Working Paper: CEPR ID: DP2633
Authors: Daniel Cohen; Olivier Loisel
Abstract: Against all odds, the euro turned out to be a weak currency. We argue that this outcome can readily be explained by the policy mix that was chosen at the onset of the period: tight fiscal policies following the convergence mechanism that was imposed by the Maastricht treaty and loose monetary policy that resulted from the convergence of interest rates to the lower point of the spectrum. We investigate this outcome empirically and show that the euro's weakness can be understood as the result of an excess supply in the zone, which is channelled abroad in the usual 'beggar thy neighbour? way. We also outline how an optimal policy mix could be set in the future and discuss a suggestion that has been made by Alessandra Casella on the proper way to determine the fiscal deficit of the zone.
Keywords: Euro; Policy Coordination
JEL Codes: F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial policy mix (E63) | euro's weakness (F36) |
| tight fiscal policies (E62) | excess supply in eurozone (E66) |
| loose monetary policies (E63) | excess supply in eurozone (E66) |
| excess supply in eurozone (E52) | weak euro (F31) |
| initial policy mix (E63) | excess supply in eurozone (E66) |
| initial policy mix (E63) | weak euro (F31) |