General
At the start of the EMS, contrasting expectations and fears were raised with regard to the consequences of a strict adherence to a system of fixed, though adjustable, exchange rates on economic developments and policies of participating countries. There was concern that the constraints of a system with fixed exchange rates would exert a powerful deflationary influence on economic developments, and that in order to ward off excessive losses of reserves, the countries with higher inflation rates increasingly would be forced to turn to overly restrictive policies, with negative consequences for growth and employment. On the other hand, many critics of the system feared that fixed exchange rates and the consequent obligation to intervene would deprive the more stability-conscious countries of the independence necessary to control domestic monetary expansion so as to contain inflationary price and cost developments. It was argued that the existence of large credit facilities would encourage their use, and that the financing would have to be provided by the countries with stronger currencies, thus allowing the deficit countries to avoid domestic adjustment measures. Such critics feared that the EMS would become a machinery for the creation of more liquidity and inflation and that, even at best, it would force the more stability-conscious countries to settle for a higher average rate of inflation. A third line of thinking was that the system would not be able to hold together for very long. It was unreasonable to expect countries with highly divergent economic developments to be able to align their policies to the degree necessary to keep a system of fixed exchange rates functioning. As a consequence, it was argued, speculative capital movements would disrupt foreign exchange markets and force authorities to make sudden and substantial exchange rate changes with adverse consequences on the economies of participating countries. Hence, the EMS would be faced with problems similar to those that occurred in the final phase of the Bretton Woods system. The only alternative to irregular, sudden, and rather large exchange rate adjustments would be to move to a system with small but frequent exchange rate adjustments—similar to a crawling peg—which would regularly bring exchange rates in line with underlying economic developments. But neither alternative was compatible with one of the basic aims of the EMS, namely, the establishment of a zone of exchange rate stability for the EC as a basis for further economic integration.
Regarding the period under consideration (1979 to 1982), it appears now that many of these concerns were exaggerated. The EMS, in its first years, worked quite smoothly in an operational sense (which in itself is an achievement considering the complex features of the system), and it was, by and large, able to avoid major disruptions. In the years 1979 to 1982, there have been six realignments (Table 3), directly involving from one to four currencies,9 which were carried out with reasonable smoothness. The first three realignments, in 1979 and early 1981, were certainly not large enough to cause any disruptions in markets; in fact, the changes in central rates were almost fully absorbed by the existing width of the EMS band without significantly affecting market rates. Nor were the adjustments frequent enough to raise doubts about the claim that the system provided a framework for exchange rate stability. The situation has changed somewhat since mid-1981. Tension within the EMS has increased, and, at times, large interventions have been necessary to safeguard existing central rates. Three realignments took place between October 1981 and June 1982. In each, the largest bilateral change of central rates went beyond any previous realignment in the EMS or under the “snake.”10 While in September and November 1979, the maximum bilateral adjustment was 5 percent, it reached more than 9 percent in February and 10½ percent in June 1982. As a result of these three realignments, the central rates of the deutsche mark and the Netherlands guilder rose cumulatively by some 20 percent against the French franc and the Belgian franc. A seventh realignment involving all EMS currencies took place on March 21, 1983 in which the largest bilateral adjustment was more than 9 percent.
In general terms, it seems that inflationary impulses have been caused either by events outside the EMS (mainly the second round of oil price increases in 1979–80) or by domestic developments, in particular, budgetary or wage developments; there is little evidence that the EMS caused inflation to be transmitted from one participant to another to a greater extent than would have been the case otherwise.
Equally, it appears that in virtually all EMS countries the impediments to growth stemmed essentially from a recognized need to curb domestic inflation decisively, from a worldwide climate of stagnation, and the requirement to secure overall external balance. In general, these impediments cannot properly be attributed to the consequences of measures introduced to maintain balance within the EMS. To be sure, at times, certain measures, in particular, interest rate actions, were taken in response to temporary developments in the EMS. But it could be said that, in view of the worldwide trend toward higher interest rates and the general need for more restrictive policies in EMS countries, these measures would anyway have had to be introduced, and that at most it was their timing that was influenced by the constraints of the EMS.
