUs  against 
currencies or other  reserve assets.

their  own

allocation of  ECUs  against  gold and  dollars  through  the
swap  operations. For the next phase it will be necessary to
consider  arrangements for  issues  against  these and  other
reserve  assets and  also  perhaps for  allocations  against
national currency. The way in which any subsequent ECUs
can  be  acquired  through  the  Fund  will  be  influenced  by
these arrangements. For example, if  the original arrange-
ments involve all banks transferring  a similar proportion of
their  contributions in  gold, so  that  exchange  risks are
equalized, any  subsequent  acquisitions of  ECUs  would
require a  transfer of the  same proportion of  gold if the
exchange risk position was not to be changed. The degree
to  which excess balances  of  ECUs  can be  converted  into
reserve assets could also be influenced by the way in which
the initial allocation of  ECUs was created. Furthermore,

convertibility  into  gold  would be  likely to  raise  many
problems such as those regarding any conditions based on
need  (see below).  Convertibility  into  dollars  raises  the
questions of whether the Fund has enough in a sufficiently
liquidform,  and if not, how it can use, either through selling
or by borrowing against, any other of its assets  (especially
gold)  to supplement  its  dollar  holdings.  This  is of  course
linked  with  the  question  of  the  way  in  which  assets  are
transferred to the Fund.

(ii) Two  types  of conditions can be considered, quantitative or

qualitative. With quantitative type  conditions, participants
would have  the right  to convert  other  reserves into ECUs
when their ECU  holdings fell  below a certain percentage,
and to convert  ECUs  into other  reserves when their ECU
holdings  rose  above  a  certain  percentage.  The  two
percentages should neither be the same nor be permanently
fixed.  With qualitative type  conditions, participants  would
have the right  to convert ECUs  into reserve assets or vice
versa  when  they  could  show  that the  transaction was
in  some  way. Whether the
justified by  need,  defined 
conditions  are  qualitative  or  quantitative  the  role  of  the
Fund  remains to be  determined. For  quantitative  con-
ditions  if  the  percentages  are fixed,  and for  qualitative
conditions if  the criteria areprespeci/ied,  the Fund's role is
limited to  that of  managing its  assets to  ensure a
satisfactory  rate of  return and  sufficient 
other extreme the Fund  could have extensive powers over
varying the  percentages or  over  specifying  conditions
depending  upon  circumstances.

liquidity. At the

IV.  Implications for  the  Fund

ECU  convertibility  through  the  Fund  raises  two  important
issues: (i)  into what should the ECU  be convertible and with
what ECUs  can be acquired, and  (ii) according  to what  rules
and  conditions ?

The  characteristics of the ECU  cannot be  determined in
isolation from  the role that the Fund is expected  to play and the
whole monetary  environment  developed  by  the system.  Some
implications for the ECU can be  drawn from 

the  charac-

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Documents relating to the European Monetary System

like its  valuation and  yield as  well as its  convertibility or
negotiability.
Convertibility and negotiability are to some extent alternatives
and so a choice has to be made over the degree of emphasis to be
given  to  one  or  the  other.  This  choice  has  important
implications  both for  the  Fund  and for  the  ECU.  With  a
convertibility-type  approach  the question has to be settled as to
whether  the  Fund  has  the  power  to  set  and  vary 
the
(quantitative  or  qualitative)  rules  or  whether  these  are
prespecified and fixed. In the  case  that  they are fixed the
Fund's powers are limited to surveillance and to managing  its
assets. The Fund's degree of  control over the quantity and use
to  which
is  also  influenced by the  extent 
the ECU 
of 
participants  have  the  right  to  convert  ECUs.  With  the
convertibility  approach  therefore any possible powers confer-

red to the  Fund  over the  control of ECU  supply  would be

limited  by  prefixing  rules for  automatic  convertibility.  A
negotiability approach  could be compatible with a swap system

if the  Fund  could  mobilize the  reserves by  some  designation

plan. To the extent that ECUs cannot be exchanged for  reserve
assets not restricted to regional use, it would, however, increase

the importance  of any powers that the Fund has to determine

the  quantity  of  ECUs  in  circulation.

teristics of  acceptability,  exclusivity,  convertibility and
negotiability  present  in national currencies but  these must be
regarded as  tentative  because the ECU may at  least for the
in some  very  important  ways
foreseeable  future  be'different 
from  national currencies: it has a limited number of  users who
are all official  authorities, as a basket of currencies its  value is
not directly determined by supply  and demand, it is not used for
interventions, etc.

Acceptability and  exclusivity are  complementary  charac-
teristics related to the use of a currency within its own domain.
The more the ECU possesses these qualities the more it will be
equivalent to a national currency, and to the extent  that the
Fund is endowed  with discretionary powers over ECU  supply,

the greater will be the potential of this institution to act in a way

similar to that of a national central bank. The important  issue
is  the domain  of  the ECU,  i.e.  the range of  transactions over

which the ECU  will be  used and  within  this the  degree of

prescriptive use. This question cannot be settled without taking
into consideration other important  characteristics of the ECU

104

ANNEX 1-2

Preparatory studies on the European Monetary Fund

— The liquidity of the Fund

Contents

Introduction

I.  Liquidity  and convertibility

A,  Conversion demand

B. The Fund's  ability to  satisfy the demand for  assets

II.  Liquidity  and negotiability

HI.  Conclusions

Introduction

Generally speaking, a financial  institution's liquidity relates to
its ability to meet its liabilities on demand or at an agreed date ;
it is therefore  dependent both on the quality of its assets and the
maturity  profile of its assets and  liabilities alike.

In the context of the  EMF, 

the concept of  liquidity  should be

assessed in the  light of the  system's  special  characteristics.

When used as an instrument of settlement between participants
in  the  EMS, the  ECU  does  not  pose  any  direct  liquidity
problem for  the Fund,  since an  ECU  settlement  is simply  an
accounting exercise, namely  transfer  by the Fund, in its books,
of ECU  liabilities vis-a-vis one central bank to another. The
operation does not  in itself  involve a call on the Fund's assets.
However, as well as being a regional settlement instrument, the
ECU  is a  reserve asset, and  reserves are  normally  held  as  a
cushion  against  any  payment  imbalances,  not  merely  those
arising out  of intra-Community  operations. Since the ECU is
acceptable in the settlement of debt only  within the EMS,  any
solution adopted  with a  view to  acquiring other, more  widely
used  assets  against  ECUs  could  confront 
liquidity problem since, in certain  circumstances, it  would be
obliged to  repurchase its  liabilities  against its  assets. The
extent of this obligation will depend  largely on the choice made
in the matter of the convertibility and negotiability  of the ECU.

the  Fund  with  a

sufficiently  negotiable to be a fully  utilizable asset.l The ECU's
negotiability  could be supplemented  by a designation formula
and by temporary  mobilization with the Fund. Here too,  if the
Fund  were obliged  to lend some of  its assets to members who
wished  to mobilize  their ECU  assets  temporarily,  a liquidity
problem might  arise, even  though it  would be  temporary  and
less acute.

Below we examine these two cases in turn, although obviously

the convertible ECU is dealt  with in more detail.

I.  Liquidity and convertibility

In  the  case  of  a  convertible  ECU, the  Fund's  liquidity
requirement  would be  determined, first, by the  demand for
converting ECUs into reserve assets and,  second, by the Fund's
ability  to supply  the  assets  required.

A.  Conversion demand

The  demand for  conversion  would  depend  on  the following
factors:

1.  Total  volume of  ECUs  outstanding

Since  all  ECUs,  whether  issued  against  reserves or  against
credit  operations,  will  have  the  same  characteristics,  the
maximum potential conversion demand  will be well below the
total volume of ECUs outstanding. It  will partly depend  on the
distribution of surpluses  and deficits  within the EMS,  and also
on the balance of payments of  the Community  as a whole with
the  rest  of  the  world.  Potential  conversion  demand  will
therefore  vary  over a period with circumstances, but  the Fund
will naturally  have to conduct its affairs 
able, easily  to satisfy  all potential demand.

in such a way as to be

2.  Degree of  convertibility  of  the ECU

The secondfactor  affecting 
convertibility of the ECU.2

the Fund's liquidity is the degree of

There are two possible alternatives:

If the ECU  were convertible, and if the Fund  were obliged to
exchange  it for  other assets, a liquidity  problem  could arise.

If  the ECU  were negotiable, there could be no demand on the
Fund's  assets from  holders  of  its  liability  and hence, strictly
speaking, no liquidity problem. In this case, the question would
then be  whether the  'market'  formed by the  participating
centralbanks (and, possibly, by associated central banks) was
wide and  flexible  enough to  ensure 

that the ECU was

(i)  convertibility on demand or convertibility in case of need:
the  right  to  convert  ECUs  may  be  unconditional  or

As discussed in the paper 'Acceptability and convertibility/negotiabiiity of

the ECU' (Annex 1-1).

This document  discusses  only the convertibility of the ECU  within  the
Community; the problems arising in connection with ECU holdings built
up by other holders are dealt with in Annex 1-5 on the external role of the
ECU.

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Documents relating to the European Monetary System

subject  either  to  the  existence  of  need  arising  from
balance-of-payments  difficulties,  or to other  rules  to be
agreed. Existence of such a need could be recognized with
full  benefit  of  the  doubt  being  given  or  could  be
challenged. The right to convertibility  might also be made
dependent  on  whether  or  not  ECU  assets  exceeded  a
predetermined threshold defined  either as a proportion of
the initial allocation or as a percentage of total reserves ;

(ii)  convertibility  subject to predetermined rules or insistence

on  the general principle  of  Fund  responsibility:

(c)  the possibilities of  acquiring  new  dollar  assets.

In  theory,  these  would  include :

(i)  the sale  of gold  against  dollars.

This possibility  will  depend  on  the formula  adopted

for the  transfer  of gold in the Fund. However, even if

the Fund  enjoyed full  control  over its gold assets, it
would probably be as reluctant as its members to sell
them;

under the first  solution, the emphasis is on the  right of

conversion for  holders ofECUs  or on the limits to these
rights;  the  second  solution  places  emphasis  on  the
responsibility  of the Fund for the smooth working of the
system,  including the  quality of the ECU as a  duly
mobilizable  reserve  instrument.

3.  Attractiveness of the ECU

A convertible ECU would entitle, but not oblige, a holder of this
instrument  to obtain other reserve assets.  Whether  or not  this
right 
is  actually  exercised  will  depend  mainly on the
attractiveness  of  the  ECU, which  itself  is  dependent  on  a
variety  of  factors,  such  as  its  acceptability, 
its  movement
against the dollar, its remuneration and the fact  that the ECU

is the  monetary  expression of a  region in the  process of

integration.

B.  The Fund's ability to satisfy  the demand for assets

First, it is important to  determine the  assets  into  which the
ECU  could be converted. Liquidity is not the same as solvency,
and the Fund might possess assets  which do not correspond  to
its members' needs. Thus, if ECU  convertibility  were to be used
to satisfy  the need to finance an external deficit,  the participant
in question would want to convert his ECUs into dollars andnot
into  gold.  Then  again,  even  if  ECU  convertibility  were
introduced  in  order  to prevent  an  excessive  accumulation  of
ECUs,  this formula  would  also  have to  take  account of the
needs flowing  from  any  external  imbalances.

