A yearlong nightmare for the European Monetary System (EMS) began in September 1992. Amid name–calling, finger–pointing, and hand–wringing, the British pound and the Italian lira dropped out of the Exchange Rate Mechanism (ERM). In succeeding months, virtually every other ERM currency came under attack.1 Three of them—the Spanish peseta, the Portuguese escudo, and the Irish punt—devalued within the system. Three others—the French franc, the Belgian franc, and the Danish krone—avoided devaluation, but only at the price of recurrent and costly rounds of intervention by multiple central banks. Finally, in August 1993, the defenders of the parities surrendered. The twelve EMS countries agreed to expand the fluctuation margins from 2.25 per cent on either side of parity (6 per cent for Spain, Portugal and the UK) to 15 per cent on either side of parity. The wider margins eliminated the potential for speculative attacks, but left the system only the thinnest veneer of exchange rate coordination. This article seeks not to assess the causes of the crisis but rather to explain why the EMS governments did not defuse it with a realignment—the mechanism built into the ERM for precisely such occasions.