Exchange Rate Developments
A number of distinct periods of strain within the EMS can be distinguished (Table 1). During some of these, the authorities attempted to resist changes in central rates by substantial intervention in the exchange market, or by measures of short-term monetary policy directly motivated by exchange rate considerations. Within months of each of these episodes, and in the absence of more far-reaching measures aimed at the correction of the underlying causes of imbalances, confidence in the will and capacity of the authorities to continue to resist the adjustment of central rates diminished, thus amplifying pressure on the exchange rates. In each case, the renewed pressures ended with an adjustment of central rates.
Other periods of strain appear to have followed different patterns. In the case of the devaluation of the Danish krone in November 1979, the authorities acted quickly, without a lengthy period of intervention. On two other occasions, both centered around a weak deutsche mark (October 1980 and February 1981), market pressures were successfully resisted. The ability of the authorities to resist market forces was a reflection of the substantial foreign exchange resources available and, in the second instance, of the forceful measures of monetary policy taken in February 1981. Ultimately, market sentiment reversed itself when it was seen that the Federal Republic of Germany continued to have a better price performance than its partners in the EMS and that an improvement in its current account could be expected.
These experiences appear to be very much in line with those of other countries outside the system: intervention against market pressure serves to buy time, but in the absence of policy measures aimed directly and with sufficient strength at the underlying causes of weakness, exchange rate changes become inevitable in the course of time.
It was early recognized that differences in the relationships between the participating currencies and the U.S. dollar could give rise to tensions within the EMS.11 When the U.S. dollar is relatively weak, mobile international capital seeks alternative locations, and particularly tends to move to the deutsche mark and vice versa. With the United Kingdom not actively participating in the EMS, currencies other than the deutsche mark play only a limited role as alternative reserve and investment currencies. Consequently, there is a tendency for the deutsche mark to be strong against other European currencies when the U.S. dollar is weak, whether or not underlying economic developments dictate this.
After a short period of strength at the start of the EMS in March 1979, the U.S. dollar remained relatively weak with respect to most EMS currencies from the middle of 1979 to the beginning of 1980 (Chart 1). On September 24, 1979, the first realignment12 under the EMS occurred with the deutsche mark being revalued by 5 percent against the Danish krone and 2 percent against other EMS currencies. The second realignment occurred on November 30, 1979 when the Danish krone was again devalued by 5 percent against all other currencies.
From early 1980 to early 1981, the U.S. dollar strengthened on average with respect to EMS currencies; there were, however, substantial short-term fluctuations. Early in 1981, an easing of U.S. interest rates and the tightening of monetary policy in the Federal Republic of Germany caused the joint float to firm temporarily relative to the U.S. dollar. An acceleration in inflation and increasing current account difficulties put pressure on the Italian lira within the EMS, triggering substantial intervention by the authorities in February and early March, and leading ultimately to the third realignment, on March 23, 1981, when the lira was devalued by 6 percent relative to the other EMS currencies. The joint float depreciated relative to the U.S. dollar from mid-April until August 1981, with the deutsche mark at the top of the band and the French franc at the bottom after its sharp fall following the Presidential elections of May 1981.
From mid-August 1981 to December 1981, the situation reversed with the EMS currencies on average appreciating relative to the U.S. dollar. There was renewed confidence in the deutsche mark as the German current account performance improved and inflation moderated. At the same time, doubts about the stability of the French franc and uncertainties about the policy stance of the new French administration increased. Worsening inflation and a widening trade deficit put renewed pressure on the Italian lira. These tensions led to the fourth realignment, on October 5, 1981, with the deutsche mark and Netherlands guilder revaluing by 5.5 percent, and the French franc and Italian lira devaluing by 3 percent against the Belgian franc, the Luxembourg franc, the Danish krone, and the Irish pound, whose central rates remained unchanged.13
The early months of 1982 were characterized by a widening interest rate differential favoring dollardenominated assets and a firming of the U.S. dollar against the joint float. The Belgian franc came under growing pressure in early February against a background of serious budgetary and current account imbalances and growing external indebtedness. The fifth EMS realignment, effective from February 22, 1982, consisted of an 8.5 percent devaluation of the Belgian franc and Luxembourg franc and a 3.0 percent devaluation of the Danish krone, against all other EMS participants.
Pressure against the French franc, the Belgian franc, and the Italian lira rose again from mid-April 1982. A widening trade deficit and continuing high inflation were major causes. The result was the sixth EMS realignment, effective from June 14, 1982: the French franc and the Italian lira were devalued by 5.75 percent and 2.75 percent, respectively, while the deutsche mark and the Netherlands guilder were revalued by 4.25 percent each against the remaining EMS currencies. This realignment was the largest since the inception of the system in terms of the magnitude of bilateral exchange rate changes.