In  the  light  of  the  above  considerations,  a  convertible  ECU
would  impose  on  the  Fund  the  burden  of  providing  primarily
dollars.  The  Fund's  ability  to satisfy  any  demand for  dollars
would  depend  mainly  on :

(a) the size of the  Fund's  dollar  holdings.

Under  the present  arrangements for  transferring  reserves
to it,  the Fund holds  close on 80°/0  of  its assets  in gold and

only 20% in dollars;

(b)  the  Fund's  ability  to  dispose  of  its  assets.

is  feasible  only 

A  convertible  ECU 
transferred to the Fund in such a way that the Fund enjoys
full  control over all or some of its assets, including the right
of  sale ;

if  reserves  are

106

(ii)  mobilization of its assets.

The  Fund  could  conclude  swap  agreements  with  the
Federal Reserve, and by activating them, temporarily
mobilize  its assets;

(in)  borrowing  directly  from  countries in  surplus and
borrowing  on  the Eurodollar  market.
The  source,  the  form  and  the  maturity  of  such
borrowing  would  have to be  consistent  with the
prospects  for  reconstituting  the  Fund's  stock  of
dollars ;

(iv)  new  transfers  of  reserves  to  the  Fund.

Such  new  transfers  could  take  place  under  rules
requiring  the maintenance of  a minimum percentage
of  reserves  with  the  Fund,  as  is  the  case  at present,
under  an  obligation  to  reconstitute  ECU  assets  or
under  a  designation  formula  allowing  the  Fund  to
purchase  dollars from its  members  against  ECUs.
This  would not  always be  possible,  however,  par-
ticularly  if  the  Fund's  liquidity  problems arose from
excessive  creation  of  ECUs.

II.  Liquidity and negotiability

In  the case of  a negotiable  ECU,  the conversion ofECUs  into
dollars  would not, in theory, be the responsibility of the Fund
but  would  essentially  be  a matter for  the participants  in the
EMS.  The  Fund  could,  however,  contribute  to  the  proper
functioning  of  this system by placing at its members' disposal
the dollars  they  required.  These  dollars  could  be supplied  by
other participants  through the Fund according to a designation
formula or by the  Fund  directly  if  members  were allowed to
mobilize  their  ECUs 
tantamount to the  Fund  lending its  dollars 
according to a formula to be  determined  (e.g. dollar-ECU
swaps).

through its  of/ices.  This  would be

temporarily

Use of  this mobilization facility  could present the Fund with a
liquidity  problem, depending  on the extent of  its mobilization
obligation. As distinct from  the problem of liquidity  that arises
with a convertible ECU,  this problem would be temporary since
the  Fund  would  merely  be  engaging  in  a  lending  operation ;
moreover,  it  would  be  less serious  and  less  likely  to  arise.

Annex 1-2

In this context, since priority  ought to be given to the smooth
working of the EMS, the Fund would, in the management of its
assets, have to take account not only of the yield on its portfolio
but also of the need to maintain a certain margin of liquidity in
the  interests  of  its members.

In the  case of a convertible ECU, (he  Fund's  liquidity  would

depend  on its ability  to satisfy  the demand for  conversion of its
liability, the  ECU, into  more  commonly  used  international
reserve assets.  The main factors  affecting 
would  be :

the Fund's liquidity

(ii) the quantity of  ECU s  created;

(i)  the attractiveness of  the ECU  in relation to other assets;

III.  Conclusions

(Hi)  the  terms on  which  conversion  took place;

(iv) the  types of  asset  into  which  conversion  would be

guaranteed;

(v) the ability of the Fund to acquire further  amounts of these

The matter of  liquidity  cannot be considered independently  of
the choices to be made as regards convertibility or negotiability
of  the ECU. It would also be closely linked to the arrangements
for  transferring  reserves to  the  Fund  and  to regulation of  the
issue  and  circulation  of  ECUs.

If the ECU  were to be negotiable rather  than convertible, the

liquidity problem would be replaced by a management problem.

assets.

It should also be noted that, as the ECU becomes established as

a  means  of  settlement  and  international  reserve  asset,  the
potential  demand  for  assets  other  than  the  ECU—mainly
dollars—will  tend  to fall  relative  to  the  Fund's  total balance
sheet,  thereby  reducing  the  threats  to  the Fund's  liquidity.

107

ANNEX  1-3

Preparatory studies on the European Monetary Fund
Arrangements for transferring reserves to the EMF

Contents

Introduction

(a)  Transfer  of  reserves  under  the existing  system

(b)  Transfer  of  reserves in the  institutional phase

I.  Formulae for  initial  transfer

A.  Retention of  the swap  system  in a modified  form

B.  Definitive  surrender  of  reserves  transferred 

Fund

(a)  Transformation  of present swaps  into the sale of

reserves to the Fund

to  the

of the ECU precarious;

(b)  Transfer  of gold and dollars  in standard propor-

tions

C.  Ad  hoc formulae  based  on  the  specific  character  of

gold assets

(a)  Transfer  of  gold as  capital

(b)  Gold 
certificates of  deposit

transfer  against  issues  of  mobilizable

agreed that  these swaps  will be renewed until 13 March  1983
unless  transition to the  institutional  phase  before  that  date
leads  to the adoption  of another transfer  formula. Any  volume
or  price  adjustments  needed  are  made  at  each  quarterly
renewal. On  13 March  1983,  if  no  unanimous decision  to  the
contrary  has been  taken,  the swaps  will be unwound.

This  system is  marred by  serious  limitations,  notably the
following :

(i)  the fact  that the system reverts to its starting point at the
end of the transitional period tends  to make the existence

(ii)  the  quarterly  value  adjustments,  and  in particular  those
carried  out for  ECUs  created  against  gold  swaps,  have
produced  substantial  automatic  variations in ECU
liquidity;

(in)  the  transfer  of  reserves is not  definitive;

(iv) the EMCF plays a passive role and has no discretionary

power either over the amount of ECUs created or over the
use of  reserves  deposited  with  it.

These limitations are not compatible with the full utilization of

(c)  Transfer  of gold with preservation of  rights over

the ECU as a reserve asset and a means of settlement as had

revaluation profits

been laid down by the European  Council of 5 December  1978
for  the institutional phase of  the EMS.

II.  Links  to  be  established  between  the  volume  of  reserves
transferred  to the Fund and the stock  of ECUs  outstand-
ing

(b)  Transfer of  reserves in the  institutional phase

A.  Retention of  volume  adjustment

B.  Imposition  of a ratio for ECU  holdings

C.  Non-automatic  subsequent  transfers

III.  The return payable  on the ECU  and the various formulae
for  transferring  reserves

Introduction

(a)  Transfer of  reserves under the  existing  system

Under the  existing  system, the  central  banks  transfer to the
EMCF20%  of their gold assets and 20% of their dollar assets
in  the form  of  three-month swaps  against  ECUs.  It  has been

108

formulae for

It  must  first be  stressed  that the  different 
transferring  reserves to the EMF  cannot be  looked at in
abstracto; the basis must be the solutions envisagedfor  a whole
range of  more general problems relating more particularly to
the functions  of  the  Fund  and  to  the  characteristics  of  the
ECU.1

However, the different  assumptions possible in this connection
have one feature in  common:  they all  lead to the  idea of
'permanence'for 
following  considerations are behind  this conclusion, those of:

the  transfers  of  reserves  to  the  Fund.  The

(i)  etting up apermanent ECU system with no automatic and

parallel  increase in liquidity;

(ii)  enabling the  Fund to  help  finance and  adjust 

the

disequilibria  which exist between the Community and the

rest of the  world;

See  The  EMF:  institutional  aspects' -  Annex  1-6,  'Acceptability and
convertibility/negotiability  of the ECU' - Annex  1-1.

Annex  1-3

B.  Definitive  surrender of  reserves transferred to the  Fund

The gold and dollar reserves would be definitively  surrendered
to  the Fund,  which  would have full  control  over  them. '  This
could  take .place  by  sale/purchase,  although  other  legal
formulae are also possible.

(a)  Transformation  of present swaps into the sale of  reserves

to  the  Fund

The  purchase  of  reserves  against  ECUs  by  the  Fund  is  an
operation similar to that carried out by a central bank when it
issues its  currency by, for  example,  purchasing  foreign
currencies  on  the  exchange  markets.  Both  operations  are
definitive  and irreversible. The bank becomes the owner of  the
assets purchased and, unless the operation in question resulted
from  an intervention at  the bilateral limits in accordance  with
the EMS  exchange rate mechanism, it is not  required  to buy
back  its  currency.  Likewise,  the  Fund,  after  selling  ECUs
against reserves, would become the owner of  these reserves in
exchange for  ECUs  definitively  acquired by  their purchasers;
this arrangement would result in the setting-up  of a permanent
ECU system.

This formula  calls for  the following  comments:

(Hi)  providing  the  Fund  with  a  guarantee  vis-a-vis  third
parties;  this  would  be  necessary  should  the  Fund  be
authorized  to  contract  loans on the international capital
market and if ECU  holdings were built up by other official
holders.

Below, we  deal first  with the  various formulae for  initial
transfer;  we  then  discuss  the  problems  connected  with  the
periodic adjustment  in the volume of these transfers,  and end by
considering the questions  raised by the return on the ECU.

I.  Formulae  for initial  transfer

A.  Retention  of  the  swap system  in a  modified  form

The first  question  to  ask  is  the following:  could  the  swap
to
system as it operates at the moment be modified  sufficiently 
remedy its  deficiencies? The  idea has  been  mooted in  this
context 
that  the  swaps  be  accompanied  by  a  renewal
obligation, until an agreement has been reached on a definitive
formula for  transferring  reserves. The precarious nature of  the
ECU  could be reduced without, however, implying a definitive
surrender  of  reserves.

(i) By the sale, the central banks would definitively  surrender

Consideration  might  also be given to  either a  'freeze' on the
gold  and  dollar  price for  the  duration  of  the  system,  while
retaining  the  volume  adjustment,  or  non-automatic  dis-
cretionary adjustments to either the volume alone or to volume
and prices. A midway solution might be to reduce the frequency
of  the price  adjustment.

In a  'closedpool'  context, the reverse procedure might also be
contemplated: price adjustments  would no longer be reflected
in the  amount of  ECUs  outstanding but in the  volume of
reserves  swapped.  This  method  would  have  the  effect  of
imposing  a  tight  ceiling  on  the  overall  amount  of  ECUs
outstanding.

