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Why Has the Euro Been so Weak?

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  • Mr. Guy M Meredith

Abstract

The weakness of the euro has been surprising given the widely-held expectation that it would be a strong currency. This paper critically examines explanations for the slide in the euro, finding that many are questionable on conceptual or empirical grounds. Two explanations are instead advanced that appear to be consistent both with theory and data. The first originates in the global surge in equity prices since the mid-1990s, which created a demand shock that disproportionately affected the U.S. economy. Model simulations indicate that this can explain the strength of the dollar against other currencies in recent years, accounting for about half of the decline in the effective value of the euro. The other component of euro weakness can be attributed to a mismatch between the demand and supply of euro-denominated assets that arose with the creation of the single currency in 1999. The effect of both these factors should fade over time, although near-term market volatility could be exacerbated by uncertainties about the fundamentals driving currency values.

Suggested Citation

  • Mr. Guy M Meredith, 2001. "Why Has the Euro Been so Weak?," IMF Working Papers 2001/155, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2001/155
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      • Giancarlo Corsetti & John Flemming & Seppo Honkapohja & Willi Leibfritz & Gilles Saint-Paul & Hans-Werner Sinn & Xavier Vives, 2002. "The Weakness of the Euro: Is it Really a Mystery?," CESifo Forum, Ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 2002(CESIFOFOR), pages 27-42, 04.
    2. Mariam Camarero & Javier Ordóñez & Cecilio Tamarit, 2002. "The Euro-Dollar Exchange Rate: Is it Fundamental?," CESifo Working Paper Series 798, CESifo.
    3. Pompeo Della Posta, 2005. "Fundamentals, International Role of Euro and 'Framing' of Expectations: What are the Determinants of the Dollar/Euro Exchange Rate?," Working Papers de Economia (Economics Working Papers) 24, Departamento de Economia, Gestão e Engenharia Industrial, Universidade de Aveiro.
    4. Renato Filosa, 2003. "Shock monetari e reali, ciclo economico e valore dell' euro," Moneta e Credito, Economia civile, vol. 56(223), pages 295-324.
    5. Minford, Patrick & Wickens, Michael R. & Davidson, James & Meenagh, David, 2010. "Why crises happen - nonstationary macroeconomics," CEPR Discussion Papers 8157, C.E.P.R. Discussion Papers.
    6. Mann, Catherine L. & Meade, Ellen E., 2002. "Home bias, transactions costs, and prospects for the Euro: A more detailed analysis," Research Notes 6, Deutsche Bank Research.
    7. International Monetary Fund, 2004. "Mexico: Selected Issues," IMF Staff Country Reports 2004/250, International Monetary Fund.
    8. Kühl, Michael, 2009. "Excess comovements between the Euro/US dollar and British pound/US dollar exchange rates," University of Göttingen Working Papers in Economics 89, University of Goettingen, Department of Economics.
    9. Kari Heimonen, 2006. "Time-Varying Fundamentals of the Euro-Dollar Exchange Rate," International Economic Journal, Taylor & Francis Journals, vol. 20(4), pages 385-407.
    10. Shams, Rasul, 2005. "Dollar-Euro Exchange Rate 1999-2004: Dollar and Euro as International Currencies," HWWA Discussion Papers 321, Hamburg Institute of International Economics (HWWA).
    11. Meenagh, David & Minford, Patrick & Nowell, Eric & Sofat, Prakriti, 2010. "Can a real business cycle model without price and wage stickiness explain UK real exchange rate behaviour?," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1131-1150, October.
    12. Camarero, Mariam & Ordóñez, Javier, 2012. "Nonlinear adjustment in the real dollar–euro exchange rate: The role of the productivity differential as a fundamental," Economic Modelling, Elsevier, vol. 29(2), pages 444-449.
    13. Fischer, Andreas M., 2002. "Fluctuations in the Swiss Franc: What Has Changed Since the Euro's Introduction?," Journal of Public Policy, Cambridge University Press, vol. 22(2), pages 143-159, September.
    14. Jean-François Goux, 2010. "Une approche déterministe du taux de change euro-dollar," Économie et Prévision, Programme National Persée, vol. 195(4), pages 35-51.
    15. Gadea, Maria-Dolores & Montanes, Antonio & Reyes, Marcelo, 2004. "The European Union currencies and the US dollar: from post-Bretton-Woods to the Euro," Journal of International Money and Finance, Elsevier, vol. 23(7-8), pages 1109-1136.
    16. repec:got:cegedp:89 is not listed on IDEAS
    17. Kari Heimonen, 2009. "The euro–dollar exchange rate and equity flows," Review of Financial Economics, John Wiley & Sons, vol. 18(4), pages 202-209, October.
    18. Shams, Rasul, 2005. "Dollar-Euro Exchange Rate 1999-2004 - Dollar and Euro as International Currencies," Discussion Paper Series 26228, Hamburg Institute of International Economics.
    19. Neaime, Simon & Paschakis, John, 2002. "The future of the dollar-euro exchange rate," The North American Journal of Economics and Finance, Elsevier, vol. 13(1), pages 56-71, May.
    20. Heimonen, Kari, 2009. "The euro-dollar exchange rate and equity flows," Review of Financial Economics, Elsevier, vol. 18(4), pages 202-209, October.
    21. Minford, Patrick & Nowell, Eric & Meenagh, David & Sofat, Prakriti, 2005. "Real Exchange Rate Overshooting RBC Style," CEPR Discussion Papers 5029, C.E.P.R. Discussion Papers.

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