DUY TAN UNIVERSITY

INTERNATIONAL SCHOOL
-------

EUROPEAN MONETARY SYSTEM

Members: Ho Thanh Phong

Le Hong Anh
Tran Thi Huong Ly

Da Nang, 2023
 TABLE OF CONTENTS

I. THE EUROPEAN MONETARY SYSTEM (EMS)

1. Definition OF EMS ..............................................................................................2

2. Important Milestones ............................................................................................2

3. Characteristics of the European Monetary System ..............................................3

4. The European Central Bank (ECB) ......................................................................5

5. Criteria for Joining the EURO ..............................................................................5

II. INTERNATIONAL ENVIRONMENT

1. Impact on the International Financial Market ......................................................6

2. Impact on Vietnam ...............................................................................................7

III. ADVANTAGES AND DISADVANTAGES OF EMS

1. Advantages ...........................................................................................................7

2. Disadvantages .......................................................................................................8

IV. HOW CURRENT POLITICAL AND ECONOMIC SITUATIONS

AFFECT THE EURO ............................................................................................9

V. THE FUTURE OF THE EUROPEAN MONETARY SYSTEM ..................10

REFERENCES .......................................................................................................11

1|Page
 I. THE EUROPEAN MONETARY SYSTEM (EMS)
1. Definition
The European Monetary System (EMS) is an exchange rate agreement with
adjustable rates within the framework of the European currency system.
2. Important milestones
 After World War II, European leaders engaged in discussions about
creating an economic union to ensure peace and stimulate economic
recovery. This led to the establishment of the European Coal and Steel
Community (ECSC) in 1951. Subsequently, the European Economic
Community (EEC) and the European Atomic Energy Community
(EAEC) were founded in 1957.
 The European Monetary System was devised as a response to the
breakdown of the Bretton Woods Agreement. The Bretton Woods
Agreement, which was established in the post-World War II era, had
instituted a fixed and adjustable exchange rate system to stabilize the
economies of its signatory nations.
 In December 1971, the Smithsonian Agreement was signed, which
expanded the range within which exchange rates could fluctuate from
±1% to ±2.25%. The European Economic Community (EEC), which is
now the European Union (EU), applied a ±1.125% exchange rate
fluctuation range for their currencies.
 In the early 1970s, with the collapse of the Bretton Woods system,
national currencies began to float freely. This situation prompted the
member countries of the European Community to seek a new exchange
rate agreement to complement their customs union.
 In 1979, the European Monetary System (EMS) was established,
originating from a proposal by the German Finance Minister, Helmut
Schmidt. The European Currency Unit (ECU), a virtual currency unit,
was created as part of this system and can be viewed as a precursor to
the Euro (EUR).
 Since the EMS members were less than fully committed to coordinating
their economic policies, the EMS went through a series of realignments.
 From July 1, 1990, to December 31, 1993, this period primarily focused
on coordinating national monetary policies and reducing economic
disparities among the member countries to establish monetary stability.
This laid the groundwork for a shared effort to control inflation and

2|Page
 interest rates. During this time, capital was allowed to flow freely
among the member countries of the European Community.
 In 1990, the European Monetary System faced a significant financial
crisis known as the Exchange Rate Mechanism (ERM) crisis. This
crisis, characterized by rising interest rates and financial pressures, led
to fluctuations in exchange rates and economic downturns.
 In December 1991, EU member countries met in Maastricht
(Netherlands) and signed the Maastricht Treaty. According to this
treaty, the EU would establish exchange rates between the currencies of
member states. This agreement set out economic and financial criteria
that member countries had to meet to join the Eurozone. It set the stage
for the creation of the Euro currency and the implementation of
monetary and fiscal policies in Europe.
 The European Central Bank, to be located in Frankfurt, Germany, would
be solely responsible for the issuance of common currency and
conducting monetary policy in the eurozone. National central banks of
individual countries then would function pretty much like regional
member banks of the U.S. Federal Reserve System
 On January 1, 1999, the common currency of the European Union, the
Euro, was introduced. Initially, from January 1, 1999, to January 1,
2002, the euro was used exclusively for non-cash transactions. Starting
from January 1, 2002, euro banknotes and coins began circulating
alongside national currencies, ultimately leading to the phasing out of
national currencies by July 2002.
 Since the introduction of the euro, many other European countries have
joined the Eurozone after meeting the necessary economic and financial
criteria. The Euro is increasingly used for everyday cash transactions,
including shopping, payments, and daily consumption.
3. Characteristics of the European Monetary System
a. Purpose
 To establish a “zone of monetary stability” in Europe.
 To coordinate exchange rate policies vis-à-vis the non-EMS currencies.
 To pave the way for the eventual European monetary union.
b. Instruments