Since late 1982, continued differences in external and domestic developments and prospects among EMS countries, reflecting divergences in financial policies, were largely responsible for a buildup of exchange rate market tensions and expectations of another realignment. In connection with elections in the Federal Republic of Germany and France in the first half of March 1983, downward pressure on the French franc as well as on the Belgian franc, and upward pressure on the deutsche mark intensified, requiring large-scale intervention. On March 21, 1983, a seventh realignment was agreed upon. The deutsche mark was revalued by 5.5 percent, the Netherlands guilder by 3.5 percent, the Danish krone by 2.5 percent, and the Belgian and Luxembourg francs by 1.5 percent, while the French franc and the Italian lira were devalued by 2.5 percent and the Irish pound by 3.5 percent.
The size and frequency of central rate realignments have increased significantly during the four years of the system’s existence. This trend suggests that the drive for greater economic convergence in order to generate exchange rate stability has been successful only to a very limited extent. The increasing size and frequency of realignments also indicate that the disciplinary effect of fixed exchange rates is not itself sufficient but that, additionally, determined and sustained domestic adjustment efforts are required.
A variety of policy measures has accompanied EMS realignments (Table 6), but only at the realignment in June 1982 were the accompanying measures directly stated in the communiqué announcing the realignment. On that occasion, there was explicit mention of the measures that France would take, as well as of the less precisely specified measures that Italy would adopt. This does not, of course, mean that other realignments have remained unsupported by economic measures. The devaluation of the Danish krone in November 1979 was part of a larger package of policy measures, as was the case with the devaluation of the Belgian franc in February 1982, and those of the French franc in October 1981 and of the Italian lira in March and October 1981. In March 1983, following the realignment, France adopted a package of restrictive budgetary and monetary measures as well as restrictions on expenditure for foreign travel.
Variability of Exchange Rates
Foremost among the objectives of the EMS is the achievement of a high degree of exchange rate stability as a basis for further economic integration. It is chiefly this objective that is supported by the institutional arrangements of the EMS. Central rate changes are subject to a multilevel consultation and decision-making process; furthermore, the implications of such changes on other aspects of EC policies need to be taken into account. At the beginning of the EMS, all this had led to the fear that needed exchange rate changes might not be undertaken in time nor to the extent required. The danger of competitive devaluations, on the other hand, was seen as remote.
In the event, the exchange rate system of the EMS proved to be much less rigid than initially feared. More recently, following the relatively large realignments since October 1981, voices have been raised querying whether exchange rate changes have not been used too much, instead of stronger domestic adjustment measures and greater efforts to achieve more convergence in economic policies and developments. It is being asked whether too frequent changes in official exchange rates did not erode a system that was intended to create “a zone of monetary stability” in Europe.
The question of the degree of exchange rate stability achieved in the EMS may be approached first by comparing the experience of the EMS countries among themselves before and after the implementation of the system. Secondly, exchange rate stability for the currencies in the EMS can be compared with those of major currencies outside the EMS. This section examines the variability of both real and nominal exchange rates before and after the establishment of the EMS in March 1979. The question at issue is whether or not the EMS has had a stabilizing effect on the exchange rates of the participating currencies. Ideally, variability should be measured relative to the equilibrium exchange rate over time for a currency, but this is well beyond the scope of this paper. Here, variability is measured by the coefficient of variation (standard deviation divided by the average) over a sample period. The variability of exchange rates of EMS currencies can then be compared both before and after the introduction of the system and with the variability of the exchange rates of non-EMS currencies over the same periods. Clearly, such comparisons are sensitive to the choice of comparator currencies, to the frequency of the data, and to the exchange rate measure used. Because of this, results are reported for differing time intervals and for several different measures of exchange rates. Nevertheless, the results should be interpreted cautiously. A particularly important qualification is that the exchange rate experience of European currencies before the introduction of the EMS varied markedly, with the role played by the “snake” being of notable importance.
