202 COMPARATIVE POLITICAL STUDIES/April 1996 monetary integration is somewhat more economically defensible than it once was,but efficiency-based economic principles cannot be evinced to explain the EMS,EMU,or variations in national policy toward them. Although these factors are important,they are not sufficient to explain change over time or across countries in willingness to fix exchange rates within Europe.I present below,and evaluate empirically in what follows,an argument that variations in the level of trade and investment with potential currency-regime partners is a crucial contributor to explaining variations in exchange rate policy. Although current levels of goods and capital market integration do not make stabilizing exchangerates unambiguously welfare-improving for mem- bers of the EU as a whole,they do make it attractive to stabilize exchange rates for those economic agents heavily involved in intra-EU trade and payments.Currency arrangements have a differential effect on firms and individuals,which can be expected to translate into cross-cutting political pressures on national policy makers.The crucial political issue typically has to do with how important currency predictability is,relative to the ability of national monetary authorities to depreciate the exchange rate to stimulate the local economy or increase the competitiveness of national producers.Re- linquishing this option is not popular,other things being equal,even if it does lead to more stable currency values. However,higher levels of cross-border trade and investment increase the size and strength of domestic groups interested in predictable exchange rates. Firms with strong international ties support a reduction of currency fluctua- tions.These effects are especially important to banks and corporations with investments throughout the EU.In addition,tradable producers with EU-wide markets,and for whom price competition is relatively less important-those whose appeal is based primarily on quality or technological prowess-may be less concerned about ability to devalue than about currency stability.12 11.In this context,it is important to keep in mind that eliminating the ability to devalue for high-inflation countries typically leads to a transitional (inertial)real appreciation of the exchange rate.This is especially troublesome for producers of tradable goods that compete primarily on price,as fixing the exchange rate in conditions of inflation above the EU average exposes import competitors to substantial price pressure. 12.It is often objected that forward markets allow firms to protect themselves against potential currency fluctuations.Although this is true for short-and medium-term exchange-rate movements,it is not true over the longer time horizon typically of concern to investment planners.Indeed,the existing literature on corporate finance distinguishes clearly between transaction exposure,which can be effectively hedged,and operating exposure,which cannot. See,for a typical example,Shapiro(1992),chapter 10.I am indebted to Rich Lyons for bringing this to my attention