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The Unstable EMS

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This paper undertakes a systematic study of the exchange rate crisis which led to a partial dismembering of the EMS in the fall of 1992. A review of possible interpretations of the crisis concludes that the EMS is now fundamentally unstable, partly because exchange controls have been banned by the Single Act and partly because the Maastricht Treaty creates perverse incentives for self-fulfilling attacks. A review of possible options suggests that "business as usual" is not viable. We conclude that some restrictions on short-term capital movements, such as requiring all institutions taking open positions on foreign exchange to make non-interest-bearing deposits with their central bank,represent the best option for succesfully traversing the treacherous Stage II

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