This section is divided into three parts. The first analyzes the degree of convergence of inflation rates, exchange rates, and interest rates achieved so far by EMS members participating in the exchange rate mechanism (ERM)12 and discusses whether the establishment of the EMS has contributed to the reduction of inflation in member countries. Existing studies on the degree of convergence will be surveyed and new updated results based on the “principal component analysis” will be presented. In light of these considerations, we then discuss the leading role of the Federal Republic of Germany within the EMS and analyze the contribution that German monetary policy has made to the reduction of inflation in the system. Finally, the working of the balance of payments adjustment mechanism within the EMS will be described, as well as the problems arising from monetary targeting and from sterilization of international reserve flows.