How does European Exchange Rate Mechanism (ERM II) work?
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The European Exchange Rate Mechanism is a system of related monetary policies across Europe that are designed to keep the exchange rates between different European currencies in line with each other. This makes the exchange rate easily predictable, thus facilitating easier trade between different economies in Europe. This is important for countries that are in the EU but have opted out of the euro such as Denmark or countries planning to join the eurozone relatively soon like Bulgaria. How it works is that the central banks of Denmark and Bulgaria are required to use monetary policies to keep the value of their currency relative to the euro within a certain range, or band. If the value of their domestic currency relative to the euro falls too low, they have to implement deflationary monetary policy to strengthen their currency. Likewise, if their domestic currency gets too valuable relative to the euro, they have to implement inflationary monetary policy to weaken their currency.
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