Even so,  introduction  of  a modified  swap  arrangement  would
not  resolve the problem of  the permanent nature of  the ECU.
This is because the swaps would have to be unwound at the time
of  the  changeover  to a  definitive  system.  The prospect  of  the
Fund  reverting  to  its  starting  point  would  not  completely

eliminate the precarious nature of the ECU and the Fund would

have control over its assets only to the extent of  holding  them
itself in the form  of swaps. The situation would, in principle, be
different 
if it were agreed at the outset to consolidate the ECU
positions when the changeover to a definitive  arrangement took
place. A  commitment of  this kind would, however, be difficult
to  reconcile  with  the  actual  concept  of  a  'swap'.

a fraction  of their reserves to the Fund. For some of  them
this solution would have the disadvantage  of severing, too
sharply, all  links  with the  gold  which had  been  sur-
rendered. In  any event, they  would all have to be sure of
acquiring in return for  the definitive  transfer  of assets, an
asset  with  similar  characteristics,  including  the  one  of
being  itself  fully  and  easily  usable  and  exchangeable
against  other  assets.  The sale  would give  the  EMF full
control  over its  assets, so  that the  Fund  would be  able
—  but not obliged — to confer  a measure of convertibility

on the ECU.

(ii)  By  the  sale,  transferors  of  gold  and  dollars  would  be
passing  over  to  the  Fund  the  risk  of  losses  or  gains
resulting from  variations in the price of the surrendered
assets. Then again, if  the arrangements laid down in 1978
at Bremen were to be adopted for  reserve transfers to the
Fund, the central banks would be contributing in differing
proportions,  to  the  constitution  of  the  Fund's  gold  and
dollar  assets,  and  consequently,  they  would  also  be
contributing in differing  proportions to the Fund's income
and to the return on the ECU to the extent that the Fund
distributed its  income between all the ECUs.

1 The transfer of other reserve assets (SDRs) is not discussed, but this is a

problem  on which  a decision would have to be  taken.

109

Documents relating to  the European  Monetary  System

(b)  Transfer  of gold and  dollars in standard proportions

It is conceivable that, while the 20% figure  would be retained

for  calculating  transfers,  this figure  would no longer apply to
gold  and  dollars  separately  but  to  the  whole  of  the  reserves
(gold  and  dollars)  of  each participant,  expressed  in  ECU.
With  each participant's  overall contribution having thus been
determined,  a standard percentage  would be fixed  indicating
the share of  the  transfer  to be made in gold.  With  this transfer
technique,  some  countries  would  have to add to  their  gold
transfer  and reduce  their dollar  transfer,  while other countries
would be in the reverse situation. The result would be changes in
the composition  of national reserves; the scale of  the changes
would  depend  on  the key  used.

At first  sight, the advantage of this formula  would be that each
participant  would  retain a  right of  recovery  over the  assets
transferred 
to the  Fund, and  that the  profits  from any
revaluation  would be  reserved for  that participant.

On closer examination, however, the situation is not so clear-
cut.

(i)  The holder of a title representing a participation  in capital
can,  in theory, exercise his right only  if  the organization is
wound up.  In  the event  of  the  Fund  being  wound up,  the
claim would be exercised over  the net assets of  the Fund;
there  would  therefore be no  guarantee  that the  initial
deposit of  gold  would be  recovered.

The  advantage  of  this formula  over the one discussed above is
that it would establishfor  each participant equality between his
share in the constitution of the Fund's assets and his share in the
Fund's income. But  this advantage would be temporary, in that
the  application  of  this  solution,  in  the  event  of  subsequent
transfers of  reserves, would pose  considerable problems.

C.  Ad  hoc  formulae  based  on the  specific  character  of  gold

assets

Given the  specific  problems linked to the  transfer  of gold, it
seemed useful to examine the alternative options for  transfer-
ring gold to the Fundl  which leave the transferor  of gold with
rights over his transfer.  In each of these cases, dollar transfers
would  take  the form  of  a surrender pure  and simple.

(a)  Transfer  of  gold as  capital

Under  this formula, gold  transfers  made by  the central banks
would  represent  participation in the  Fund's  capital. The
transferor of  gold  would  receive a  title of  ownership, not
transferable,  expressed in  gold  weight, and not a  means of
settlement. The Fund would also allocate simultaneously  to the
participating  central  banks an  amount of  money in  ECUs
proportionate to their capital participation; these ECUs would
be permanent in character. In order to maintain the accounting
equilibrium of  the EMF's  balance sheet, the latter operation,
which  would  increase  the Fund's  liabilities, would require  the
entry  of  an equivalent  amount  on  the assets side.

This formula  thus consists of two separate, albeit  coordinated
operations: a transfer  of reserves as capital and the creation ex
nihilo  of  a  quantity  of  ECUs  which  might  be  equal  to,  or
different  from,  the  countervalue of  the  reserves  transferred.

1 The retention of swaps for gold transfers alone could also be regarded as

an  ad hoc  formula,  but  this  would  not  really  eliminate  the  precarious
nature of the ECU.  '

110

(ii)  The guarantee of  recovery  also  depends  on  the extent  of
the Fund's control over the assets received as capital.  This
is  a grey  area.  According  to  the  reasoning  behind  the
'capital'  formula, the  Fund  could  lend its  assets,  i.e.
contribute to mobilization  of  the ECU,  but  would not be
able to ensure its convertibility  since the latter operation
could  be  interpreted  as  an  indirect  recovery  by  the
participants  of their capital contribution. It could here be
argued  that  this would not be the case, however, where a
participant  wished to convert ECUs accumulated over and
above his initial allocation. Because of  the  difficulties  of
interpretation  raised by the question of the extent of the
Fund's  control over its assets,  there  would seem to be a
need  for 
supplemented by precise statutory  clauses.

'capital'  formula,  in  any  event,  to  be

the 

(Hi) The  link  between  participation in the  capital and the

creation of money in ECUs should be clarified.  More than
one  hypothesis is possible:

- ECU issue equal to the entire capital; money creation

would occur to the extent that the capital was not fully
paid  up;

~  ECU  issue  independent  of  the amount of  capital;  the

Fund  would  have the  right to  decide,  depending on
circumstances, on the amount  of  ECU  to be created.

(b)  Gold  transfer  against issues of mobilizable certificates of

deposit

The gold transfer  would give rise to the issue of a non-interest-
bearing  certificate of  deposit,  expressed in gold  weight; the
risks  on  gold  would  continue  to  be  borne  by  the  depositing
central bank.

For the certificate  of deposit  to be converted into an instrument
of settlement— the ECU— it would have to be mobilized; at
the  holder's  request, the  Fund  would  'rediscount' the  gold

certificate.  This  mobilization,  which  could  be automatic  and

Annex  1-3

participants record an increase in their reserves after  the initial
them  to  make  further
deposit,  there  is  an  obligation  for 

transfers; in the  opposite  case,  they  would  receive a  refund.

The  adjustment  in  the  volume  of  the  reserves  deposited  and,
consequently, the stock of ECUs outstanding takes place when
the  swaps  are  renewed  each quarter.

In  the institutional phase, several formulae  can be considered
for  new  transfers  and  the final  choice will be influenced  by  the
method  of  transfer  used  initially  and  by  the  option  chosen as
regards the control of ECU creation. The possible formulae are
based  on  the following  principles:

A.  Retention of  volume adjustment

The retention of the existing formula for  adjusting the volume
of  reserves  transferred  would  continue  to  link  the  stock  of
ECUs  outstanding to changes in the participants'  gold assets
and  to their exchange rate policy vis-a-vis third currencies; it
would involve agreement on the price at which the new transfers
were made. Consequently, the rate of ECU  creation, as well as
the  rate  of  new  transfers  of  reserves,  would  continue  to  be
highly  automatic  in character. Assuming  a  convertible ECU,
this formula  would be something of a brake on the conversion of

ECUs on the  sole gounds of  reserve  diversification.

B.  Imposition of a ratio for ECU  holdings

Instead of the  requirement to keep a minimum percentage of

reserves  (gold  and dollars)  with the Fund, participants  would

be required to hold a certain percentage of  their reserves in the

form  of  ECUs.  Such  a  rule  would  establish  a  degree  of

for an  indeterminate  period,  would  entail the  payment of

interest. Being a liquid instrument, the gold certificate  would be
recorded as a reserve asset in central bank balance sheets while
the gold  deposited  would be shown  among the  Fund's  assets.

This option, while ensuring that the gold was mobilized,  would
reserve for 
the  transferor of  gold the  profits  from any
revaluation.

However, since it would only be the holder of the gold, the Fund
couldnot release it: this could have implications for  the Fund's
liquidity  assuming  that it had to ensure a fairly  high degree of
ECU  convertibility.

This  solution  would  also  mean  that the  creation of  ECUs
against  gold  would  keep  pace  with  the mobilization  of  these
certificates.  As  a  result,  the  volume  of  ECUs  created  at  the
start  of  the final  phase  would  be smaller  than  the amount  in
circulation at the end of the transitional period, unless there is a
substantial  (and  perhaps  temporary)  increase in the propor-
tion of  dollar  transfers.  Although  this formula  achieves a
relatively satisfactory  solution with regard to the return, it does
not  lead  to  a genuine  transfer  of  reserves. For  this reason, it
might be agreed  that the participants  would have the  right to
convert gold  certificates  into a definitive  surrender. Such an
operation would have to be done collectively at an agreed time,

if it is considered necessary to avoid any problems that might
arise from the coexistence of several formulae for the  transfer
of  gold.

(c)  Transfer of  gold  with  preservation of  rights  over

revaluation pro/its

Under  this option, the transfer  of gold against ECUs  would be
accompanied  by  the preservation of  a right  to the profit  from
any revaluation of  the gold. Since the Fund  would pay  interest
on all ECUs  held by  the participants,  and since gold does not
produce interest, each member country  would have to pay back
compensatory  interest  on  its share of  ECUs  received against
gold.

Like the previous formula,  this form of  transfer  would not

transfer; it  would pose  scarcely any

amount to a  definitive 
accounting problems. Nor  would it show up a reduction in the
amount  of  ECUs  outstanding  at  the  time of  transition  to  the
institutional phase.

II.  Links to  be  established between the volume

of  reserves transferred to the Fund and the

stock  of ECUs outstanding

Under the present system, participants are required to keep at
least 20% of the  volume of  their  gold and  dollar  reserves
permanently  with the  EMCF.  This  means  that,  when the

parallelism between the use of the ECU and the use of national

reserves.  From  this  point  of  view,  it  would  moderate  the
possible  convertibility  of  the  ECU  as,  when  a  participant's

ECU  holdings fell to the  level  determined by the  ratio, any

conversions of  ECUs  would  have to be  accompanied by a
proportional  reduction in the reserves held on own account by
the participant in question. However, this rule would inhibit the
use  of  the  ECU  for  Community  settlements  since  it  would
require the user  to reconstitute them. Although  the period for
reconstitution could, by agreement, vary  in length, the effect  of
such  a  rule  would  be  to  make  the ECU  more  like  a  credit
instrument  than an  instrument  of settlement.

C.  Non-automatic subsequent transfers

In  this case, there would be no subsequent automatic transfers.
They  would  either be  decided  collectively by the  Fund
authorities  or made,  with  the  agreement  of  the  Fund,  on  the
initiative  of  the participants  who wished  to reconstitute  or to
increase their ECU assets. This practice would be the one most
compatible  with an  effective  control of ECU  liquidity.

