Asymmetric fluctuation bands in ERM and ERM-II: Lessons from the past and future challenges for EU acceding

Abstract

The forthcoming EU enlargement raises a series of questions related to the new entrants’ entry to Exchange Rate Mechanism II and their subsequent adoption of the single currency. In this paper, the issue of how to determine the central parity for the acceding countries with which to enter ERM-II is tackled. This is followed by a discussion of the asymmetric nature of the fluctuation bands around the central parity that could be deemed as compatible with the Maastricht criterion on exchange rate stability, i.e. +2.25%/-15% within the officially announced ±15% fluctuation margins. Then, practices of the European Monetary Institute/ECB and the European Commission are compared when assessing the criterion on exchange rate stability. With this as a background, hypothetical ERM-II is constructed for 4 acceding countries with flexible exchange rate regimes so as to assess ex post the sustainability of these countries’ participation in ERM-II. Based on this, given ex post exchange rate variability and the limited intra-marginal intervention facilities ERM-II participant countries have at their disposal, the defence of the asymmetric band appears a tricky task even though the +2.25% limit on the weaker side of the band is rendered somewhat intangible by a 10-day moving average rule used by the EMI/ECB and further flexibility is given to the system in that a depreciation of more than 2.25% is not automatically viewed as a non-fulfilment of the criterion on exchange rate stability.