THE EUROPEAN EXCHANGE-RATE MECHANISM AS A MACROECONOMIC DESTABILIZER

For over a decade, the ERM survived in defiance of gloomy predictions that its fate would be similar to that of 'the Snake' in the 1970s, wh ich disintegrated a few years after the collapse of Bretton Woods. It survived even the abolition of exchange controls in 1990. But finally it broke down in the face of a series of large shocks-a fluctuating do llar, German reunification, and the debate over the Maastricht Treaty. This paper uses stochastic simulation of the Liverpool World Model to examine the weaknesses in the ERM and compares its stochastic perform ance with that of floating exchange rates. It argues that European mon etary policy should return to domestic monetary targeting within float ing exchange rates. It finds that cooperation in European monetary pol icy is delivered with least stochastic disturbance within such a regim e.