The variability of exchange rates of EMS currencies in the period 1979 to 1982 appears to have declined, compared with a number of non-EMS currencies inside and outside Europe (Chart 4). For all EMS currencies, except the Danish krone, average variability in 1979–81 was less than that in 1974–78 (Table 7).14 It may at first appear surprising that the average variability of the nominal effective exchange rates of the five non-EMS European countries considered (Austria, Norway, Sweden, Switzerland, and the United Kingdom) declined by a similar degree as the EMS currencies over 1979–81, compared to 1974–78. On reflection, this is less so, given the close economic and financial ties between many European countries, whether EMS participants or not, and given the formalization of these links in the exchange rate regimes of several of the countries concerned. The exchange rate of the Austrian schilling is closely associated with the EMS currencies, in particular, the deutsche mark, and the exchange rate for the Swiss franc, although largely market determined, is heavily influenced by developments in the EMS. Both Norway and Sweden peg their exchange rates to baskets of currencies in which the combined weight of EMS currencies is 44 percent (for Norway it was 33 percent before August 1982).15
Variability of Nominal Effective Exchange Rates, 1974–821
Sources: International Monetary Fund, International Financial Statistics; and Fund staff calculations.1 Variability is measured by the coefficient of variation (standard deviation divided by the average) multiplied by 1000, of the nominal effective exchange rate. The variability of EMS currencies is measured by the simple average of variability of nominal effective exchange rates of participants.Of the non-EMS European currencies considered, only the pound sterling is less dependent, directly or indirectly, on the behavior of EMS participants. Consequently, it is to be expected that the pound sterling is the only European currency under consideration, inside or outside the EMS, to exhibit a major rise in average exchange rate variability after the system’s introduction (Table 7).
Predictably, the average variability of each of the EMS member currencies with respect to the rest of the EMS group diminished after the introduction of the system (Table 8). This is presumably the minimum achievement one would expect. The variability of the non-EMS European currencies considered (with the exception of the pound sterling) relative to the EMS group also diminished after the system’s inception (although to a lesser degree) which could be expected since these currencies are closely linked to the EMS currencies. On the other hand, the average variability of the exchange rates for the U.S. dollar and the Japanese yen relative to the EMS group increased sharply after the introduction of the system. The variability of the non-Sources: International Monetary Fund, International Financial Statistics; and Fund staff calculations. EMS currencies considered relative to their own group has also risen somewhat since the inception of the EMS (Table 9).
The real exchange rates16 of EMS countries have, as well, become less variable relative to their own group (Table 10) and more variable relative to currencies outside the joint float (Table 11), since the system was instituted.
In sum, it appears that the exchange rate variability of the EMS currencies has diminished since the introduction of the system, and that this stabilizing influence has spread to the exchange rates of the currencies of those European countries outside the EMS which have close economic and financial ties to EMS participants. In contrast, the exchange rate variability of the major currencies not tied to the EMS (the pound sterling, the U.S. dollar, and the Japanese yen) appears to have risen significantly.
The Problem of Convergence
The EMS Concept of Convergence
The concept of convergence, which has become widely used in the context of economic integration, needs to be given some precision of meaning. In general, convergence means a development in which economic variables move closer to each other over time. By itself, however, the concept of convergence neither identifies the variables under consideration nor the direction of their movements.17
The ultimate aim of the European Community in the economic field is, according to the Preamble to the European Economic Community Treaty, “to ensure the economic and social progress of their countries…” and “the constant improvement of the living and working conditions of their peoples.”18 From the beginning of the EC, there have been efforts to reduce regional disparities among member countries. The lending activities of the European Investment Bank (EIB), the European Social Fund, the European Regional Development Fund, and—more recently—the New Community Instrument (“Ortoli facility”) are directed toward these aims. In connection with the establishment of the EMS, it was decided to lend support to strengthening the economic potential of those less prosperous member countries which fully participate in the EMS by subsidizing interest rates on loans from the EIB and the New Community Instrument.19 Italy and Ireland are the countries benefiting from those measures.
A reduction of disparities among EC member countries is, however, a goal in itself and not necessarily a condition for economic integration. Disparities are present within individual countries and sometimes are as pronounced as among different countries. By contrast, it has long been recognized that economic and/or monetary integration requires a certain degree of “harmonization” or “convergence” in economic policies and developments. While the EMS is expected to contribute to the longer-term aims of the EC, it has as its specific aim the creation of “a zone of monetary stability in Europe,” encompassing “greater stability at home and abroad.”20 “Stability abroad” is equivalent to exchange rate stability, and from many references, it is clear that “[monetary] stability at home” is to be interpreted as domestic monetary developments consistent with stability of costs and prices.21 Both the stability of exchange rates as well as that of costs and prices are seen as essential preconditions for further economic integration among EC countries for future economic growth and the narrowing of differences in living standards.