I ll

Documents relating to the European  Monetary  System

III.  The return payable on the ECU and the
various formulae  for transferring  reserves

A close link exists between the problem of  the return payable
and  the problem  of  transferring  reserves.  The  return  on  the
ECU  is in essence a distribution of  the Fund's income; the level
of  this  income, as  well as the  amount of ECU  liabilities on
which a return had to be paid, depends on which of the various
transfer  formulae is chosen.

The return paid on the ECU  would be relatively low if it were to
be based on the Fund's current income alone (interest received
on its dollar  investments and on its loans).  This return might,
however,  be  considered  satisfactory 
if  it  were  borne  in mind
that the ECU enabled a relatively illiquid, non-interest-bearing
asset, i.e. gold, to be mobilized.

A  higher  return  could be paid  if not  only  current  income but
also the revaluation profits  on the Fund's gold and dollar assets
were taken into account.

The return payable on the Fund's ECU  liabilities is one of the
factors  which  will  determine the  attractiveness of  this
instrument as a  reserve  asset. The  return  would be paid in
ECUs.

If the return were topped up in this way,  this would presuppose

Without  embarking on inflationary  ECU  creation, the return

payable on the Fund's ECU  liabilities as a whole can in no way

be greater  than the  income  obtained by the  Fund on its own
assets, i.e.  the reserve assets transferred  by the participants and
the credits granted by the Fund. In other words, with regard to
yield, the ECU  cannot be better  than the assets backing it.

Within  (he limits of  its own  income, the Fund  will be able  to
modify  the return on the ECU.  However, its power to influence
its  income  is  more  restricted:  it  is  non-existent  as  regards
revaluation gains and  very  limited for  dollar  income, but the
interest  rates for the  credits  granted  (Community  credits,
mobilization of  gold  certificates) are fixed  discretionally by
the Fund.

The  main  questions  raised  by  the  distribution  of  the  Fund's
income, and consequently the return payable on the ECU, are
the following:

(i)  What  income  will  the Fund possess and  what  will be  the

amount of  liabilities on  which a return has to be paid?

(ii)  Given the heterogeneous nature of the assets transferred to

the Fund against ECUs, how could the income arising from
these different  kinds of assets be fairly  redistributed by the
Fund in the form  of a return which ought to be identical for
all ECUs?

The  answers provided  by  the  different 
briefly  reviewed below.

transfer  formulae  are

1.  Sale  of gold  and dollars  against  ECUs

Under this formula,  the Fund would possess the following  types
of  resources:

(i)  current income: interest received on dollar investments and

on credits granted  to members ;

(H)potential  gains  (or  losses):  gold  or  dollar  revaluation

profits.

112

(a)  that  there  were  capital  gains  on  the  assets  transferred
(which willdependon the transfer prices of the gold and dollars
and on subsequent  changes in them) and (b)  that agreement
has  been  reached  on  the  arrangements  for  realizing  and
distributing  these  capital  gains.  If  the  Fund  were  to  effect

payment of the  return in  ECUs, the  problem  arises, in

connection  with the  equilibrium of its  balance sheet, of the
contra-entry on the assets side for  some portion of the interest
paid.  Several solutions can be envisaged:

(i)  the Fund would make these interest payments by imputing
purely accounting gains. Such a formula, which wouldnot
involve realizing such gains, could in particular be adopted
in the event of an official  price for  gold being reintroduced,
or of  the central banks regularizing rates; in this system,

the  payment of a  return in  ECUs  would  result in the

Fund's liabilities being inflated  against assets which were
unchanged in  volume but  revalued in  value;

(ii)  the Fund would realize its capital gains by the sale of gold
anddollars  to the participants. It would acquire the ECUs
needed to pay  the return; the effect  of this formula  would
be to reduce the volume of the Fund's assets, while leaving
the stock  of  ECU  outstanding  unchanged;

(Hi)  the Fund would realize its capital gains by  the sale of gold

and dollars on the market. In  this case, the Fund  would

acquire  Community or  third  currencies  against  which
ECUs  would be created  when the  return was paid.

Whatever the formula  adopted for  this payment, the continuity
of  a high  remuneration  on  the  ECU  cannot  be assured  in all
circumstances  and  the  Fund's  solvency  would  require  the

participants to guarantee the Fund against a turn-round in the

situation, i.e. against capital losses. It  therefore follows  that a
distribution of interest payments to the Member States is liable
to  involve  them in  incurring  expenditure at a later stage.

2.  Transfer  of  gold as capital

Should  the  Fund  create  ECU  ex  nihilo,  in  parallel  with
transfers  of gold as capital, the return payable on these ECUs
would have to be the same as that payable on ECU  created in
other  ways.  As  in  the  case  of  the formula  discussed  above,

Annex  1-3

distribution of the Fund's current income alone would provide a

low  return on the  ECUs. If,  moreover, any  exchange-rate

profits  on the gold  capital  were  reserved for  the shareholders
alone, their distribution would not represent a topping up of the
return on the ECUs. Large transferors  of gold would receive a
return on the ECUs createdex nihilo, while retaining a right to
the  revaluation pro/it on  their  gold  transfer. For  their part,
participants  who had made a greater  transfer  of  dollars —  an
asset  whose income and exchange rate gains would be spread
over all the ECU—  would be at a disadvantage.

3.  Transfer  of gold against issues ofmobilizable  certificates of

deposit

The  gold  certificates  would  not  constitute  ECUs;  con-
sequently,  no  return  would  be paid  on  them. As  a result,  the
Fund's  obligation  to  pay  a  return  would  be  limited,  at  the
outset, to  the ECUs  it had created  against  the acquisition of

assets  generating  current  income  (dollars  and  Community
loans). Since interest would have to be paid on the creation of
additional  ECUs  by  the mobilization of gold certificates,  the
in any event, for  it to pay  a
Fund's income would be sufficient, 
relatively  high  return on the ECUs.

4.  Transfer  of gold with preservation of rights over revaluation

profits

The  transfer  of gold would give rise to the immediate creation
of  ECUs on which the Fund would be required to pay  the same
return  as  on  ECUs  created  in  other  ways.  However,  gold
transferors  would  have to pay the  Fund  interest in  order to
reserve  any  revaluation  profits  for 
would  give the  Fund  substantial  current  income. The
accounting  implications  of  this formula  are  comparable  to
those  of solution 3 above since all  the gold  certificates  would
have been permanently  mobilized.

themselves  alone.  This

113

ANNEX  1-4

Preparatory studies on the European Monetary Fund

—  Consolidation of  Community credits in the European Monetary  Fund

Contents

Introduction

I.  Role of the  EMCF in the mechanisms in force

1.  Very  short-term financing

2.  Short-term monetary  support

3.  Medium-term financial  assistance

4.  Community  loans for  balance-of-payments  support

II.  Consolidation of the  credit  mechanisms and  role of the

Fund

A.  Powers of  the different 

types  of Fund as regards credit

B.  Very  short-term financing

1.  Provision  of  the  currency

2.  Financing procedures

C.  Other financing  operations

1.  Financing procedures

2.  Principles for  determining the credit  amounts

3.  Automatic  nature  of  the  credit  and  discretionary

power of the  Fund

4.  Conditionally and  cost of the  credit

III.  Problems raised by the  consolidation of  credits

1.  Choice of the  credits to be  consolidated

2.  Method  of financing  consolidated  credits

3.  Checks  and balances

Introduction

This note analyses  the consolidation  of  the credit mechanisms

in the Fund. It does not prejudge the range of mechanisms to be

included  in  such  consolidation,  either from  the  start  of  the
institutional phase or at a later stage depending  on the  way  in
which  the  EMS  develops.

114

The  note  begins  by  recalling  the  main  characteristics  of  the
mechanisms in force  and  the EMCF's  role  in  these mechan-
isms. It  then goes on to analyse the possible role of the Fund in
the consolidation of  these mechanisms; lastly, it comments on

some  of  the  major  problems  which  such  consolidation  would
raise.

I.  Role of the EMCF in the  mechanisms in force

Under the  present  credit  system,  the.EMCF's  role  varies
according to the  type  of  credit, but, in any  event, its role is a
minor  one.

1.  Very  short-term financing

This is not strictly speaking a credit at all, but a reciprocal cash
facility  between central banks in the context of interventions in
Community currencies. This type  of financing  is automatic and
unlimited  when  it  relates  to  interventions  made  at 
the
fluctuation  margins,  such  interventions  themselves  being
obligatory and  unlimited in  nature.  However,  interventions
within the margins are subject  to agreement by the bank issuing
the  currency  sold;  the  agreement  on  making  the  currency
available  also  relates  to  other  arrangements:  immediate
settlement or recourse to  very  short-term financing.

Although  the system  is a strictly  bilateral one  (central  bank
making the currencies lent  directly  available to central bank,
agreement  between the parties  concerned as  regards  intra-
marginal interventions), the EMCF fits  into it as a mandatory
but purely formal  intermediary, being both creditor and debtor

for  identical  amounts. It  also  keeps the  accounts for  these

operations.

2.  Short-term  monetary  support

This is a  reciprocal  credit  system  between the EEC  central

banks under  which each of the members is assigned a creditor
the  proportion of  support  which it
quota  determining 
undertakes to finance and a  debtor  quota  determining the
amount  of  support  which it  may  receive  on  application.  This
quota  system  is supplemented  by  non-individualized  creditor
and debtor rallonges which enable the volume of  such support
to be increased. Support,  which is for  a period of  three months
(renewable  twice), can be obtained almost automatically  and
is  unconditional  within the  limits of the  debtor  quota, but
subject to the discretion of the Committee of  Governors when
the amount requested necessitates recourse to a rallonge. The
creditor  central banks  exercise a certain power of  assessment
as to their individual ability  (balance of payments and reserves
situation)  to participate  in a credit  operation.  The  support  is
denominated in the  currency  actually  supplied; 
it is de-
nominated in ECUs in the case of an operation which replaces a
very  short-term financing  arrangement.

Annex  1-4

In  raising the  amount of  short-term  monetary  support 
to
14 000  million  ECU, the  Brussels  Resolution  introduced  the
new concept,  accepted by the central banks, of the maximum
available  credit: the  quotas and
amount of  effectively 
rallonges  were adapted  accordingly.

The role of the EMCFis  limited to keeping  the accounts of this
mechanism.

3.  Medium-term  financial  assistance

The principle of  these mechanisms, or at  least some of  them,
being taken over by a Community  body has been laid down by
the following  instruments:

(i) as regards the EMCF: Article 3 of the Council Regulation

of 3 April  1973  establishing the  EMCF  made the  Fund

the  administration  of  very  short-term

responsible  for 
financing and of short-term monetary  support  and for the
regrouping of  these  mechanisms in a  renewed  mechan-
ism ; '

the

The  Brussels  Resolution set at  11 000  million ECU 
maximum  amount  of  effectively  available  credit  under  this
form  of assistance: it is granted by Council decision and carries
economic policy  conditions  laid  down  by  the  Council.  The
credit,  which  is  normally  granted  in  successive  tranches,  is
denominated in ECUs and paid up in a national currency. This

is a reciprocal  credit  system, but the  credit is granted by the

Member  States instead of  (he  central banks.

