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Toward Virtual Exchange-Rate Stability in Western and Eastern Europe with or without EMU

Jun 1997
Stanford King Center on Global Development Working Paper
6
What should be the rules of the game for stabilizing exchange rates within the European Union, including Central and Eastern European countries which might join in the future? I propose rules that are consistent with "virtual" exchange rate stability. They are flexible enough for Western European countries not in EMU and for the transitional economies further east. Nevertheless, the rules are strong enough to allay fears of beggar-thy-neighbor undervaluations or other unfair trading practices.

A further set of issues arises if EMU should fail altogether. How should the existing ERM (European Exchange Rate Mechanism) be reorganized so it becomes less crisis prone, more easily facilitates accepting new members from further east, and constrains the range of exchange rate variation to be much less than the current nonfunctional +15 percent on either side of parity? Here I propose that the ERM become more formally a Deutsche-Mark zone-but one where Germany becomes more accountable to the group. In particular, the Bundesbank would weigh price-level movements in other core member countries as well as in Germany.