Unsustainable Parities: The Exchange Rate Mechanism in Turmoil

JEL Classification F33

Mary Davis

Bank of Ireland Group Treasury, PO Box 2386, International Financial Services Centre, Dublin 1, Ireland


An 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 an aspiration.


The author would like to thank Prof Dermot McAleese for his helpful comments and assistance.