EUROPEAN MONETARY

SYSTEM CRISES
1992

Dr. Yong Lao

SBS 318 – 01

Prepared by:
Jerome Sindano

California State University

Monterey Bay

12/21/2007
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1. Introduction
Research topic: The impact of the European Monetary System crisis of 1992-1993 on
the financial system of European Union member countries.

Research question: What impact did the EMS crisis of 1992-1993 have on financial
systems of European Union member countries?

Specific research questions:

Did the crisis affect credibility of European Central Bank?
What were major reasons that caused the EMS crisis in 1992 - 1993?
Did the crises strengthen the EURO?
What countries were involved in the crises and which ones were affected the most?
What strategies and methods were applied by key actors involved in the crises: the
European Monetary Committee, the European Central Bank and others?

Overall objective: The overall objective of this paper is to study and understand the
European Financial system, and how the decisions are made during the economic
problem in the region. We will bring our focus on the EMS crises that occurred in
September 1992 and then in August 1993. We will examine the reasons of this financial
catastrophe. We will also examine the actions European Central Bank during the crises in
rebuilding and readjusting the currency exchange rate.

The importance of this research: This paper will give us some knowledge about how to
make good policy can be a lifeguard for entire population in the region. After reading this
paper one will be help able to explain the causes and understand the EMS crises. The
great thing is that I will write some alternative policies that will help to prevent the future
crisis or to diminish the risk of the financial crises. The paper will show the important
role played by the central and the International monetary institutions to rescues countries
in currencies chaos.

Why does topic need to be dealt within Social and Behavior Sciences: This topic is
very important to be one of the case studies in Social and Behavior science, because it
reveals many key issues related to the financial management. Since a Social Behavior
Science faculty, students deal with money and work with money it is a great deal to
understand the money market and how it’s works. Also, studying the EMS crisis there are
different countries involve in this EMS crisis issues. So, many behavior and different
societies played important roles in solving this problem in different ways using different
social status, different behaviors and many strategies that need different skills and
experiences.

2. Current literature and studies

One of the world interesting currency events which makes us try to ask the question that
will lead to the finding the main and the causes of the EMS crisis. Is the EMS crisis of
1992 and 1993 that permit the Euro functioning?
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In different literature review many authors writing about the begging of the European
Union (EU) and its economic agencies. The European Union start with 6 countries
included; France, Germany, Italy, the Netherlands, Belgium and Luxembourg, and then
joined by the nine which are; Spain, Portugal, the UK, Ireland, Greece, Austria, Denmark,
Sweden and Finland. (Weerapana) From 1979 until early 1990s the EU members
countries formed a joint system for coordination of monetary and exchange rate policies:
The European Monetary System (EMS). This organs is the precursor to the more recent
European Monetary Union (EMU) (Weerapana)

Since the breakdown of the EMS researches continues to examine the cases or the nature
of the crises, Kostas Mouratidis and Nicola Spagnolo examine the nature of the currency
crises and ascertain whether the currency crises of the European Monetary system (EMS)
where based either on bad fundamentals, or on self-fulfilling market expectations driven
by external uncertainty, or combination of both.( Mouratidis and Spagnolo)

In the social and behavior science this question, is one of the topic many social scientist
write about, they went to understand how social influence to issues of finance problems,
how society handle it. How did people solve monetary problem and what are relationship
between money and people. Political and economists, study also different strategies and
the future finances policies. They also study how region political and economic issues
influence the monetary system and switch the decisions, from bad to good, or from good
to bad.

EC member had a talk about a new EMS, a system characterized by progress toward
more convergence and without a need for exchange rate realignments. However, in
January 1987 there were controversial realignments.
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Theoretical and methodology frameworks that could be applied in the research:

Will take two to three weeks to complete this research, the first week will be used to
conceive and collect the research fields, in this stage we will visits different libraries and
University work place such banks and some markets places; malls, grocery stores. By
doing this visit it will be to make ourselves to be familiar with financial places and see
how money are used and circulate among people with different tasks and dealing with
different business involved mostly with money and financial.

