The Forex Mechanism is actually a very simple concept to grasp- it is generally put in place to reduce exchange rate variability and help to keep things stable monetarily. Based on a concept of a fixed currency exchange rate margin, it takes into account that exchange rates vary within the margins themselves. Sound a little confusing? It’s really not. They call this the semi-pegged system and before the Euro came about, exchange rates were based on the European Unit of Account- and the value of that was used as a weighted average of the participating currencies.
To boil this all down to simplest terms, the Forex Mechanism really is just a tool to pave the way towards a single currency- at least, that’s what it was intended to do. Member currencies were fixed against each other with a very narrow band of fluctuation based on the ECU rate and floating against the non-member countries.
When a currency deviated enough, the European Monetary Cooperation fund and central banks would take control and stabilize that currency. Unfortunately in 1192, the UK dropped from the mechanism due to chaotic circumstances in their own economy- something we’re seeing resurface now and once again, to accept or deny use of the Euro in the UK is being discussed.
So basically, the Forex Mechanism is a system in place to stabilize currency deviations and keep the global market within the mechanism stable by having one central cooperation step in when the time is needed to bring it back to a closer margin.
