BEN BULLOCK & LACEY RUSHTON The Euro: Its History & Future

Outline What is the euro? How did it come to be? Who sets the monetary policy? What are the pros of the euro? What are the cons? What’s happening currently with the euro? What does the future of the euro look like?

WHAT IS THE EURO? Official currency of 16/27 European Union nations  Eurozone: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain Formal agreements  Vatican City, Monaco, San Marino, Saint Pierre and Miquelon, Mayotte De-facto currency  Andorra, Kosovo, Montenegro

WHAT IS THE EURO? Used daily by 327 million Europeans  175 million worldwide have currencies pegged to it Surpassed $US Nov. 2008, as the highest combined value in cash currency, totaling €751 billion Second largest reserve currency to the $ Second most traded currency to the $

REQUIREMTENTS OF ADOPTION Requirements to adopt euro  Each member must have a budget deficit less then 3% their GDP  They must have a debt ratio less then 60% their GDP  Low inflation  Interest rates must be similar to the rest of the Eurozone

CURRENCY INTRODUCTION Euro introduced in January 1, 1999  Invisible currency – used for only accounting purposes and electric payment only  Old currencies still used for cash transactions January 2, 1999 – Euro currency introduced  Cash and coins replaced older currencies at fixed conversion rate (based on European Currency Unit) Old currencies accepted for transitional period along with euro  Typically 2 months, extended a few years to forever in some cases (Austria, Germany, Ireland, Spain)

EXCHANGE RATES Introduced: 1999, $1.18/€  depreciated to all time low Oct to $.8228/€ After physical currency introduced, appreciated dramatically (Currently $1.4098/€)  Since December 2002, never dipped below parity with $

HOW DID THE EURO COME TO BE? Maastricht Treaty, December 1991  Goals:  Coordinate economic policy-making b/w member states  Coordinate fiscal policy through limited govt. debt and deficits  Create a central bank that independently sets monetary policy  Establish single currency within the euro area Implemented in three stages  Diagram

EURO IMPLEMENTATION

MONETARY POLICY & EURO GOVERNANCE Eurosystem  Centralized policy-making/decentralized implementation  European Central Bank (ECB) – solely responsible for monetary policy (aim for price stability)  National Central Banks (NCB) – print, distribute currency in particular nation Governing Bodies  Governing Council (like Fed. Res., 15 NCB governors)  Executive Board (President, VP, 4 NCB notables)  Policy committees (Working Group on Forecasting, Econometric Modelling, Public Finance)

MONETARY POLICY & EURO GOVERNANCE Goals: Low inflation/price stability  ECB modeled after German Bundesbank (large centralized banks have had success keeping prices stable)  Similar to Federal Reserve, without burden of supporting economic growth or high levels of employment  Targets interest rates rather than exchange rates (floating exchange regime), ECB does not intervene in foreign exchange market

BENEFITS OF THE EURO Price Transparency  Consumers can compare prices across member borders much more easily  Leads to more increased competition, keeps downward pressures on prices Low Inflation  Lower prices have led to steady, low levels of inflation  70’s & 80’s inflation was as high as 20% on average  Since introduction of euro, inflation has remained steady around 2% across the Eurozone

INFLATION

BENEFITS OF THE EURO Businesses and households can borrow more cheaply  Low inflation has led to lower interest rates across the board  1980’s home mortgages were b/w 8-14%, rates have converged around 5% today Cross-border trade has increased  Estimated 4-10% increase since euro’s introduction Reduction/Elimination of foreign exchange risk  Without currency fluctuations, businesses no longer incur losses due to cross-border purchases (€20-25 billion/yr)

BENEFITS OF THE EURO Reduction of costs  increased available capital Government debt reduced  With lower rates, reduce debt and reinvest in job-creation Fully integrated financial sector  Invite foreign direct investment  Increased asset liquidity  Reduction of long-term interest rate risk

10 yr. BOND INTEREST RATES

CONS OF THE EURO Continued euro strengthening against $ and Yen  Makes Eurozone exports more expensive, less attractive to foreign markets  Leading to trade deficits and imbalances in BOP Lack of ability to set monetary policy for own nation  ECB controls money supply  ECB not influenced by any nation or political body One fits-all policies don’t always work  Controlling country specific inflation through raising interest rates, could help some nations and hurt others  Lose tools of economic management like currency devaluation

CURRENT ECONOMIC STATE European Commission on Economics & Financial Afffairs  Predicts 4% contraction of Eurozone economy in 2009 (0.9% 2008 growth)  2010, predicted growth of 0.1% as a result of economic stimulus  Inflation has remained low, expected to drop ½% in 2009, and increase by 1.25% in 2010 Labor market hit hardest  8.5 million jobs lost (8.9% unemployment) for (compared to 9.5 million new jobs created b/w ) Euro predicted to appreciate relative to $  Economic stimulus packages take effect  As US debt grows and € appears to be more stable to investors

CURRENT ECONOMIC STATE - GRAPHS

Conclusion Economic & Monetary Union has accomplished its goals  Price stability, low inflation  Member states enjoy significant economic advantages  Euro is highly competitive globally Despite current economic downturn  Euro value has remained strong against $  Eurozone economy expected to rebound in near future  More member nations expected to adopt euro World Currency…  Larger scale of the euro  Increased integration of markets, increased liquidity