Working Paper: CEPR ID: DP2058
Authors: Maria Demertzis; Andrew Hughes Hallett
Abstract: The size and economic relevance of Europe may imply a new role for the EURO in the international financial markets. But will the EURO compete with the $US and the Yen for a place in the basket of international currencies? Will that induce a bipolar or indeed tri-polar system, and with what consequences? Two important uncertainties arise from the fact that the long run trend of the EURO depends on the economic performance of the partner countries as well as on the properties of the new currency. They are: a) the international use of the EURO in trade, as well as its effect on the stability of the foreign exchange markets more generally, and b) the implementation of monetary and fiscal policies: how the new European policy mix will affect the degree of international policy co-ordination and exchange rate management.Much of this uncertainty is due to the fact that some of the effects will work in opposite directions and many will be felt gradually (primarily those that are dependent on private sector expectations), while others will become obvious as soon as the EURO is introduced. In this paper we discuss some of the reasons why the EURO might be strong or weak but more importantly why it may be volatile at least in the initial stages. Finally, we calculate the "synthetic" EURO and show how one EURO is not one ECU, an additional reason why it may prove volatile.
Keywords: EMU; currency markets; exchange rates; euro
JEL Codes: F3; F4; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| euro's strength or weakness (F36) | economic performance of partner countries (O57) |
| strong euro (F36) | increased international use in trade (F19) |
| strong euro (F36) | stable monetary policies (E63) |
| weak euro (F31) | volatility in fiscal policies (E63) |
| weak euro (F31) | lack of coordination among member states (F55) |
| initial volatility of euro (F31) | transition process leading up to its introduction (Y20) |
| frequent changes in interest rates (E43) | initial volatility of euro (F31) |
| demand for euros (F31) | euro becoming a reserve currency (F31) |
| conservative ECB (E58) | demand for euros (F31) |
| risks of euro as reserve currency (F31) | difficulties in controlling money supply (E51) |
| risks of euro as reserve currency (F31) | potential for financial instability (F65) |
| lack of coordination in fiscal and monetary policies (E61) | greater volatility in euro's value (F31) |