(ii)  as regards  the EMF:  the Annex to the Conclusions of  the

Presidency of the Bremen European  Council provides for
the  creation of  ECUs for  credit  purposes  against the
contribution  of  national  currencies  and for  the  existing
arrangements and  institutions to be  consolidated in a
European  Monetary  Fund. The  Brussels  European
Council  confirmed 

these  conclusions,  giving  particular

emphasis to short and medium-term  credit.

The  EMCF  has no  role  in operating  this mechanism.

4.  Community  loans for balance-of-payments  support

This  mechanism, established  by  specific  Council  decisions  in
1975,  has just been modified  and renewed. Its purpose is to raise
capital,  either  directly  from 

third  countries and  financial

institutions, or on the capital markets, with the aim ofrelending

the funds  raised to  Member  States, in  order to  help  them
overcome  balance-of-payments 
directly  or  in-
directly  related to an increase in prices of petroleum products.
The funds  lent carry economic conditions fixed by the Council.
The outstanding amount of borrowings authorized has been set
at  6 000 million  ECU  in principal.

difficulties 

The funds  are borrowed  by  the  Commission  on  behalf  of  the

EEC  after  authorization by the  Council. The  financial

operations pass through  the accounts of  the EMCF,  which is
responsible  for  managing  the  borrowings.  However,  the
operations are  self-balancing: 
operations are carried out on the same terms and with the same
value dates, with the result that the EMCFis  never required to
manage  cash funds.

the  borrowing and  lending

II.  Consolidation of  the  credit mechanisms and
role of the  Fund

The  term  consolidation  is  interpreted,  in  this  note,  as  the
regrouping  of  disparate  mechanisms,  introduced  at  different
times  by  different  authorities,  into  a  single  and  definitive
structure. The  advantages to be  gained from  consolidation
would  be  that  a  more  effective  mechanism  better  suited  to
requirements  would be  established, the  status of the ECU
would be enhanced and the economic convergence of  Member
States  would be furthered.

(i)  The transition to a system in which the Fund had a central

role would be equivalent to effectively  putting Community
credits on a multilateral basis. It would necessarily mean a
revision of at least some of  the rules governing the present
mechanisms and  would  result in an  important  change in
the  nature  of  the  system  of  Community  credits:  the
mechanisms in force —  which are, in fact, a network of
bilateral  relationships—  would  be  replaced  by  a  Com-
munity  institution granting a range of  credits in its own
name: the comprehensiveness of the range would depend

on the option  chosen.  This  would allow the duration and

amount of  credit as well as its terms to be adapted  to the
specific  requirements  of  each  Member  State.

(ii) The fact  that the  Fund  granted  credits in  ECUs  would
enhance the  role of the ECU as a  means of  settlement
between  participants  in  the  EMS; consequently,  the
Community  could  gradually  switch  to  using  its  reserve
assets  other  than  ECUs  solely for  external settlements.

The above exposition  shows that the EMCF has no significant
role in the Community  credit mechanisms: even though it is a
necessary  intermediary for  very short-term financing,  this is a
legal device  of no real consequence; in fact  its role is confined
to  tasks  of  managing  the  accounts, and  these are,  moreover,
carried  out  by  the  agent  on  the  Fund's  behalf.

(in)  Through its role both on exchange markets and in defining

the conditions attached  to the credits  it grants, the Fund
could  increasingly  help to foster  economic  convergence
between  the Member  States.

1  This  task  has  not  been  carried  out.

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A.  Powers of  the different  types of  Fund as regards credit

Consolidation of  the credit mechanisms within the EMF  would
constitute  only one  of the functions  attributed to  this new
institution. It  is consequently  clear that  the decision to choose
one  or  other  of  the  credit  options  will  flow  from 
the
fundamental  choice  which  will be made  between the  different
options  concerning  the nature and purpose  of  the Fund.

Other  notes  addressed  to  the  Monetary  Committee  have
distinguished four  possible  types for the  European  Monetary
Fund:

months to jive years. However, if it were felt  important to
retain the principles at present governing these two credit
mechanisms, the Fund  would grant short-term monetary
support to the central banks, as under the present rules;
medium-term credit  (over  one year)  would be granted to
Treasuries and  would  carry  economic and  monetary
policy  conditions.

(iv)  A  'sui  generis'  Fund  with both  economic and monetary
in  a  homogeneous  structure,  all

powers  could  unify, 
credits,  ranging from the  very  short-term financing to
medium-term financial  assistance  and,  possibly,  Com-
munity loans. These credits are complementary  in purpose

(i)  an  'accounting'  type  Fund similar to the present EMCF;

but up to now  they  have  been  separated and are the

(ii)a 

'central  bank'  type  Fund,  which  would  be  assigned

monetary powers;

(Hi) a  'regional IMF'  type  Fund, which would be essentially an

economically-oriented  institution ;

(iv)  a  'sui  generis'  Fund:  whereas  in  the  two  preceding

options,  either the  monetary  function or the  economic
function  predominates, a  'sui  generis'  Fund  would be
endowed  with both monetary and economic powers.

The  choice between the  different 
the nature  and extent  of  this body's  power  as regards  credit.

types of  Fund  would govern

(i)  The  sole  task  of  an  EMCF-type  Fund  would  be  to
administer  all  the  mechanisms;  its  powers  would  vary
according  to the interpretation  given to this administrat-
ive function  which, moreover, had already  been laid down
in  Articles of the  Council  Regulation of 3 April  1973
establishing  the  EMCF.  The powers  of  the  EMF  would
enable  it as a minimum to administer  the accounts of  all
credit  mechanisms, from  very  short-term financing to
Community  loans.

can either be settled on the spot, or be the subject  of a financing

authorities;  if 

responsibility  of  different 
they  were
consolidated,  credit  could,  without  any  break  in  con-
tinuity,  be  tailored  to  the  specific  needs  of  each
participant,  both in terms of duration and amount and in
terms  of  conditions.

types  of Fund in turn,

Instead of  taking each of  these  different 
and studying  their powers as regards  credit —  which would be
repetitious—  we propose,  in the paragraphs  which follow,  to
discuss  the  consolidation  of  very  short-term  financing
separately  from the  consolidation of the  other  credits. The
problems raised by very short-term financing are different  from

the problems concerning the consolidation of the other credits

which, whatever  the option  contemplated,  are similar and can
therefore be examined  together.

B.  Very  short-term financing

There are two aspects  to very short-term financing:  the first  is
the provision  of  the  currency  requested,  and  the  second  the
possible financing  operation  involved; the  currency  provided

operation.  It  is  important  to  distinguish  between  these  two
aspects  in analysing  consolidation.

(ii) A central bank  type  Fund would in its own name take over

responsibility for the credits  of a monetary  nature which

1.  Provision  of  the  currency

the  central  banks  grant  each  other  in  the  event  of
difficulties  considered to be  temporary:  cash  credit for
very short-term financing,  credit lasting some months for
short-term monetary  support.  It could also be responsible
for  administering  the  accounts of  the other  credits.

(Hi)  Under a  regional IMF 

type  Fund,  very  short-term

financing  would  remain the  responsibility of the  central
banks, ' and  short and  medium-term  credit  would be
consolidated  in a  single mechanism  ranging from  three

  Except for  the  renewing  of  such  financing  which  wouid  be  regarded  as

forming  part of  short-term  monetary  support.

1
116

Two  solutions are possible as  regards  consolidation.

LI.  In line with current practice, the bank issuing the currency
requested  would  supply  it  directly  and  compulsorily  to  the
intervening  bank  when  interventions  at  the  margin  were
involved.  It  might  be  possible  to  envisage  extending  the
obligation  to  supply  national  currency  (up  to  a  certain
amount)  to intramarginal  interventions justified  in particular
by a currency crossing the divergence  threshold; at the request
of  the intervening central bank,  these  interventions would be
the subject  of  a financing  operation.

Annex 1-4

see mopped  up from  the market.  Thus,  the procedure  in force
under  the present bilateral arrangements could be extended  to
all  the participants  in  the system.

2.2.  If it  were thought that ECU  creation for  very short-term
financing  would not  offer any real advantages over the present
situation  and  would  even  be  a  source  of  difficulties 
controlling the amount of the overall issue of  ECU, one could
fall  back on a solution whereby the creditor acquired a claim in
ECU  on  the  Fund,  with  the  debtor  settling  the  EMF  at  the
settlement  date,  either  by  remitting  the  currency  previously
surrendered (andpossibly  repurchased in the meantime), or by

for

supplied the currency requested, and in so far as this operation
gave rise to a claim in ECUs instead of a settlement, a system
would still exist  under  which  the Fund fulfilled  only  a formal
role,  with the  very  short-term  financing  mechanism  then

1.2.  Alternatively, in order to establish a genuinely multilate-
ralized  mechanism, the  intervening  central  bank  ought  to  be
able  to  obtain  directly from  the  EMF  the foreign  exchange
required for  interventions, whether  these were interventions at
the  margins  or  interventions  made  after 
the  divergence
threshold had been crossed.

One way by which the EMF  could obtain this foreign  exchange
could  be  through  swap facilities,  automatic  and  unlimited  in
amount, at least for  interventions at  the margins, between the
Fund  and each of  the  Community  central banks, whereas  the
present  arrangements  operate  bilaterally  between  all  the
central banks  concerned.

remitting  ECUs. In so far as the  issuer, and not the  Fund,

2.  Financing procedures

remaining the  responsibility of the  central  banks  alone.

A  choice  is  also  possible  between  two financing  procedures
depending  on  whether  or  not  the  Fund  creates  ECUs  for
financing  interventions.

2.1. In the first  case, the central bank  supplying the currency
would immediately  be settled in ECUs  by  the Fund, ' on the
debtor's  behalf,  unless the parties had agreed  otherwise. The
Fund would create the ECUs delivered to the creditor against a
claim  in ECUs  on  the debtor  central bank.

the present  practice
The  proposed  system  would  not  affect 
whereby  the debtor  repurchases  the currency sold and  refunds
it  to  the  issuer  as an  advance  repayment.  The  interest  of  the
debtor would, as previously, continue to lie in limiting, as far  as
possible, the  definitive  loss of  reserves.  Only the  procedure
the  debtor,  having  repurchased 
would be  different: 
currency previously sold, would exchange it against ECUs  with
the issuer; with the ECUs obtained in this way, he would clear
his debt with the Fund. So as to reinforce  the present practice of
repurchase,  it  could  also  conceivably  be  extended,  under  the

the

auspices of the Fund, to all the partners wishing, in connection

with the  ECU's  negotiability, to  obtain  this  reserve  asset
against remittance of  the currency  which  the issuer wanted to

In the proposed system, the central bank issuing the currency sold, instead
of  holding a  very  short-term  claim in  ECUs on the  Fund,  would
immediately be settled by a transfer of ECUs which would be recorded as

an increase in the heading 'ECU'. The outstanding amount of this heading

could then decrease rapidly to the extent that the central bank concerned
re-entered  into  possession  of  the  national  currency  previously  issued.
Some central banks already group ECUs held as reserves or as claims in
respect of very short-term financing together in their balance sheets under
a  single  heading  'ECU'  or  'claims  on  the  EMCF'.  For  these  banks,
immediate  settlement  in  ECUs would  involve  no  change  in  the  way  in
which their balance sheets were presented. But those central banks which
now divide these operations into two separate headings in their present
balance sheets, would have to merge them into a single heading, 'ECU'.

