Exchange Rate Mechanism

The Exchange Rate Mechanism (ERM) was a system of fixed exchange rates between the currencies of European Union (EU) member states that was in place from 1979 to 1999. The ERM was designed to promote monetary stability and economic convergence among EU member states.

The ERM operated by setting a narrow band around each currency’s central rate against the euro. This meant that each currency could only fluctuate by a maximum of 2.25% against the euro. If a currency’s exchange rate reached the upper or lower limit of its band, the central bank of the country issuing that currency would be required to intervene in the foreign exchange market to buy or sell the currency in order to keep it within the band.

The ERM was a success in promoting monetary stability among EU member states. However, it also proved to be inflexible, and it was ultimately abandoned in 1999 when the euro was introduced.

Here are some MCQs on the Exchange Rate Mechanism:

  1. What is the Exchange Rate Mechanism (ERM)?
    • The Exchange Rate Mechanism (ERM) was a system of fixed exchange rates between the currencies of European Union (EU) member states that was in place from 1979 to 1999.
  2. What was the purpose of the ERM?
    • The purpose of the ERM was to promote monetary stability and economic convergence among EU member states.
  3. How did the ERM work?
    • The ERM operated by setting a narrow band around each currency’s central rate against the euro. This meant that each currency could only fluctuate by a maximum of 2.25% against the euro. If a currency’s exchange rate reached the upper or lower limit of its band, the central bank of the country issuing that currency would be required to intervene in the foreign exchange market to buy or sell the currency in order to keep it within the band.
  4. What were the benefits of the ERM?
    • The ERM promoted monetary stability among EU member states.
    • It also helped to reduce exchange rate volatility.
    • It made it easier for businesses to operate across borders.
  5. What were the drawbacks of the ERM?
    • The ERM was inflexible, and it could not adjust to changing economic conditions.
    • It also led to speculation against some currencies, which put pressure on the central banks of those countries.