In the European Monetary System, a member country was allowed to fluctuate its exchange rates within a band around the fixed parities with other members. In 1993, this system came under severe speculative pressures. Several currencies were pushed down to the limit of their allowed fluctuation margin against the DM; for example, the French franc could not stay within 2.25 percent of its central parity with the DM. One solution would have been to keep the same fluctuation band around the central parity but devalue the parity of the franc against the DM. Instead, the European Union decided to keep the same bilateral parities but widen the allowed fluctuation band to 15 percent on each side of the parity.
a. What do you think are the advantages and disadvantages of each solution?
b. Which solution is more likely to prevent currency speculation?