It had been hoped that the EMS would promote greater convergence of economic policies and developments and eventually facilitate economic integration. So far, however, such hopes have not been fulfilled as convergence of policies, particularly budgetary and monetary policies, has been insufficient to maintain a high degree of exchange rate stability. The lack of coordination of policies has been reflected in a lack of convergence of economic performance and, in particular, of cost and price developments. An opinion held by many, however, is that the existence of and the constraints imposed by the EMS have helped to prevent a greater divergence of economic developments in the participating countries.
While the following summarily reviews price and monetary developments, reference is made to more detailed studies by the EC Commission and various authors.22
Price Developments
The level and dispersion of inflation rates is of central importance for evaluating the extent of convergence toward monetary stability within the EMS. In 1979, the preconditions for convergence appeared to be improving both within and outside the EC. Inflation rates had been dropping or stabilizing since 1975, both in terms of consumer prices and gross domestic product (GDP) deflators. At the same time, differences between the highest and the lowest inflation rate of the member countries were diminishing and reached their minimum in 1978 (Table 12).
The launching of the EMS roughly coincided with the second major oil price increases, which caused an intensification of inflationary pressures. The response to these pressures varied considerably between countries, leading to a renewed increase in inflation differentials. Thus, while consumer prices in the Federal Republic of Germany rose by 16.3 percent from 1978 to 1981, they increased by 37.5 percent in Denmark, 42.2 percent in France, and 63.9 percent in Italy. By the end of 1982, a major convergence of inflation rates was not yet in sight. However, inflation differentials had fallen somewhat from their 1980 levels.
Inflationary developments in selected countries outside the EMS since 1979 were broadly similar. The differences in inflation rates were, however, not as pronounced as those within the EMS (Chart 5 and Tables 12–13).
Consumer Prices
(Second quarter 1979 = 100)
Source: International Monetary Fund, International Financial Statistics.Monetary Developments
Since 1979, very pronounced and similar rises in nominal domestic interest rates have taken place in the countries concerned, partly in response to the large interest rate increases in the United States. In most countries participating in the EMS, nominal interest rates were 2–4 percentage points higher in 1979–81 than in 1975–78. Because interest rate changes in the medium term were unrelated to actual changes in inflation rates (Chart 6 and Tables 12–15), real interest rates generally increased most in countries with decreasing or stable rates of inflation. The rise in real interest rates was especially sharp in Belgium, Denmark, the Federal Republic of Germany, and the Netherlands, while the increases were less pronounced in France, Ireland, and Italy.
Changes in Interest Rates and Prices1
(Average change from 1974—78 to 1979–81 in percentage points)
Sources: International Monetary Fund, International Financial Statistics, and Fund staff calculations.1 Vertical axis: change in average interest rates from 1974—78 to 1979–81. Horizontal axis: change in GDP deflator from 1974–78 to 1979—81. The higher up and more to the left a country lies in the diagram, the more real interest rates have increased.During 1979–82, there was a definite increase in the correlation between interest rate movements in countries participating in the European Monetary System (Tables 16–17). While interest rate developments in the United States played a significant role, a substantial part of the convergence of interest rates within the EMS can be attributed to monetary measures following the establishment of the EMS. Larger EMS countries, especially the Federal Republic of Germany, have used the rate of growth of monetary aggregates as normative, intermediate goals of monetary policy. As stability of the exchange rate is especially important for the smaller EMS countries with very open economies, monetary policy in these countries has often been geared to maintain this stability. While this has resulted in a tendency to equalize interest rate developments within the EMS, monetary expansion within the small countries has remained partly outside the control of the national authorities.
The medium-term rise in interest rates in most EMS countries has been accompanied by a decelerating growth of the nominal money supply (Chart 7 and Tables 18–19). The change in the growth rate of both narrow and broad money was, however, very different in individual countries.
