Discretionary Exchange Rate Regimes: Lessons from the European Monetary System, 1979-1988

This article focuses on EMU’s predecessor, the European Monetary System (EMS), and how this looser monetary arrangement was more conducive towards facilitating realignments among EU’s diverse member-states, paying particular attention to France and Germany.  We argue that in the EMS, devaluations did indeed help more than revaluations did hurt. Assuming that the political-economic heterogeneity of the Eurozone will not vanish in the foreseeable future, the move to a more flexible exchange rate regime might therefore be economically advantageous. However, a purely economic view ignores the huge political costs of negotiable realignments, costs that the EMS members aimed at overcoming when they negotiated the Euro. A move to a new EMS would therefore be not an attractive option for the Eurozone governments. We argue that an alternative, discretionary exchange rate regime would have to guarantee that the fallback option of realignment negotiations is not the status quo ante, but an inflation-adjusted version of it.