Unsustainable Parities: The Exchange Rate Mechanism in Turmoil
JEL Classification F33
Bank of Ireland Group Treasury, PO Box 2386, International Financial
Services Centre, Dublin 1, Ireland
AbstractAn examination of ERM parities demonstrates that several
currencies were misaligned due to disparate performance regarding inflation.
Overvalued currencies partly explain the existence of economic imbalances, such
as large fiscal and current account defecits and high unemployment. These
imbalances, combined with the shocks emanating from German economic and monetary
union, rendered existing parities unsustainable. The European Union does not yet
satisfy the criteria for an optimal currency area; labour is immobile, fiscal
federalism is absent, asymmetric shocks are still possible. A European Monetary
Union will not be possible until economic convergence is a reality rather than
AcknowledgementsThe author would like to thank Prof Dermot McAleese for
his helpful comments and assistance.