I will have chance to ask financial personals and manager questions about how they work
with money who work with banks and big monetary institution.

The mains themes, trends and findings presented in existing research:

I find out that just after the EMS crisis then the ECU change to Euro and give power to
Euro and this was the beginning of Euro to function officially in the EU members states.
I learn the UK better and quick Monetary decision making, this help me to understand
how if the country have experts in charge of overcome financial crises can be very help
for the nation to handle its currency stability, study the case of UK in the late 1992 and
mid 1993.

3. Theory and methodology

Is the research based on any kind of theory or analytical models?
The research is based on the empirical theory used by Mouratidis formulas to examine
different possibilities to overcome the currency crises. Mouratidis and Nicola use
different formula through the Theatrical Underpinning of currency crises, they adopt the
empirical methodology:

Formula #1:

y= outputs, y n = natural rate of output, π= inflation rate, π *= inflation target, λ=relative

weight that the Central Bank attaches to output (relative to inflation stabilization), k =
parameter which may be justified in several accounts.

This formula is used by the Central Bank to minimize the loss function in terms of
expected depreciation and deviation of optimal value of the exchange rate from its
normal level.

Krugman (1996) represented this formula as follows:

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S= log of the exchange rate, s*= a value used by a government if credibility cost is not
received, s f = a parity to which the Central Bank stacked its reputation, є = is the
expected rate of depreciation. R= stands for stochastic dummy variable that takes on
value zero if central bank does not devaluate the money and use the value C if it does.

Formula #3:

iD = domestic EMS member country interest rate, iG = German interest rate, Hst (s=1,2)
= variability of the error term defined as :

This research will be mostly qualitative, and sometime a combination of both. Based to
the limited of time and the needs of mean to support a deep and qualitative research, this
fact will limited our search to find the necessary material to accomplish this task.
However, we will use some other qualitative research sample done by other academic
scholars. For instance I will use the econometric Methodology to find some alternatives
for solving the problem and the theoretical underpinning of currency in this theory I will
focus on the empirical methodology adopted those methods are from Mouratidis and
Spagnolo.

This method it convincible because it examine the nature of the currency crises in order
to apply some importance practice to overcome the crises, and the why authorities can
process to help the currencies in crisis.

4. Data collection and analysis

I collect data from internet search, academic library such the CSUMB, Monterey
Institute, and from my old class material from International political courses. Most of the
research from websites are very clear and make the research question clear the finding
from the internet were many, some of them didn’t enough mean to put in the reference.

The books find in our Universities Library are very rich in materials, they wrote by the
expert and professor, so are very reliable to my research. Most of the materials I get from
the University Data base resources.

Explain in details your data analysis process.

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First of all I though about the topic, since I figure out about dong research concerning the
EMS crises in 1992, I collect any sourced related to the topics. Those sources are from
internets, libraries and sometime asking friends to explain about the issue according to
their understanding.
By researching I find different search done in the field of the European Financial System.
I collect books with related topic. After that I start thinking about my research question,
my research was find and I start reading different author who wrote about my research
topic. I take note of the important keys words and paraphrase some important theoretical
method use in achieving their research. I collect data from different sources and different
authors. I consider other research question to mine see the difference. And I continue find
new source and create new ideas concern this search.

5. Discussions and discoveries

The finding was mostly applicable and helps to strait my research. In doing this research I
understand the differences between the world financial crises such as the one in East Asia
and the Peso from Mexico.
This paper gives a deep understanding about the causes of the EMS and the strategies
used by expert to solve the EMS crises of 1992 and 1993. Also, we understand the
importance of treaties and the flexibilities if some policy doesn’t work well.
We also know when the ECU changes to EURO and when begin working.