The European Monetary System (EMS) began operating in March 1979

based on two main instruments:

3|Page
  The European Currency Unit (ECU)
o The European Currency Unit (ECU) is a “basket” currency
constructed as a weighted average of the currencies of member
countries of the European Union (EU). The weights are based on
each currency’s relative GNP and share in intra-EU trade. The ECU
serves as the accounting unit of the EMS and plays an important role
in the workings of the exchange rate mechanism.
o ECU indicates the exchange rate deviation of each currency from the
average exchange rate of the currency basket. ECU serves as a
warning signal for central banks of countries to intervene.
 The Exchange Rate Mechanism (ERM)
o The Exchange Rate Mechanism (ERM) refers to the procedure by
which EMS member countries collectively manage their exchange
rates. The ERM is based on a “parity grid” system, which is a system
of par values among ERM currencies. The par values in the parity
grid are computed by first defining the par values of EMS currencies
in terms of the ECU.
o The ECU was defined based on a basket of 12 currencies of the EU
member states. The ECU served as a reference currency for
exchange rate policy and determined exchange rates between the
participating currencies through officially recognized accounting
methods. The exchange rates were referred to as official ECU rates.
o For example, the official ECU rate for the German Mark was
1.94964 Marks = 1 ECU, and for the French Franc, it was 6.53883
Francs = 1 ECU. This means that the equilibrium rate between the
German Mark and the French Franc was 6.53883/1.94964 = 3.3539.
So, 1 German Mark = 3.3539 French Francs.
o In 1979, when the EMS system was implemented, each currency was
allowed to fluctuate within a range of ±2.25% against the grid
exchange rate (except the Italian Lira, which could fluctuate ±6%).
By September 1993, the maximum fluctuation range was ±15%.
o When a currency deviated lower or higher than the agreed range, the
central banks of the two countries had to intervene in the foreign
exchange market to bring the exchange rate back within the allowed
range. Central banks had the right to borrow from a credit facility
funded by contributions from member countries in gold and foreign
exchange.

4|Page
 o To assist countries in adjusting their macroeconomic policies, the
EMS system also implemented the "mutual cross-rate notation"
system. This system compared the official ECU exchange rates with
the market price of the ECU. If the market price of a particular
currency deviated from the official rate beyond the allowable limit,
that country had to adjust its macroeconomic policies to ensure parity
between its currency and the currencies of other countries..
4. The European Central Bank (ECB).
 The European Central Bank (ECB) was officially established on July 1,
1998.
 According to the Maastricht Treaty and other legal documents of the EU,
the ECB was officially granted full responsibility for the common
monetary policy of the Euro-11 region starting on January 1, 1999.
 The ECB's headquarters is in Frankfurt.
5. Criteria for Joining the EURO
 According to the Maastricht Treaty, to be part of the Economic and
Monetary Union (EMU), member countries must meet specific criteria:
o The rate of inflation must not exceed 1.5% of the average inflation
rate of the three EU countries with the lowest inflation.
o Long-term interest rates should not surpass 2% above the average
long-term interest rates of the three EU countries with the lowest
rates.
o The gross public debts are below 60 percent of GDP.
o The ratio of government budget deficits to gross domestic product
(GDP) below 3 percent.
o National currencies must be part of the Exchange Rate Mechanism
(ERM) for two years without significant devaluations before joining
the Economic and Monetary Union (EMU).
 In May, 1998, 11 countries met these criteria. Greece and the UK had
not due to high inflation and economic downturn. Sweden and Denmark,
despite meeting the criteria, were not yet ready to join the common
currency area but had plans to do so in the future.
 On May 2, 1998, the European Commission decided to assess the
countries that met the criteria and were ready to participate in the
Eurozone for the first time. The initial list was arranged according to
GDP, and it included: Germany, France, Italy, Spain, the Netherlands,
Belgium, Austria, Finland, Portugal, Ireland, and Luxembourg. The
5|Page
 Eurozone could potentially expand to include Eastern and Northern
European members such as Switzerland and Norway.
II. INTERNATIONAL ENVIRONMENT
1. Impact on the International Financial Market:
 Euro and Globalization
o The Euro, as the common currency of the EMU, signifies unity and
integration among its member countries. The emergence of the Euro
is a significant step in the journey of globalization, promoting
interaction and trade among global markets.
o International Trade Medium:
o The Euro becomes a crucial international payment medium, widely
accepted in international trade transactions. This brings about
convenience and ease in conducting global transactions.
 Financial Diversification:
o The presence of the Euro increases financial diversification in
international management. Having an additional common currency
helps reduce risks and enhances flexibility in uncertain market
conditions.
 Competition for Investment Capital:
o EMU countries compete with each other to attract foreign direct
investment. This puts pressure on improving the business
environment and creating favorable conditions for international
businesses.
 Exchange Rate:
o Decisions on the exchange rate between the Euro and other national
currencies are particularly important to stabilize the financial market
and avoid increased debt due to exchange rate fluctuations.
 History and WTO:
o The emergence of EMU and the Euro may pose new challenges to
how international financial organizations operate. Questions arise
about the role and structure of the World Trade Organization (WTO)
in this new context.
 Trade Conflicts:
o Trade conflicts between the U.S. and EU at the WTO reflect
competition and influence on both sides. The emergence of EMU

