NCPA - National Center for Policy Analysis

Why Has The Euro Fallen So Far?

May 15, 2000

The euro -- the international currency that is replacing the national currencies of 11 European countries -- has fallen in value since its introduction on Jan. 1, 1999. Some economists are puzzled as to why this has occurred, since all the signs pointed to the emergence of a stable currency, able to rival the U.S. dollar as a store of value.

  • The European Central Bank (ECB), the monetary authority that issues the currency, has a mandate to maintain a stable value for the euro.
  • In preparation for a unified currency, the 11 European partners moved to put their fiscal affairs in order, meeting strict standards for government debt and deficits.
  • But in the 17 months since the euro was introduced, it value has sunk from $1.18 against the U.S. dollar to a low approaching 89 cents, before rebounding last week to about 92 cents.
  • Consumer prices are up and producer prices look even worse, with a 6.2 percent year-over-year increase in March.

One reason for the euro's decline may be "liquidity effects," says Robert L. Bartley of the Wall Street Journal. In a newly published symposium, "The Euro as a Stabilizer in the International Economic System," Robert A. Mundell, this year's Nobel laureate and the euro's "top intellectual godfather" suggests that because of the increased efficiency of replacing 11 national currencies with one, banks need fewer liquid reserves (currency) to support a given amount of transactions. Thus the ECB may have created too many euros, given the temporarily lower demand for reserves.

Of course, tighter monetary policy could threaten the recovery now underway in Europe. To compensate for the deflationary effects of a tighter monetary policy, Bartley suggests Europeans look at cutting high marginal tax rates, reducing rigid labor market regulations and cutting agricultural subsidies.

Source: Robert L. Bartley (WSJ editor), "The Mystery Of the Vanishing Euro," Wall Street Journal, May 15, 2000.

 

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