© Martin Joppen / ECB

The European Central Bank (ECB) is celebrating its 25th anniversary. On 25 May 1998, the governments of the 11 participating member states appointed the president, Wim Duisenberg, along with the vice-president and the four other members of the ECB’s Executive Board, one of whom was Otmar Issing, formerly the Bundesbank’s chief economist. They took up office on 1 June 1998, formally establishing the ECB.

Origins in the 1970s

The idea of creating a single currency for all of Europe had been hatched long before. Indeed, it began to garner interest when the Bretton Woods system, the international monetary system with fixed exchange rates, began to crumble. Pierre Werner, Luxembourg’s prime minister at that time, presented in the early 1970s a plan to introduce a single currency for all the European Community member states by 1980.

Several European countries – the first being Belgium, France, Germany, Italy, Luxembourg and the Netherlands – agreed in 1972 to initially set up a European exchange rate arrangement known as the “snake in the tunnel”. Under this system, exchange rates were not allowed to fluctuate around the agreed central rates by more than 2.25%. However, cohesion among the member states proved to be weak. Their inflation rates diverged too greatly; currency reserves and mutual financial assistance were insufficient to prevent repeated appreciations and depreciations – and to keep countries from leaving the “snake”. These difficulties induced France and Germany to work towards a system that allowed fixed exchange rates but also temporary, substantial adjustments. The idea here was to facilitate the integration of countries that tended to have less counter-inflationary discipline.

Finally, in 1979, the “snake” arrangement was superseded by the European Monetary System (EMS). The heart of the EMS was the European Currency Unit (ECU), which was used both as a unit of account and reference variable for exchange rates and as a payment instrument and reserve currency for central banks.  Participating countries set a central ECU rate for each currency which could then be used to determine the central rates for a given currency pair. Most exchange rates were allowed to fluctuate by up to 2.25% around their respective central rate. However, central rates were realigned substantially on numerous occasions. The EMS was discontinued in 1999 with the introduction of the euro.

Balance sought between different national interests

The EMS contributed to the emergence of the European economic and monetary union (EMU) in two ways. The Bundesbank’s policy of stability, which led to the Deutsche Mark becoming the unofficial anchor or benchmark currency in this system, was significant in this respect. On the one hand, the EMS fostered a general commitment to stability among the participating countries. The weak-currency countries – primarily France – embarked upon a restrictive monetary and fiscal policy from 1982 in a bid to pare back their high inflation rates and thus escape recurrent devaluations. This experience resulted in stability-inducing rules being incorporated into the institutional architecture of the monetary union. These included agreements on limiting fiscal deficits and on the indebtedness of the participating countries, the independence of their central banks from political interference and a ban on lending to general government by central banks.

The EMS nevertheless remained vulnerable. Currency-weak countries succeeded in lowering inflation only if they set high central rates. Yet these, in turn, put pressure on economic activity and employment. Keeping exchange rates stable vis-à-vis the Deutsche Mark thus became a heavy burden for a number of countries. This burden reinforced the desire for a shared institution, which some of the countries participating in the system hoped would balance out national interests. Discussions on establishing the EMU got underway in 1988.

© Danny Gys / European Commission

Independent from political influence

The heads of state and government of the 12 member states of the European Community at that time signed the Maastricht Treaty on 7 February 1992. Around 20 years after the Werner Plan, this treaty provided for the introduction of the euro as a single currency and for the establishment of a European economic union. Every country wishing to join the euro area had to meet the economic convergence criteria set forth in the Maastricht Treaty.

In the years that followed, preparations were made for the launch of the euro. The European Monetary Institute (EMI) was established in 1994. The members of the EMI were the central banks of the EU member states, which coordinated their monetary policy from then on. From 1 June 1998, the EMI was replaced by the ECB, which has its headquarters in Frankfurt am Main and which together with the national central banks of the EU makes up the European System of Central Banks (ESCB).

© Deutsche Bundesbank

This system was modelled on the Bundesbank in that the ECB is independent from political influence, price stability is its primary objective and the ESCB is federally structured. Initially, the ECB Governing Council set as its price stability objective an inflation rate of below 2%, later switching to a more specific definition of “below, but close to, 2%”. Since the summer of 2021, the ECB has been aiming for an annual inflation rate of 2% for the euro area over the medium term. This target is symmetric, meaning negative and positive deviations of inflation from the target are equally undesirable.

The Bundesbank forms part of the Eurosystem

© Claudio Hils

At first, in 1999, the single currency was introduced as book money. Euro banknotes and coins replaced the national currencies in 2002. Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain were the first countries to use the euro as legal tender. Since then, responsibility for the stability of the currency has rested with the Eurosystem instead of with the national central banks. The Eurosystem comprises the European Central Bank and the national central banks of the EU member states that currently use the euro. The Bundesbank as Germany’s national central bank is part of the Eurosystem. Following the accession of Croatia on 1 January 2023, there are now 20 countries in the euro area.