ABSTRACT

The Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) 1 adopted a target zone system in March 1979, because the flexible exchange rates were too volatile. The ERM provides that each participating currency has a central rate expressed in terms of the European Currency Unit (ECU), an index based on member currencies, and the currencies cannot deviate from their central rates beyond a margin of +/- 2.25 percent. When the currency deviates from its central rate beyond the margins, its ECU rate is redefined by realignments, and revaluation (or devaluation) of the currencies are determined in order to eliminate changes in relative price levels.