Major findings

In this research I come up with different understanding about the currency crisis. I can
now have knowledge of two main theoretical models, that explain currency crises, which
are first the old currency crises model defined as seignorage-driven, and the second the
new generation currency crises model determine by self-fulfilling expectations of
speculators. By knowing these two generation model it could help us to understand what
kind of currency crises it is, in order to know where to start dealing with the currency
crises problematical.

What were major reasons that caused the EMS crisis in 1992 - 1993?

According to Ungeree, Horst, the main causes of September 1992 were due the U.S.
dollar weakness during the end of the first Bush Administration, pressures within the
Exchange Rates Mechanism (ERM) because of the insufficient convergence of economic
developments and the incongruity of fiscal and monetary policies of ERM nations, and at
the end there were uncertainties surrounding the ratification of the Maastricht Treaty
which had an objectives to realize single market under the European Economic
Community Treaty and the Single European Act.

The other fact was the German unification which contributed to the underlying
imbalances among the EMS members, and the collapse of the satellite system of
countries in Central and Eastern Europe, which were dominated by the USSR, the
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disintegration of the Soviet union alone, and the war in the former Yugoslavia, changed
dramatically the political climate in entire Europe. These were followed by a considerable
precondition for the volatility of the foreign exchange markets was the rapid integration
of international financial markets and the innovation in financial instrument.

These situations bring the difficulty to the potential of market operators to move gross
sums swiftly from country to country which was increased tremendously. At this time
there was a day by day turnover on the foreign exchange markets has been estimated at
more that $1000 billion of which only a relatively small part is related to nonfinancial
transactions. Such amount surpassed by far the possibilities of central banks to manage,
in the absence of other policy measures, foreign exchange markets by intervention. The
collection of all this together go against the EMS capacity which drive it to the crises of
1992 and 1993 outspread.

Did the crises strengthen the EURO?

The EMS gets affected and couldn’t resist until some major reforms were done. In 1995
the ECU change the name to “Euro” and was the begging of the Euro market in the EU
community and around the World market.

What countries were involved in the crises and which ones were affected the most?

Italy and Germany were the one that get affected seriously, first Italy joined the ERM
later compare to others, and had manage its to moved smoothly among the ERM from the
wider to the narrow fluctuation margins of ± 2.25%.Countries like Italy and others
followed the policies of “borrowed credibility and monetary stability,” shored up by high
interest rates and built the on overly optimistic convergences in economic performance
persisted. The others countries affected were, Portugal, Spain, France, and UK.

6. Conclusion
The following points summarize our research:
- The European Central Bank has proved to be credible enough to manage
- Monetary policy of the European Union.
- The European Central Bank created competition to domestic central banks of
- EU members
- Euro became much stronger and more reliable
- The Maastricht Treaty was reformed

The limitations included:

- lack of time and methodologies to conduct quantitative research
- lack of literature
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7. References
Bordes, Christian, Eric G, Melitz (1995). European Currency Crises and After. New
York, NY: Manchester University Press.

Frenkel, Jacob, Morris G. (1996). Functioning of the International Monetary System.

Washington, DC: International Monetary Fund.

Helleiner, G.K. (1996). The International Monetary and Financial System. New York,
NY: St. Martin's Press, Inc.

McKenzie, George, Stephen T. (1992). Financial Instability and the International Debt
Problem. Houndmills, Basingstoke, Hampshire RG21 2XS and London: MACMILLAN
ACADEMIC AND PROFESSIONAL LTD.

Mouratidis, Kostas (January29, 2003). Retrieved 12/20/2007, from

www.niesr.ac.uk/pubs/dps/dp207.pdf

Ungerer, Horst (1997). A concise history of European Monetary integration: from EPU
to EMU. Westport, CT: Greenwood Publishing Group, Inc..

Weerapana, Akila (spring semester 2003-2004). The Exchange Rate Mechanism Crisis of
1992. Retrieved Dec. 19, 2007, from
http://www.wellesley.edu/Economics/weerapana/econ213