Need help with my writing homework on European Monetary System. Write a 2000 word paper answering; Only those members were considered as the permanent members of ERM who committed themselves to keep their currencies within that particular band and made policy initiatives to keep them within that range. This system gradually evolved in such a manner that most of the currencies were linked with the stronger currency of the region. Ultimately all the currencies were pegged or linked with the German Mark because Germany was the largest economy in Europe. (Baldwin & Wyplosz 2006)
One of the key events which created the crisis was the unification of Germany in which a larger economy has to merge with a smaller economy. As a result of this reunification, West Germany has to spend on fiscal expansion which further widened its fiscal deficit to as much as 13 % of GDP. (Heitger & Waverman, 1993). .Consumers in Eastern Germany spent the voluntary government transfers received from West Germany in rather quick manner. At the time of reunification, East Germany’s currency was pegged at a ratio of 1.8:1 however, such disparity discouraged firms to sell their inventory at loss. Higher demand from consumers versus low level of supply, therefore, resulted in inflationary pressures on the economy. (Mulhearn & Vane, 2008)
At the time of the ratification of the Maastricht Treaty in 1993, differing opinions started to emerge against EMS as referendums in Denmark and France gave a hint about small minority which was against the treaty itself. This was mainly due to higher German interest rates and the impact of the same on foreign exchange rates of other countries.
In September 1992, Italy decided to devalue Lira by 7% followed by the UK’s withdrawal from the ERM. As a prelude to this, currency speculators were able to precisely forecast that European economies may exit ERM and started to speculate against the British Pound on the basis that the GB pound will lose its value. Massive short selling took place for British Pound putting further pressure on British Sterling in global markets.