Discussing Euro Volatility
AbstractThis paper deals with Euro introduction and ask whether it is likely to increase the exchange rates volatility on a world-wide scale. Following this purpose, we present a three country-model (US, Germany and France) and compare the exchange rate volatility according to the nature of the shock (demand or supply shock) and to the exchange rate regime in Europe (flexible, EMS or EMU). Each country is represented by two authorities: a central bank and a government (a single central bank and two governments in Europe in the case of EMU). Within this framework, we compute Nash-equilibria. In theory, the exchange rate of a large closed country fluctuates more than the exchange rate of a small open country (the size effect), but results are ambiguous in the specific case of the Euro. An increase in volatility would only occur after demand and external supply shocks. Volatility would be reduced following internal supply shocks. The conclusions are the opposite if the sensitivity of intra-European trade to relative prices is particularly strong. In the case of common shocks in Europe, the excess of volatility would help economic stabilisation. As for asymmetric shocks (hitting only one country), the Euro would fluctuate less than the currency of the hit country in the previous monetary system (EMS), but this stability would harm economic stabilisation, as loss functions show. We note also that the independence of the ECB could lead to strong variations of the Euro after inflationary shocks if the ECB and European governments do not share the same inflation target. The constraints on fiscal policies which are induced by the Stability pact could make more active monetary policies necessary: these would be a source of instability for the Euro.
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Bibliographic InfoPaper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 1998-03.
Date of creation: 1998
Date of revision:
Publication status: published under the title " May the Euro Increase Exchange Rate Volatility? ", in T. Moser & B. Schips (eds.), EMU, Financial Markets and the World Economy, Kluwer Academic Publishers, October 2000.
Find related papers by JEL classification:
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
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