Euro Currency Report

Euro Currency Report

Introduction

Currency is one of the key drivers of the economy of a country or region. Currency is used in almost every business and trade transaction today. A country’s monetary and financial systems are the key drivers of the economy since these two systems are involved in the daily business and other trade transactions. The Euro is one of the most popular internationally recognized currencies. It is the official currency in 19 of the total 28 European Union member countries. The Euro was introduced as the official currency of the EU in 1999, and the European Central Bank (ECB) is the custodian institution for the currency (Dyson, 2000). Working together with the European Commission, the ECB is in charge of the maintenance of the value and stability of the Euro. It is also in charge of establishing the criteria that are necessary for EU member countries to enter the euro area (also known as the Eurozone). This paper will look at the Euro currency and discuss it to provide an insight into its exchange regime, the monetary policy, the currency’s strengths and weaknesses, and the future of the Euro.

Exchange Regime

Exchange regime refers to the way an institution, such as the government or other institution, controls a currency as compared to the other world currencies. Exchange regimes and the monetary policy are related and often depend on similar factors. The euro is managed by the ECB through the basic forms of exchange regimes: floating exchange rate, pegged float, and fixed exchange rate (Dyson, 2000). In most cases, the economies of the countries where the Euro operates as the official currency are responsible for controlling the movements or shifts in the exchange rate. In some cases, a pegged float is applicable, where the ECB regulates the Euro to prevent the exchange rate from deviating too far in relation to the targeted value.

Other countries that use the Euro as an unofficial currency apply a fixed exchange rate whereby the Euro is tied to another reserve currency. For instance, the euro may be tied to the US Dollar using a fixed exchange rate. The European Community came up with the European Exchange rate Mechanism (ERM), a system that was a component of the monetary system of Europe, in 1979. The ERM was meant to minimize the variability of the exchange ratehttps://www.peachyhomework.com/compare-the-3-sub-plans-high-risk-standard-and-low-risk-under-the-hiring-and-variable-pay-program-summarize-your-approach-for-negotiating-the-starting-salary-of-your-recruit-basis-the-standard-an/ and to bring about the stability of currency used in Europe. In 1999, the Euro was introduced as a unitary currency, signifying the monetary unity of the European countries. With the introduction and adoption of the Euro, the ERM policy changed and the currencies that were used in countries beyond the Eurozone were linked in order to have a common currency used as the central point (Kim, 2002). This linkage was meant to stabilize the currencies used in Europe and to act as a way of evaluating potential Eurozone member countries.

The introduced mechanism for exchange rates was based on fixed currency exchange rate limits, even though the exchange rates were permitted to fluctuate within set limits. This was an example of a semi-pegged regime. Prior to the adoption of the Euro, the rates of exchange were all based on the European Currency Unit (ECU) which was the unit of account in Europe (Palley, 2011). The ECU’s value was calculated as an average of all the involved currencies. The member countries developed the Parity Grid, calculated using the central rates and indicated in ECUs. The fluctuations in the exchange rates were maintained within a 2.25 percent margin on either side of the agreed upon rates (Kim, 2002). However, some currencies such as the sterling pound, the Spanish peseta, and the Italian lira were allowed to vary by up to 6 percent on either side. In the ERM, loan arrangements and interventions by the monetary policy protected the currencies from huge fluctuations. The Euro replaced the ECU in 1999 at the exchange rate market at a ratio of 1:1.

The Eurozone is made up of countries that have taken up the Euro as the official currency, including nations such as Belgium, Italy, France, Netherlands, and Greece. In these countries, currency is controlled by the market forces of demand and supply, and the economy is responsible for control. Some countries are European Union members but are outside the ERM. These countries either use a currency system that is pegged to the Euro or have a free float currency system. Presently, the floating exchange regime is the most widely used form of exchange regime for the Euro. The Euro is recognized as an international currency or a reserve currency. It is used in the world markets and has faced challenges in the past. The Euro has endured several challenges and is one of the strongest reserve currencies, alongside the US Dollar.