2.3.  Each of the two financing  procedures  outlined  above is
compatible  with one or other of the two methods  of providing
currency, i.e. directly by the central bank  (point  1.1. above)  or
indirectly  through  the  Fund  (point  1.2.  above).

C.  Other  financing  operations

The  mechanisms  involved are the  following;  short-term
monetary  support,  medium-term  financial  assistance  and
possibly  Community  loans  raised for  the  purpose  of  giving
balance-of-payments  support.

their  simple

Examination of the consolidation of  these mechanisms cannot
to the  questions  flowing  from 
be  confined 
juxtaposition  within the Fund, but extends  to certain connected
questions — in particular, the amounts,  cost and duration  of
the  credit.  This  approach  must  not  be  considered  as  going
outside the problem of credit consolidation; on the contrary,  it
is justified  by  the  concern  to merge  mechanisms  which up  to

now  have not  really  been  linked.

1.  Financing procedures

While starting from the principle  that credits are denominated
in ECUs, the financing procedure differs  depending  on whether
the liquidity  is created  through  the  issue of  ECUs  or  through
the lending of existing assets: the adoption of one or other of
these  options  will flow  from the  choice  made  between the
different 

types  of  Fund.

1.1.  Financing by ECU  creation

In so far as the  Fund has a  role to play in the financing of

credits, it is logical for  it to finance  them by means of ECUs it
creates  itself.

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1.2.  Financing  by  the  redistribution  of  existing  assets

There  are several possibilities here:

(i)  redistribution of the  Fund's  assets.

Under  the operation, the Fund  would  temporarily  make its
assets available to participants;  such financing  would be

carried out by putting back into circulation assets held as
a  result  of  the  transfer  of  reserves;

(ii)  redistribution of  central  bank  assets.

This  procedure  would  make no  change to the  present

situation with regard to the financing  of the various credit
mechanisms, and the Fund would create no liquidity  of  its
own: the credits, although denominated in ECUs,  would
be  paid  in  monetary  instruments  which  already  exist
(dollars, ECUs or SDRs) and which would be drawn from
the  reserves of the participating  central banks.

However, it should be noted that such redistribution would
itself generate new liquidity, unless the creditor renounced
the liquidity  of  his claim. This method of financing  would
mean that the concept  of  creditor quotas would have to be
retained;

(Hi)  redistribution  of  international assets.

The  Fund  could  make  available  to  its  members  assets
which  it  had  itself  borrowed,  either  under  swap  agree-

ments or on the  international markets.

2.  Principles for  determining the credit  amounts

The  principles  governing the  determination of the  overall or
individual  credit  amount do not  depend on the option  chosen,

but the solutions envisaged  would  differ  according to  whether

or not the  credit  were financed by ECU  creation.

2.1.  Overall  credit  amount

source. In  that  case, however, assuming  that  very  short-term
financing gave rise to immediate settlement with the creditor in
ECUs,  the  ceiling  should  not  include  the  volume  of  ECUs
corresponding  to  the  outstanding  amount  of  very  short-term
financing,  which  should  remain  unlimited.  If  financing  were
carried  out  through  the  redistribution  of  the  central  banks'
assets  on  the  basis  of  creditor  quotas, the  overall amount  of
available credit would vary  with the circumstances  (particular
difficulties  of potential  lenders) and the  borrower,  while not
excluding providing some of the credit through a rallonge as in
the  current  arrangements.

2.2.  Individual  credit  amount

Several formulae are possible, but whether or not the individual
credit amount is determined, the potential beneficiary  would in
all cases have to be guaranteed being able, as under the present
system, to  count on a  virtually  automatic  minimum  credit
amount.  Perhaps  the  total  individual  amount  might  not  be
determined, for  example  if  an amount  were set for  the overall
volume of  credit  which  could be  granted by the  EMF. The
absence of a ceiling set  in advance would in no way mean that a
beneficiary  could run  up  unlimited debt,  but  on  the  contrary
would give the  Fund  discretionary  power  over the  conditions
and procedures for  granting the credit.

If,  however,  the  creditor  quota  solution  were  adopted,  one
might consider  whether it would not be necessary, in return, to
assign to each  Member  State an overall  debtor  quota  which
determined the maximum ceiling on the credit which that State
could receive. If  a system o/rallonges were retained, this would
introduce an element  of flexibility.

3.  Automatic nature of  the credit and discretionary power  of

the  Fund

The system at present in force for  short-term monetary support
comprises  an automatic part, the quotas, and a discretionary
part, the rallonges. It is proposed that, under the consolidated
system,  each participant  be guaranteed  the  availability  of  a
credit  that  would be  virtually  automatic,  though  limited in
amount  and duration.

If  the  Fund  were  to  take  over financing  by  means  of  ECU
creation, this would lead to the ending of creditor quotas: since
they  determine  individual  contributions,  they  would  become
pointless. It  would then be possible to fix a maximum amount
for  the volume of credit and medium-term financial  assistance.
Another approach  might conceivably be to determine no ceiling
the  volume  of  credit,  which  would  be
in  advance  for 
incorporated  into a general ceiling  set for  the  issue of  ECUs
whether  they  were  created against  the  transfer  of  reserves or
credit.  This is because the danger  that monetary  discipline in

the system might be weakened lies not so much in an excess of

credit  as  in  an  excessive  creation  of  ECUs,  whatever  the

According to the circumstances, this virtually automatic credit
would either be apart  of its debtor quota, under the new system,
or the guaranteed part  of an indeterminate credit potential left

to the Fund's discretion. The discretionary power of the Fund

would be exercised from the outset if the amount which could be
granted automatically  was exceeded, and on renewal of a credit
granted  automatically.

The sum of  these individual amounts which could be obtained
automatically  within  the  overall credit —fixed  in advance  or
not—  would  determine  a  credit  amount:  the  Fund  would,
whatever  the  circumstances,  have  to  be  sure  of  having  the
necessary  resources available to finance  this  credit  amount.

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4.  Conditionality  and cost  of  the credit

Beyond narrow limits of  amount and duration, within which a
credit  could be  obtained  automatically, the  granting of
assistance  would  justify  an  examination  of  the  monetary
situation  similar  to  that  currently  made for  the granting  of
short-term monetary  support.  For longer periods  and greater
amounts, should consolidation extend to medium-term credits,
whether or not  they are part of debtor quotas, economic policy
conditions  would  be  imposed  as  is now  the  case for  'medium-
term financing  assistance and  Community  loans.

For  very  short-term financing,  the  present  rules  impose  an
interest  rate based on the average of  national  discount  rates,
weighted in accordance with the weight of each currency  in the
ECU.  By  contrast,  interest  rates on short  and medium-term
credit are  left  to  the discretion of  the authorities granting  the
credit. If  the Fund were given discretionary power, it would be
logical for  it also  to be able  to set  the  rates at  which it  lends.

Although a regional IMF  type Fund is more an economic than a
monetary  institution,  it  would,  however,  be  conceivable for
such a Fund to assume certain monetary functions  such as the
issue of liquidity  in ECUs or the administration of  reserves and
for  it thus to be able to finance  the credits it grants by creating
ECUs.

However,  problems  could  be  created  by  such  an  institution
creating ECUs to finance  medium-term financial  assistance:
the duration of medium-term assistance exceeds that generally
accepted for  monetary financing  and  as  a  rule  needs  to  be
financed  by  redistribution  of pre-existing  assets.

The  sui  generis  Fund  would be  structured so as to  possess
monetary powers, like the  'central bank'  Fund, and economic
powers, like the 'regional IMF'  Fund. These closely  associated
powers by definition  ought to open the way to the financing in
ECU  of  these  credits  as a consolidated  whole.

III.  Problems raised by the consolidation of

credits

The  consolidation  of  credits  raises  the  following 
problems :

three

1.  Choice of the  credits to be consolidated

The  answer to this problem will depend on the choice made in
institutional  terms  between the  different 
question was examined in  Chapter  H.A.

types of  Fund.  This

2.  Method of  financing  consolidated credits

to  this  problem,
Two  types  of  solution  may  be  applied 
depending  on  whether  or not financing  is carried out  through
the  issue  of  ECUs  created for  this purpose.

The problem  differs  according  to  the  type  of  Fund:

It  should  be  recalled  that  if  a  credit  were financed  by  ECU
creation,  there  would  be  no  difference  between  the  ECUs
created  against the  transfer of  reserves and  those  created
through a  credit  operation. In  both  cases,  they  would be
'money'  ECUs. For transactions between partners, the origin
of  these ECUs would not be known and they  would all enjoy  the
same  characteristics of  acceptability,  convertibility/negoti-
ability and remuneration.

Because it would be impossible to identify the origin of such an
ECU,  a  central  bank  could  not  avoid  accumulating  them by
seeking to limit its contribution to the financing  of the credit in
the form  of a creditor quota. A country accumulating too many
ECUs for its  liking  would find  itself in a  surplus  payment
situation and its  monetary  authorities  could not  settle  this
problem by limiting their contribution to a credit  which would
now  be granted  by  the  Fund;  they  would  have  to find  other
solutions so as not to  have to  bear the  burden  of financing
deficit  partners: opportunities for  converting  the ECU  and,  in
the last  resort, exchange  rate adjustments.

An  accounting  type  Fund  could  finance  a  credit  only  by
redistribution of  existing  assets.

3.  'Checks and balances'

A central bank type  Fund should logically finance  the credits it
grants in its own monetary  instrument, the ECU.

The  issue of ECU for  short-term financing —  which theoreti-
cally can be unlimited— is liable to be permanent if the debtor,
when the credit matures, repays the Fund in reserve assets other
than  ECUs.  However, it  must be  stated  that  this  would not
increase the  overall  volume of  credit but  would add to the
balance  sheet of the  Fund,  since the  counterpart of  these
permanently  created  ECUs  would not  then be the  credits
granted,  but  an  additional  deposit  of  reserves.

For  credit to  cease to be  granted on the  basis of  individual

contributions and to be granted by a central institution with the
power of money creation would be a major  change, which would

pose the  problem of  checks and  balances,  i.e. of the

demarcation and  interaction of the  competent  authorities'
respective powers as regards money  creation. These questions
are part of the larger group of institutional problems posed by
the  establishment  of  the  Fund.  Consequently,  we  confine
ourselves below to studying  the problems posed for  institutional

equilibrium by the  disappearance of the  link  existing in the

present system between creditor quotas and liquidity  creation.

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In  this  connection,  it  is felt  by  some  that  the  existence  of
creditor quotas is an adequate answer to the problem of checks
and balances. Changes in these quotas, made  in response  to a
request  by  the  political  authorities,  require  the  individual
assent of each participating  central bank. It is these quotas as a
whole which determine the potential scale of liquidity  which can
be activated by  (he system. ' Fears  have been expressed  that
this balance may be disturbed in the context of a Fund which as
itself  to
regards  the financing  of  the  credit  did  not  confine 
redistributing  the liquidity  available within  the quotas agreed

by  the central banks, but  which itself  granted  these credits by
means of  EC Us  created for the purpose.

