The Performance of the Euro

The Performance of the Euro

“Leading nations in Europe wanted to increase their economic ties to promote growth and piece. In 1951 Belgium, France, West Germany, Italy, Luxemburg and The Netherlands signed the Paris Treaty, creating the European Coal and Steel Community. In 1957, the same six countries signed the Treaties of Rome, creating the European Economic Community.” (Olmstead&Graves, 2003)

In 1979, the European Monetary System created a currency unit called the ecu to stabilize exchange rates and keep inflation in check. The Single European Act increased Political co-operation between the six EEC countries in 1986. In 1992, the ambitious Maastricht Treaty was signed setting a deadline of January 1999 for a shared currency. The treaty created the European Union following a single monetary and exchange rate policy with shared economic policies.

The Euro circulated in January 1999 as planned. The 11 member countries officially pegged their exchange rates to the euro. Companies began using the euro for internal reporting, invoicing and also for issuing bonds. Stocks began trading in euros and banks started offering euro credit-card accounts and provided euro balances for bank accounts. The currency went into common circulation on January 1, 2002.

In 1999, the ECB was a new bank with no decision-making history and that made it difficult to pass out the monetary policy strategy to the market and the public, and that was a real challenge for ECB. By now, the understanding of ECB’s monetary strategy has greatly improved. “The ECB today ranks as one of the most open, transparent and predictable central banks in the world, and they continually seek to improve their communication” (ECB, 2004)

During the first five years of the existence of the Euro, the average rate of inflation in the euro area has been 2 per cent, which is in line with the ECB’s definition of price stability. Even though inflation has occasionally risen above the 2 per cent ceiling this was a consequence of a number of shocks such as the oil shock. What is important is that these first five years of the euro’s existence, inflation expectations have remained secured to a rate close to or less than, 2 per cent as can be derived form the yields of index-linked long-term bonds.

“Back in 1999, many observers expected that the quality of the new currency, in terms of the stability of its purchasing power or the associated prevailing level of market interest rates, particularly at the long end of the yield curve, would be something like the average quality of its legacy currencies. What we have witnessed instead is convergence towards the best performer.” (ECB, 2004)

The Euro area today is a zone of monetary stability, and interest rates are at levels last seen more than five decades ago, creating good conditions for economic growth.

The cash changeover, although it was carried out smoothly, it had some bad effects on prices. The irritation caused by some disproportionate price increases, especially in the service industry, in some euro area countries. Even though ECB’s statistics show that the changeover had a small impact on inflation (around 0.1 per cent to 0.3 per cent) people had the impression that inflation was much higher in the consumer price level. Gradually, this wrong perception was changing.

EMU had a significant effect on price changes in product markets. They have become more homogeneous across euro area counties. “A Monetary Union is a strong force towards additional trade creation among its members.” (ECB, April 2005)

Moreover, the launch of the euro had contributed to raising reciprocal trade among euro area countries. Trade among them has risen over the last 50 years since the onset of European institutional integration that started in 1958. Also, the impact of the euro on financial markets is evident in some market segments such as money markets. In bond and equity markets a gradual process of structural change and increasing integration is unfolding.

Ban and Klaassen (2002) using a dynamic panel model found that the euro has already increased trade by 4 per cent in the first year. Anderton