Monetary Policy

The European Central Bank (ECB) regulates the Euro through the discussed exchange regime and through a monetary policy. The monetary policy is designed in such a way that all the financial and economic activities or decisions within the Eurozone are affected (Jabko, 2010). The monetary policy affects almost every transaction that involves the exchange of money, such as loan borrowing and repayments, real estate purchases, and any other form of business exchange. The ECB’s main role is to maintain the stability of currency in the Eurozone and is highly credible in the EU countries. The ECB fulfills its role by the use of measures such as interest rates and through the control of other financing conditions (Jabko, 2010). By controlling the interest rates, the ECB is able to affect the level of financial activity in the European economy. The targeted level of inflation is met through interest rates control.

There are three main interest rates used by the ECB for the monetary policy: the rate of interest on the MRO (major refinancing operations), the rate of interest on the deposit provision for banks, and the rate of interest on the marginal lending (Richter & Wahl, 2011). For the major refinancing operations, banks within the region may borrow money from the ECB against a collateral at a pre-determined rate of interest. For the deposit facility, banks have the ability to make deposits at the ECB at a predetermined rate that is lower than the rate for the refinancing operations.  For the lending facility, the ECB gives credit to banks at a predetermined rate of interest, which is higher than the rate for refinancing operations. As such, the rate on the deposits and the rate on the lending provision act as the main controls for the rate of interest at which local banks give loans to one another and to the public.

The monetary policy affects the supply and the demand for the currency (and the exchange rate), as it regulates the amount of money in the economy and the cash flow. Other factors that affect the demand and the supply of the Euro include the demand for imported or foreign goods, the preference for domestic goods, the relative price levels in European and world markets, and the performance of other currencies in the world markets.

The Performance of the Euro in World Markets

As one of the major world currencies, the Euro has experienced challenges and good times in almost equal measure. In 2017, for instance, the Euro performed very well against the other world currencies such as the US Dollar and the Japanese Yen (Kim, 2002). The Euro was the strongest currency in 2017, with a cumulative year-to-data (YTD) increase of 61 percent versus all the major pairs (European Central Bank, n.d.). The US dollar saw a cumulative YTD decrease of 48.5 percent. In addition, the ECB left the interest rates on hold for the year, whereas the Federal Reserve raised interest rates three times during the year (Sinn, 2012). In the last ten years, the euro has been gaining in value, even though there were certain periods when the currency performed poorly, especially during the world financial crisis and the instability during the Brexit, as represented by the graph below (obtained from the ECB’s website).

The US dollar is the main competitor to the Euro on world markets. Between 2001 and 2008, the Euro recorded a steady growth, with the exchange rate against the USD rising. By 2008, the exchange rate was at 1.47. This rate meant that a single Euro could buy 1.47 US dollars. The exchange rate has been fluctuating since 2008, dropping to 1.11 in 2016. In 2017, the exchange rate was 1.13, a slight increase from 1.11 in 2016. A graph of the exchange rate between the Euro and the Sterling Pound shows a similar pattern (European Central Bank, n.d.).

Conclusion

The Euro is predicted to grow in value, at a rate similar to that observed from 2016 to 2017. With the EU achieving stability after the Brexit, the currency is expected to perform better in the future. Since the beginning of 2017, the ECB has performed very well in maintaining the interest rates constant to allow for the stability of the currency and its growth in value. With increased investment and trade with African countries, the value of the Euro is bound to increase, with the exchange rate against other world currencies increasing.

References

Dyson, K. (2000). The politics of the euro-zone: stability or breakdown?. OUP Oxford.

European Central Bank. (n.d.). Selected euro area statistics and national breakdowns. Retrieved November 23, 2018, from https://www.ecb.europa.eu/stats/ecb_statistics/escb/html/index.en.html

Jabko, N. (2010). The hidden face of the euro. Journal of European public policy, 17(3), 318-334.

Kim, S. (2002). Exchange rate stabilization in the ERM: identifying European monetary policy reactions. Journal of International Money and Finance, 21(3), 413-434.

Palley, T. I. (2011). Monetary Union Stability: The Need for a Government Banker and the Case for a European Public Finance Authority (No. 2/2011). IMK working paper.

Richter, F., & Wahl, P. (2011). The role of the European Central Bank in the financial crash and the crisis of the Euro-Zone. In the Report based on a Weed expert meeting.

Sinn, H. W. (2012). Fed versus ECB: How TARGET debts can be repaid. VoxEU. org, 10.