It can, however, be argued that an institutional balance similar
to the one which exists at present could be introduced into such

the  credit  ceiling  requested by 

a  system. The  practicalities of  creating  this  balance  would
clearly  vary  according to the  type of  Fund  chosen.  Thus, for
example, in a central bank type  Fund, it is conceivable that any
raising  ,of 
authorities couldnot  take place until it was agreed by the body
managing the  Fund,  i.e. all the  central banks.  However, the
decision  to  raise  the  ceiling  would  be  a  collective  one  taken
within the Fundandno  longer the adding  together of individual
decisions. Consequently, the decision-making procedure within

the  political

1  However, when  such  activation  takes place, the  central banks record, in
their balance sheets, the corresponding claims as the maintenance of their
available reserves.

the Fund  (unanimity or majority)  would determine the degree

of  influence  which each central bank, taken separately,  would
continue  to exercise  in this area.

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ANNEX  1-5

Preparatory studies on the European Monetary  Fund

— External role of the ECU

Contents

Introduction

I.  Interests of  those  involved and  areas of  application

A.  The Community

B.  Third  countries

C.  Coincidence  of  interests

II.  Techniques by  which third countries could acquire and use

ECU  claims on the Fund

A.  Criteria for  enlarging the  'ECU  zone'

B.  Origin  of  the  ECU

countries

D.  Implications for the  characteristics of the ECU

E.  Implications for  the functioning  of  the EMS

Introduction

2.  The external use of the ECU  will in the first  instance result
from  a decision by  the Fund,  but  in the end,  it  will depend  on
how the instrument will be received by third countries. The task
of the Community authorities, if they were to decide to give the

ECU an  external  role,  would be  that of  creating favourable

conditions for  enlarging  the  circle  of  official  ECU  holders.

3.  There  already 

is,  moreover, a  certain use of ECU
is
denomination  by  the  private  sector;  the  development 
spontaneous,  and  independent  of  the  ECUs  issued  by  the
EMCF.  It  consists  particularly 
in  ECU  bank  deposits,
certificates and issues. The possible holding  of  such assets by
monetary  authorities  cannot,  however, be  assimilated to
reserve asset-ECUs proper.

4. The first  part of the note examines the interest  which the

Community  and  third  countries might  have  in  extending  the

envisaged.  Next,  it  deals  with  the  techniques by  which  third
countries would acquire and use ECU  claims on the Fund and
the implications of such techniques for  the characteristics of the
ECU  and  the functioning  of  the EMF.

I.  Interests of those  involved and areas

of  application

5.  The question of  the external role of  the ECU  must first  be
the  viewpoint  of  the  interest  which  the
considered  from 
Community  might  have  in  such  a  development,  while  also
taking into account  the possible  effects  on  the functioning  of

C.  Techniques for  the  acquisition  of  the  ECU  by  third

role of the ECU and the  areas of  application  which can be

I.  This  note  is a preliminary  attempt  to present  and  analyse
the  objectives and the  technical implications of  conferring an
external  role  on  the  ECU  issued  by  the Fund.

the international monetary system. The internationalization of
the ECU must also be placed in the context of an international

monetary  system  evolving  towards a multipolar  system.

The  ECU  will  have  an  external  role  as  a  reserve  asset  and
means  of  settlement  when  it  will  be  used  by  the  monetary
authorities of  countries outside  the Community,  and  when, in
order to do so, they will hold ECU  in an account with the Fund.
Whether  these  ECUs  are  drawn from  the  ECU  reserves  of
Community  central banks, or whether  they  are issued directly

by the EMF to third countries, they would in essence be reserve

asset-ECUs.

This  extension .of  the  ECU's  role presupposes  that  it  would
already  have become a fully-fledged  reserve asset and means of
settlement  for  EMS  participants,  i.e. the  extension  of  the

external role of the ECU is dependent on the strengthening of

its  internal  role:  consequently,  extension  belongs  to  the
institutional phase of the  system.  Having  said  that,  certain
forms  of use of  the ECU  can be envisaged in a nearer future,  in
the Fund's  relations with third country  central banks, e.g. the
use  of  the  ECU  as a simple  unit  of  account.

The  Community

6.  The possibilities of mobilizing the ECU  would be increased
by  extending  its  zone  of  transferability.  If  the  EMF  were  to
empower authorities other than the Community, central banks
to  acquire and  hold  ECU, the  question of 
the  con-
vertibility/negotiability of the ECU  held by the  Community
central  banks  might no  longer  arise in the  same  terms: the
Community  central  banks  would  be  able  to  obtain  dollars
against ECU  from  sources  other  than the  Fund or EMS
participating  banks.  With the  development of the  ECU's
external role, the demand to convert or mobilize the ECU  with
the Fund would tend to decrease, since the main reason for  such
operations—the  regional nature of the ECU's acceptability—
would  tend to  disappear. The  Fund  would,  however,  have to
continue to guarantee, in the last  resort, the  convertibility or
possibility of  mobilizing the  ECU.

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7. The  Community  might have an  interest in an extension of

'European

the  zone of  exchange  rate  stability, in  accordance  with the
Brussels  Resolution  of  5  December  1978,  to 
countries  with particularly  close  economic  and financial  ties
with the European  Communities'. Furthermore, to the extent
that  the Community  might wish to favour  a moderation in the
fluctuations of  major  third currencies, it  could accept  certain
forms  of  association  with  other  central  banks,  authorizing
them to intervene in Community  currencies. The techniques of
association  would be  varied,  ranging from the  accounting
centralization  by 
currencies to avoid accentuating the undesiredfluctuations in
third  currencies'  exchange  rates,  to  participation 
exchange rate and intervention mechanism on an equal footing
with Community  central banks. The ECV's  role  would  differ
according to which formula  was proposed: a unit of account if
the agreement was for  operations in Community  currencies to
be centralized and recorded in ECUs  with the EMF; a reserve
asset  and" means of  settlement if  these  operations  were to be
settled  in  ECUs  and  if, for  this purpose,  the  EMF  were  to
empower  third  country  central  banks to  acquire and  hold
ECUs.

the  EMF  and  the  use  of  Community

in  the

8.  The  tendencies  toward  reserve  diversification,  which  have
been  evident for  some  years, add to the  instability of
international  monetary  relations.  The  Community  would
therefore  have an interest, in order to preserve the cohesiveness
of the EMS, to give third countries which were holders of large
reserves and wanted to diversify  into Community currencies the
possibility  of  acquiring and holding ECUs.  Such a possibility
would in fact  help to  avoid the  destabilizing  effects on the
exchange markets provoked by massive purchases and sales of
certain Community  currencies and the unsettling consequences
of  such  transactions on the  domestic  monetary  policy of the
countries  issuing the  currencies  concerned. The ECU  can,
however, fulfil  this role only  if  it is competitive in comparison to
the national currencies one  would  wish  to substitute  it  to.

The  third country acquisition and holding of ECUs  would also
make  it possible  to finance  a  current  account  deficit,  if  one
existed, of the Community  as an entity, by the EMF  becoming
indebted  in ECU. The ECU  would  thus gradually  become an
official  reserve instrument, and the Community — the EMF—
would administer this instrument, and become a reserve centre.
An  internationalization of  the ECU  in this way is not  without
its  dangers,  both for 
monetary policy  and for the control of  international liquidity.
However,  with  its  progressive  emergence  as  the  monetary
symbol  of  a  vast  economic area  in the process of  integration,

the  autonomy of the  Community's

the ECU  will, like all major  currencies, spontaneously  begin to
play an international role.

Third countries

fluctuations  of  major 
third  currencies.  Certain  European
countries with  very  close economic and financial  ties with the
Community  might  wish to participate de jure in the EMS
exchange  rate  and intervention  mechanism, in order  to form
part of the zone of exchange rate stability  which it defines.  Yet
other countries might wish to have access to the ECU— and to
extend its zone of transferability  — and to have ECU accounts
with the EMF  in order  to use them as a reserve instrument, or
even  as  a  means  of  settlement  with  member  and  associated
countries.

10.  Third  countries  holding  large  reserves  might  also be
interested  in  the  ECU  as  a  diversification  medium.  In
particular,  the  surplus  OPEC  countries,  whose  reserves  are
mainly in dollars, might wish to match the composition of their
reserves more closely to the structure of their imports, of which
Community products represent  a large share. Their decision to
hold ECU  reserves will, however, be influenced  by the yield and
exchange  risk  of  the ECU.

Coincidence of  interests

11.  The  areas  in which  the external  role of  the  ECU  applies
will be defined by the conjunction  of the Community's  interests
with  those  of  third  countries.  A  preliminary  examination
suggests that these interests coincide where the extension of the
ECU's zone of  transferability  or the zone of stability  of  EMS
exchange  rates are  concerned;  and, although  different, 
seem to meet in seeing  the ECU  as an answer to  the wish for
diversification. For the  Community, the  decision to promote
the external role of  the ECU  would not be taken until a more
thorough analysis had been made of its advantages and costs:

they

its  characteristics to make  them  more attractive.

11.  Techniques by which  third countries could
acquire and use ECU claims on the  Fund

12.  Giving  authority  to  third  countries  to  acquire  and  use
ECUs means, in effect,  giving the Fund the right to open ECU
accounts for  these  countries.

for the extension of the role of the ECU might involve changing

13. In the present  situation, the EMCF is not  empowered to

issue ECUs, as a means of settlement, except  to and for  the use
of  Member  State  central  banks  alone. '  However,  not  all
claims on  the Fund  are by  nature  ECU  reserve  assets.  Thus,
interventions in Community  currencies can give  rise  to  ECU
claims to be settled at least partially in other reserve assets than
the ECU. In  this  case,  the  ECU  is used  as an  instrument  of

9.  Outside  the Community,  certain  third  countries may  have
the same interest in reducing the  effects of the exchange  rate

1  Council  Regulation (EEC) No  3181/78 of  18 December  1978 relating to

the  European  Monetary  System.

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Annex  1-5

denomination only and not as a means of settlement. Such third

country use of the ECU  would  pose  legal and  technical

problems less complex  than the ones raised by  the holding  of
reserve ECUs.

14.  The  third  country  acquisition  and  use  of  ECUs  which
would be a means of settlement  raises a number of  questions
concerning the criteria to be used to define the external role of
the ECU, the origin of the ECU acquired by third countries, the
techniques for  acquiring  them  and  the  implications for  the
ECU's characteristics and the functioning  of the Fund.  These
questions are briefly  examined below.