6|Page
 could change market dynamics and create new conditions for global
trade confrontations.

7|Page
 2. Impact on Vietnam:
 Increase in EURO against USD:
o If the price of EURO rises against USD, the exchange rate with VND
may also increase. This affects Vietnam's reserve management,
raising the value of their foreign exchange reserves and posing
challenges to exchange rate management policies.
 Federal Reserve (FED) and Interest Rate Policy:
o When the FED implements a policy of cutting interest rates, the USD
becomes less attractive to investors. This can decrease the value of
the USD and increase pressure on the EURO. In this context,
Vietnam's reserve management may face volatility and increased
pressure in borrowing and foreign exchange management.
III. ADVANTAGES AND DISADVANTAGES OF EMS
1. Advantages
 Reduced Transaction Costs and Elimination of Exchange Rate
Uncertainty
o The most direct and immediate benefits are reduced transaction costs
and the elimination of exchange rate uncertainty. When using a
common currency like the Euro, there is no need to convert between
different currencies, reducing the associated costs. This helps
businesses and consumers save costs and creates a more stable
trading environment.
 Increased Price Transparency and Europewide Competition
o Increased price transparency will promote Europe-wide competition,
exerting downward pressure on prices. When people and businesses
can easily compare prices across different countries without being
affected by exchange rate uncertainty, they can choose products and
services with the best prices. This promotes competition, reduces
prices, and increases purchasing power for consumers.
 Enhanced Efficiency and Competitiveness of the European
Economy
o The enhanced efficiency and competitiveness of the European
economy are significant benefits. When member countries share a
common currency, transactions and business become more flexible,
optimizing the use of resources and enhancing efficiency in
production and services.

8|Page
  Promotion of Political Cooperation and Peace in Europe
o Sharing a common currency should promote political cooperation
and peace in Europe. When countries share the same currency, they
may have common interests and need to work together to maintain
economic and financial stability. This can help prevent conflicts and
create a favorable environment for political cooperation and peace in
the region.
2. Disadvantages
 Loss of National Monetary and Exchange Rate Policy Independence
o The struggle to maintain community benefits: Balancing the interests
of all member countries in the EMU is a challenging task. Countries
may have to compromise and accept economic measures they are not
satisfied with to maintain the stability of the Euro and the EMU as a
whole. Inconsistencies in tax policies, spending, and social welfare
can lead to struggles and conflicts among member countries.
 Difficulty in Maintaining a Strong Euro
o Researchers argue that the use of the Euro has somewhat negatively
impacted the economies of France, Spain, Italy, and all Southern
European countries. An IMF report pointed out that the Euro has
caused a 0.8% decrease in economic growth in France, and the use of
this common currency has resulted in a loss of 3.591 trillion euros
for the French economy.
o Challenges in Economic Policy Coordination: In coordinating
economic and monetary policies, the European Central Bank
assuming the role of managing the monetary policy for the entire
bloc may lead member countries to lose tools to regulate their
economies. Each country traditionally uses monetary policies to
stabilize its domestic economy, but with a common currency, their
intervention capabilities are reduced, making it difficult to regulate
the economy of each country.
 Difficulty in Harmonizing Interests of Member Countries
o Maintaining a strong Euro is a challenging task for participating
countries because these countries have different levels of economic
development, each facing its own difficulties. Achieving harmony in
the interests of all member countries requires significant compromise
from each nation. On the other hand, to ensure the smooth operation
of the EMU, participating countries must continue to strive to meet

