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Why Has the Euro Been so Weak?

  • Guy Meredith
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    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.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/155.

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    Length: 50
    Date of creation: 01 Oct 2001
    Date of revision:
    Handle: RePEc:imf:imfwpa:01/155
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    1. Giancarlo Corsetti & Paolo Pesenti, 1999. "Stability, Asymmetry, and Discontinuity: The Launch of European Monetary Union," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 295-372.
    2. Torsten Sløk & Hali J. Edison, 2001. "Wealth Effects and the New Economy," IMF Working Papers 01/77, International Monetary Fund.
    3. Detken, Carsten & Hartmann, Philipp, 2000. "The euro and international capital markets," Working Paper Series 0019, European Central Bank.
    4. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
    5. William D. Nordhaus, 2001. "Productivity Growth and the New Economy," NBER Working Papers 8096, National Bureau of Economic Research, Inc.
    6. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    7. Aude Pommeret & Anne Epaulard, 2001. "Agents' Preferences, the Equity Premium, and the Consumption-Saving Trade-Off; An Application to French Data," IMF Working Papers 01/117, International Monetary Fund.
    8. Hans-Werner Sinn & Frank Westermann, 2001. "Why Has the Euro Been Falling? An Investigation into the Determinants of the Exchange Rate," NBER Working Papers 8352, National Bureau of Economic Research, Inc.
    9. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
    10. Robert N. McCauley, 1997. "The euro and the dollar," BIS Working Papers 50, Bank for International Settlements.
    11. Hans-Werner Sinn & Frank Westermann, 2001. "Why Has the Euro Been Falling?," CESifo Working Paper Series 493, CESifo Group Munich.
    12. Benjamin Hunt & Peter Isard & Douglas Laxton, 2002. "The Macroeconomic Effects of Higher Oil Prices," National Institute Economic Review, National Institute of Economic and Social Research, vol. 179(1), pages 87-103, January.
    13. Torsten Sløk & Hali J. Edison, 2001. "New Economy Stock Valuations and Investmen in the 1990's," IMF Working Papers 01/78, International Monetary Fund.
    14. Vincent Koen & Laurence Boone & Alain de Serres & Nicola Fuchs, 2001. "Tracking the Euro," OECD Economics Department Working Papers 298, OECD Publishing.
    15. Cedric Tille & Nicolas Stoffels & Olga Gorbachev, 2001. "To what extent does productivity drive the dollar?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 7(Aug).
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