Abstract

Possible Monetary and Currency Policy Configurations of the European Monetary System

Liquidity effects of exchange market interventions are governed to a decisive extent by institutional circumstances in the various countries. They may, as in the case of the Federal Republic of Germany, result in imbalances of foreign exchange movements being accompanied by parallel changes in the stock of current central bank money; they may, as in the USA, in the event of automatic compensation by opposed open-market transactions, be liquidityneutral; and they may, as in Great Britain, result in the banks’ supply of liquidity changing even when exchange movements are balanced, but other compensating deficits or supluses occur on the balance of services and capital movements. From this two conclusions may be drawn for the design of the European Monetary System. On the one hand, it should be ensured that symmetrical exchange market interventions are accompanied by symmetrical liquidity effects. Only in this case can the financing potential of the commercial banks in the Community countries remain unchanged in the event of exchange rate support. Secondly, symmetrical intervention rules may be linked with asymmetrical liquidity effects, the outcome of which is that only in exchangereceiving countries are liquidity effects offset by compensatory open-market transactions. Money market paper to be made available by the European Monetary Fund could be used to absorb liquidity influxes. This arrangement could contribute towards hardening the currency system. The system of divergence limits is a new element in a fixed exchange rate system. It is intended to compel countries whose currencies diverge substantially from the Community mean to take precautionary action. However, the divergence limits can hardly take over the function of an early-warning indicator for future, strained exchange rate situations, and in the event of intramarginal interventions, currency risks arise as a result of redistribution of exchange reserves among the participating countries. Moreover, there is a tendency for a country to take on the function of a reference currency country, if no arrangements are made for the distribution of interventions. Supplemented by a yardstick which is oriented to forward rate constellations and serves as a pointer for expected exchange rate trends on the spot market and for preventative interventions, the divergence limits are an important element for the stabilization of the new currency system.