9|Page
 the imposed EMU targets, forcing the governments of these countries
to implement austerity measures in budget spending, tax policies,
and welfare—tightening belts and cutting social welfare spending.
IV. HOW CURRENT POLITICAL AND ECONOMIC SITUATIONS
AFFECT THE EURO
1. Russia-Ukraine Tensions (Since October 2021)
 Tensions between Russia and Ukraine make things shaky for the Euro.
When people worry about war or conflicts, they often move their money
to safer things like the US dollar or gold. This can make the Euro's value
go down.
2. Sanctions and Russia's Response (2022)
 If the West puts sanctions on Russia, it could make European money
markets less stable. Russia has a lot of money in European banks. If
sanctions stop them from using that money, European banks might lose
some of it. This could create worries and instability in European money
markets. Also, since Russia supplies a lot of gas and oil to Europe, any
problems with supply or price changes could affect industries and impact
the Euro.
3. Inflation and Interest Rates
 Inflation, which is when prices go up, can affect the Euro. If inflation is
higher than what the European Central Bank wants, they might raise
interest rates to control it. Higher interest rates can make the Euro more
attractive to investors and businesses but might also affect the
Eurozone's financial situation.
4. Global Financial Market Volatility
 If the global stock markets go up and down a lot, it can also affect the
Euro. When markets are uncertain, people often choose safer options
like the US dollar, which can lower the value of the Euro.
5. Italian Political Crisis (Late 2019 and Early 2020)
 The political issues in Italy could impact the Euro and the money
markets in Europe. Political problems can create uncertainty, affecting
how people see the Euro. If there are big or uncertain political troubles,
investors might lose trust in Italy and Europe's financial stability, leading
to a lower value for the Euro. Remember, the effects of a political crisis
might not last forever and depend on what happens and how Italy and
Europe handle it.

10 | P a g e
 V. THE FUTURE OF THE EUROPEAN MONETARY SYSTEM
1. Will the Euro Survive?
 The future existence of the Euro depends on various economic, political,
and financial factors. Factors like global economic conditions, monetary
policies within the Eurozone, political situations in Euro-using countries,
and more can influence the exchange rate of the euro. However, if
Europe can resolve internal issues and imbalances, there is a good
chance that the euro will continue to exist.
2. Future Value of the Euro
 Predicting the future value of the Euro involves considering several
factors. According to an analysis in El Economista, the Euro is expected
to reach around $1.12 USD by the end of this year, and the revaluation
process may continue in the coming years, potentially reaching $1.15 by
2025. However, the article emphasizes that reaching $1.15 might depend
on various factors, and it might be influenced by the U.S., which could
be the first country to increase or decrease its basic interest rates.
3. Euro as a Global Currency
 The Euro has the potential to become a major global currency,
challenging the dominance of the U.S. dollar. The dollar has been the
primary global currency since after World War I due to the strength of
the U.S. economy. Now, the Eurozone is comparable to the U.S. in terms
of population, GDP, and trade. The Euro is increasingly used in
international bond markets, and with sound monetary policies from the
European Central Bank, it is emerging as the second global currency.
This shift might also lead to discussions about cooperative monetary
arrangements in Asia and beyond.

11 | P a g e
REFERENCE:

Cheol S. Eun & Bruce G. Resnick. International Financial Management

(seventh edition).New York, NY 10121.
https://dubaotiente.com/eur-dong-tien-chung-chau-au-library-31.html
https://luatminhkhue.vn/he-thong-tien-te-chau-au-european-monetary-system-la-
gi.aspx
https://dav.edu.vn/so-25-dong-euro-ra-doi-va-nhung-tac-dong-cua-no/
https://dav.edu.vn/so-24-tac-dong-cua-dong-tien-chung-chau-au-voi-dong-do-la-
my/
https://nhandan.vn/mat-trai-cua-dong-euro-post359173.html
https://tuoitre.vn/tuong-lai-kho-doan-cua-dong-euro-20220722080042403.htm
https://vtv.vn/kinh-te/dong-euro-tang-vot-so-voi-usd-
20230717094405781.htm#:~:text=Theo%20b%C3%A0i%20b%C3%A1o%2C
%20%22D%E1%BB%B1a%20tr%C3%AAn,%2C15%20v%C3%A0o%20n
%C4%83m%202025%22.

12 | P a g e