Snake In The Tunnel

Published Sep 8, 2024

Definition of Snake in the Tunnel

The term “Snake in the Tunnel” refers to a concept used in the negotiation of the European Monetary System (EMS) during the 1970s. It describes an exchange rate mechanism where member countries agreed to keep their currencies within narrow margins of a central parity. The “snake” represents the fluctuations of the exchange rates within a set range (or “the tunnel”). This was an early attempt to achieve greater monetary stability and integration among European countries.

Example

To illustrate the concept, consider three European countries—Country A, Country B, and Country C—in the 1970s. They decided to peg their currencies to each other within a +/-2.25% margin around a central rate. For example, if the central rate was set at 1 Currency A = 1.5 Currency B, each country’s currency was allowed to fluctuate only within a narrow band around this rate. If the exchange rate moved outside these predefined bands, corrective measures would be taken to bring it back within range.

If Country A’s currency started to appreciate too much against Country B’s and Country C’s currencies, it would hit the upper margin of the “tunnel.” This would signal a need for intervention by either or both of the countries involved to bring the exchange rate back within acceptable limits. The system aimed to create a stable exchange rate environment, which was particularly important for economies closely tied through trade and investment.

Why Snake in the Tunnel Matters

The “Snake in the Tunnel” mechanism represented one of the earliest efforts at economic integration in Europe. It was a predecessor to more extensive forms of monetary cooperation, including the establishment of the EMS and later the creation of the Euro. Its importance lay in its role as a learning process for European countries, helping them understand the challenges and benefits of closer monetary policy coordination.

• Stability: By setting strict exchange rate margins, the “Snake in the Tunnel” aimed to reduce currency volatility, providing a more predictable environment for trade and investment.
• Coordination: It encouraged member states to coordinate their monetary policies, which was a necessary step towards deeper economic integration.
• Precedent: This concept laid the groundwork for future monetary arrangements, including the EMS’s Exchange Rate Mechanism (ERM) and the eventual adoption of the Euro.

However, maintaining the system proved challenging due to differing economic conditions and policies among member states, leading to frequent realignments and interventions.

Frequently Asked Questions (FAQ)

What were the main challenges faced by the “Snake in the Tunnel” mechanism?

The main challenges included divergent economic conditions among member countries, such as differences in inflation rates and economic growth. These divergences made it difficult to maintain stable exchange rates without frequent interventions. Additionally, the lack of a centralized monetary authority to enforce rules uniformly led to inconsistencies in policy implementation.

How did the “Snake in the Tunnel” influence the creation of the European Monetary System (EMS)?

The “Snake in the Tunnel” served as a pilot project for greater monetary cooperation in Europe. The experiences and lessons learned from this mechanism highlighted the need for a more structured and comprehensive system, leading to the creation of the EMS in 1979. The EMS introduced the European Currency Unit (ECU) and the Exchange Rate Mechanism (ERM), which were more robust and better equipped to handle the complexities of maintaining fixed exchange rates among diverse economies.

What eventually replaced the “Snake in the Tunnel” system?

The “Snake in the Tunnel” system was eventually replaced by the EMS in 1979. The EMS introduced the ERM, which allowed for broader exchange rate bands and introduced the ECU as a unit of account. The EMS aimed to provide greater stability and flexibility, addressing some of the weaknesses of the “Snake in the Tunnel” and paving the way for the eventual creation of the Euro.

Did the “Snake in the Tunnel” system achieve its objectives?

While the “Snake in the Tunnel” system had limited success in maintaining exchange rate stability, it faced several challenges that hindered its full potential. Economic disparities and the lack of policy coordination led to frequent realignments and interventions. However, it did succeed in laying the groundwork for future European monetary integration efforts, demonstrating the feasibility of closer monetary cooperation and highlighting the need for more comprehensive mechanisms.

In conclusion, the “Snake in the Tunnel” was a significant early attempt at monetary policy coordination among European countries. Despite its challenges and ultimate replacement by more robust systems, it played a crucial role in the evolution of European monetary integration.