Monetary Expansion Before and After the Introduction of the EMS1
(Average annual change for 1974–78 and 1979–81 in percent)
Sources: International Monetary Fund, International Financial Statistics, and Fund staff calculations.1 Countries on the diagonal have the same average monetary expansion rates in 1979–81 as in 1974—78. Countries below (above) the diagonal have a lower (higher) rate of monetary expansion in 1979–81 than in 1974–78. The greater the distance from the diagonal the greater is the difference in the average rate of monetary expansion between the two periods.The rate of domestic credit expansion is perhaps of greater interest as an indicator of the determination and success of the authorities in controlling monetary developments (Chart 7 and Table 20). This rate is, like those for other monetary aggregates, quite different in the various participating countries. Developments appear, however, to have converged somewhat during the first years of the European Monetary System. In all participating countries (with the exception of Denmark) credit expansion was then, on average, slower than or about the same as that experienced in the period 1974–78. The rate of domestic credit expansion has generally decreased more for countries with a high rate of expansion in the period preceding the introduction of the EMS.
The development of the real money or credit supply is often considered a more reliable indicator of monetary stringency than the expansion of purely nominal variables. Deflating the monetary aggregates with the GDP deflator produces measures of real monetary expansion which are as widely divergent during 1979–81 as before. On the other hand, correcting monetary developments for changes in the consumer price index (Tables 21–23) indicates that the rates of real monetary expansion have been, on average, more similar in 1979–81 than in 1974–78 (the evidence being weakest in the case of credit expansion).23
During the first years of the EMS, there was also a general rise in the general government borrowing requirements of EMS countries relative to increases in the money supply (Table 25). These developments to a large extent reflect the result of the “automatic” effects of the onset of recession in 1980 on tax receipts and transfer outlays, as well as the different timing and impact of financial policies as the recession developed.
Factors Influencing the Performance of the System
As shown above, the trend toward a higher degree of convergence in economic performance among EMS countries, which was evident mainly in price performance during the two years prior to the establishment of the EMS, did not continue afterwards but rather reversed itself. In particular, inflation differentials between the Federal Republic of Germany and the Netherlands, on the one hand, and France and Italy, on the other hand, grew larger over time. These divergences would have been expected to create major tension within the EMS. Expectations at the outset were that the deutsche mark would remain strong within the EMS, while concern over future developments concentrated on the French franc and the Italian lira. However, the EMS operated smoothly and free of major disruptions, at least up to mid-1981.
After May 1980, the deutsche mark weakened within the EMS, and somewhat later, in line with the EMS as a whole, it weakened also against the dollar. One important factor in this development was the current account development in the Federal Republic of Germany. It deteriorated dramatically from the second quarter of 1979 not only because of the changing relative cyclical position and a delayed response to the deterioration of competitiveness, but also, as in the case of other EMS countries, because of the second round of sharp oil price increases. The impact of current account developments on exchange rates was exacerbated by developments in the capital account. The reputation of the deutsche mark as a steadily appreciating currency, and thus as a safe alternate reserve and investment currency, was undermined. Interest rate developments contributed to pressure on the deutsche mark while supporting the U.S. dollar as well as other EMS currencies, such as the French franc. Lastly, there were political developments that cast a spell over the deutsche mark and favored the U.S. dollar as well as, temporarily, the French franc.
The authorities of various EMS countries have also on several occasions taken external or domestic measures designed to cope with the consequences of divergence, to ensure some degree of convergence or at least avoid more divergent developments. The existence of the EMS and the resulting exchange rate constraint in some countries have induced (and have been used in the public debate as an argument for) a stronger domestic adjustment effort by modifying wage indexation provisions (Belgium, Denmark, and Italy) or by introducing more restrictive budget policies (Belgium, Denmark, and France).
The initial moderating effects that contributed to a smooth beginning of the EMS have dissipated, however; no clear signs of a noticeable convergence of economic policies and developments could be detected; and recourse to measures to temporarily mitigate balance of payments difficulties (such as interest rate changes or foreign borrowing) may become more difficult. As a result, it might well be that tensions within the EMS increase. It appears that, in principle, the following main options for action remain open to the authorities of EMS countries, short of abandoning the EMS in its present form. On the one hand, further changes in EMS exchange rates may have to be made. On the other hand, more substantial domestic adjustment programs will have to be put in place by the countries with less stable currencies and with serious payments problems as it seems difficult to imagine that the more stability-oriented countries will be prepared to compromise their policy stance and agree to an “average” degree of convergence in terms of monetary expansion and inflation. The countries under pressure could combine medium-term programs for stabilizing and restructuring their economies with recourse to longer-term external financing. It is also obvious that the first option, more frequent exchange rate action, would nevertheless require supportive domestic measures to ensure success.