A.  Criteria for enlarging the 'ECU zone*

/5.  Any  enlargement  of  the  'ECU  zone' for  official  holders
requires, at the very least, the Fund's assent, for not only is the
Fund the sole authority entitled to create ECUs but, since there
is  no  market  in  ECUs,  the  transfer  of  ECUs  between
participants must be carried out by debit or credit entries in the
Fund's  books.  Consequently, the  Fund is in a  monopoly
position  which  enables  it  to  lay  down  the  criteria  which  the
extension  of  the  ECU's  role  should  satisfy.  These  criteria
might  cover:

(i)  the demarcation of the geographical area: the Fund could,
for  example,  limit  the  circulation  of  the  ECU  to  the
countries associated  with the exchange  rate mechanism;

(ii)  the  laying-down  of general  terms  on  which  third  country
official  authorities  or  international  monetary  organiz-
ations  could  acquire, hold  and  use ECUs.

and third countries. This would be the case if, for  example, the
present swap network between EC  central banks and the FED
were replaced  by  a single dollar/ECU  swap  between the FED
and  the  Fund;  or  if  the  Fund  contributed  directly  to  the
diversification  process  by  buying  dollars  against  ECU,  or
contributed  to  recycling  for 
the  purposes  of  balance-of-
payments financing, by  issuing  ECU-denominated  securities
against, for  example, dollars for  on-lending to Member  States.
The  significance  of  these  operations  would  differ  since, for
some of  them, ECU  creation  would be  only 
(swaps),  while for  others  (diversification), 
lasting.

it  could be more

temporary

C.  Techniques  for  the  acquisition  of  the  ECU  by  third

countries

18.  In exchange for  'what'will the official  third country holder
be able to acquire the ECU? The answer is obvious for  ECUs
surrendered by another participant in the context of the wider
negotiability of the  ECU: the  counterpart  would be the one
agreed  between  the parties.

19.  For  ECUs  issued  to  third  countries  by  the  Fund,  the
counterpart  could  vary  according to the  circumstances
surrounding  such an  operation.  Thus, the  issue of  ECUs to
third  countries or the  offer of  ECU-denominated  investment
instruments is conceivable:

(i)  against  surrender  of  reserve assets;

(ii)  against surrender  of  Community  currencies;l

(Hi)  in  the form  of  credits.

In the absence of general criteria, the Fund could authorize, on

an ad hoc  basis, a  third  country to acquire ECUs.

B.  Origin of  the ECU

D.  Implications for the  characteristics of the ECU

16.  One  possibility  would  be  to  permit  third  countries  to
acquire ECUs from  EMS  members. In  this case, the stock  of
ECUs  would remain unchanged since no new ECUs  would be
issued;  there would merely be a  transfer, in the Fund's books,
of  ECUs  held by  members to  official 
example, a central bank could  'swap'  ECUs for  dollars with a
third country central bank; this would improve the possibilities
of mobilizing the ECU. Or a member country whose currency is
used by third official  holders as a reserve currency  could buy it
back  outside the market in exchange for  ECUs  which would
help to  regulate the  diversification of  reserves. Or  again, an
EMS  member could surrender ECUs  to associated countries in
settlement for  their interventions to support its currency.

third  holders. For

17. A second, wider-ranging alternative, would be for the Fund
to issue ECUs to third countries. Unlike the first  solution, new
ECUs  would be createdby a direct  operation between the Fund

20.  Conferring  an external  role  on  the  ECU  means that  the

ECU, as it exists  within the EMS,  will be made  available to

official 
third  holders.  This  should  not,  in  theory,  have much
influence  on the unity of the ECU.  A monetary instrument does
not  change its nature just because it  changes hands.

21.  Nevertheless,  the extension of  the ECU's role beyond  the
Community, or the  mere prospect of it  being so  extended,
should perhaps be taken  into  consideration from the start of
transition to the  institutional phase. The  areas  likely to be
affected are the following :

The possibility of a third country acquiring ECUs against the surrender of
Community currencies should not be dismissed out of hand if only in order
to  avoid the case  of  a  third country  which  held Community  currencies
exchanging them for dollars on the foreign  exchange market, since this
would have the effect of upsetting exchange rates. In this case, steps would,
however, have to be taken to prevent the financing of a Member State's
external deficit by its own currency: the central bank issuing the currency
in question could be required to buy back against ECUs the amounts of its
currency  acquired by  the  Fund.

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4.  Tasks in the field  of  exchange rate policy:

(i)  coordination of  intra-marginal and  third-currency  inter-

ventions;

5.  Granting on own  account and financing of the  credits
available  under  the system.

6.  Definition  of  (i)  monetary  or  (ii) economic  conditions

(ii)  coordination  and  multilateralization  of  relations  with

that may be  attached to  Fund  credits, and  monitoring of

non-member countries;

(Hi)  Fund intervention on the foreign  exchange market, where

appropriate  against  ECUs,  which  would presuppose the
existence of an ECU  market.

compliance.

7.  Implementation  of enabling clauses; in other words, action
to  ensure  that  the  Fund's  development  is endogenous.

Functions

(1)  Accounting and  executive  functions:

(i) 

recording debts and claims arising from  interventions in  EEC currencies and  from
activating the STMS  mechanism

(ii)  creating  ECUs against  the temporary  deposit  of reserves (present  swap system)
(iii)  managing  the  MTFA  mechanism  and  Community  loan  operations  to  support

Member States' balances of payments

Type of  Fund:

central
bank

regional
IMF

EMCF
accounting
agent

(2)  Management of reserves held on own account:
(i) 
in the case of  reversible  transfers  (amended  swap system)
in the case of definitive transfers to the Fund
(ii) 

(3)  Regulation of the issue and circulation of ECUs:

(i)  among  EMS  members
(ii)  in relations with official  other holders

(iii) for use by the  private sector

(4)  Tasks in the  field of  exchange rate policy:

(i)  coordination of intra-marginal and  third-currency  interventions
(ii)  coordination and  multilateralization of  relations  with  third countries
(iii)  Fund  intervention on the  foreign  exchange  market

(5)  Granting and  financing of credits available under the consolidated  system:

(i)  very  short-term and  short-term
(ii)  short-term  and  medium-term

(iii) all three types of credit

(6)  Definition  and  administration  of loan  conditionality:

(j)  monetary  conditionality
(ii)  monetary and economic conditionality

(7)  Implementation of enabling clauses

(8)  Issuing of Community loans to give Member States balance-of-payments support

Annex  1-6

an  appropriate 
institutional  set-up,  say  a  multi-tier
structure,  within  which  all  the participants,  i.e.  central
banks and national Treasuries, would be able to play their
respective  roles.

The  table on the preceding page relates the four  types  of Fund

to the  different 

spheres of  activity  listed  above,  making it

possible to identify  the powers that could be exercised by each
type  of  Fund.

III.  General  observations on institutional

matters

In view of the evolving nature of the European Monetary  Fund,
the functions  listed above could be assigned to it only gradually.

Leaving  aside  the  'accounting  agent'  Fund,  the  institutional
structures of  all the other  types  of  Fund  would have to reflect
the  division  of  powers  and  responsibilities  that  exists  at  the
national level  between central banks  and governments.  Since
powers and responsibilities are allocated quite differently  from
one  country  to  another,  a  compromise  will  have  to  be found

balances'  that  are  encountered  in  relations  between  the
different  decision-making  centres  both  at  national  and  at
Community 
appropriate  national  and  Community  legislation.

level can be  resolved  only on the  basis of

when  this new  body is set up. The  problems of  'checks and

8.  Issuing  of  Community  loans  to  give  Member  States
balance-of-payments  support.

9.  Decision-making  centre for  adjustments of  central  rates
and amendments to the  definition of the  ECU.

10.  Tasks in the monetary policy field:

(i)  coordination  of  domestic  monetary  policies;

(ii)  formulation  of  a  Community  monetary  policy;

(Hi)  Fund  intervention  on national  money  markets.

B.  Respective  functions of  the different  types of  Fund

The Committee earlier distinguished four  broad types  of Fund.
is  necessarily  a  rough  but  none  the  less  useful
This 
classification  in that it provides a reference framework for  the
Committee's future  work.  The four  types  of  Fund  were  as
follows :

(i) an  'accounting agent'  Fund  along the lines of the present

EMCF.  Since  such  a  Fund  would  perform  merely  an
accounting  function, 
it  would  not  require  any  new
institutional structure;

(ii)  a 'central bank' type  Fund. Such a Fund would be assigned
monetary powers and its governing bodies would basically
be  modelled  on  those  of  central  banks.  However,  since
participation by the political authorities in the exercise of
monetary powers  differs  from  one  country  to another,  it
would be necessary  to determine what place and what role
these  authorities  would  have in such a  Fund.

A  variant  of  this  would  be  an  institution  which,  while
providing  support  for  the general  course  of  Community
economic policy,  would be completely  independent  of  the
political authorities, at least as regards  the means used to
achieve  its statutory  objectives;

The EMF  would be the common decision-making body, and its
actions  could not but  reflect 
the joint  resolve of the EMS
participants. Two points should be emphasized here: first, the
Fund  would operate  within a framework  in which the general
policy  choices remained  the  responsibility  of  the government
authorities; second, as regards  the exercise by  the Fund of  its
own powers, one needs to stress the importance  of its internal
decision-making  process.  Questions  that may  arise in  this
respect  concern  the following  points  in particular:

(Hi)  a  'regional  IMF'  type  Fund.  The functions  assigned  to
such  a  Fund  would  be  those  currently  carried  out  by
government  authorities  (exchange  rate  regime  and
balance-of-payments  financing  normally  with conditions
attached),  the implication  being  that  it  would be  largely
governed by  those same authorities. Since a Fund of  this
type  could  also  assume  certain  monetary  functions
(liquidity  creation  in  ECUs,  reserve management),  the
central  banks  would  have to be  represented on its
governing  bodies;

(i) the  balance to be  struck  between  prescribed  rules and

discretionary  powers.  When  conferring  powers on the
Fund,  the  national  authorities  could  also  spell  out  how
these powers should be exercised. If, as a result, it did not
possess any powers of  appraisal,  the Fund  would have no
competence of its own; its role would be restricted to that
of  a managing  body;

(iv) a sui  generis  Fund.  Whereas  monetary or  economic

functions  would be predominant in the two preceding types
of Fund, a sui generis Fund would have both monetary and
economic functions.  The problem would then be to create

(ii)  general direction  of  the  Fund's  activities.  The  Fund  will
have  to  assist  in framing  and  in giving  expression  to  a
Community  policy  in  the  monetary  and  economic field.
Whatever  type  of  Fund is chosen, its activities will have to
further the objectives set  at  Community  level;

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(Hi)  unanimity  or  majority.  Although  unanimity  may  be
required for  the most important decisions, it ought not to
be the rule. In view of the need to strike a balance between
the collective interest and the individual interest, decisions
could be  taken,  depending on  their  purpose,  either
unanimously,  by  a  qualified  majority  or  by  a  simple
majority; furthermore,  the nature of this distinction could

If  a decision-making procedure were adopted for  the Fund that,

at least in certain matters, did not require unanimity, it would

have to be accepted  that action by  the Fund  would not  always
meet  with the  approval of all its  members. A  unanimity
requirement would downgrade the Fund's functions to those of
a managing body  or would make it impossible in practice for
the  Fund  to  take any  decisions.

itself  evolve: as  time  went by and the Fund developed, a

decision for  which  unanimity had  been  required at the
beginning  could subsequently  be  taken by  a majority.

128