2000, the euro’s annus miserabilis?

Economics Department

The euro makes its second grand entrance on January 1, 2002, when it physically replaces the currencies of 12 European countries. One of the puzzles during its “virtual” existence so far, however, has been its anaemic performance on the foreign exchange market.

On the eve of the euro’s launch in January 1999, most analysts and market participants expected it to appreciate. Their chief fear was that an overly strong new European currency would exacerbate the slowdown in activity then underway in the euro area.

In the event, the currency weakened almost uninterruptedly through all of 1999 and most of 2000, boosting exports and helping make 2000 the best year for growth and employment in a decade. While for a time commentators welcomed the depreciation as a desirable cyclical adjustment, its persistence in 2000 sparked concerns about the implications for inflation. It was also increasingly felt that the exchange rate had lost touch with fundamentals.

Although many observers acknowledged after the event that the currency might have started from a relatively high level, its continued depreciation came as a surprise. The euro ended its second year at 93 US cents, 21% below its inaugural level. It depreciated somewhat less against other currencies, but even so, compared with exchange rate swings in the past, this was a large one.

Many theories have been put forward to explain the euro’s anaemia, but no single version is fully convincing. One popular explanation relates the euro’s fortunes to cyclical divergences. Over certain periods, the dollar/euro rate indeed mirrored the expected growth differential. But markets tended to react somewhat asymmetrically, seemingly giving more weight to US than to euro area news, be it positive or negative. Interest rate differentials, which are partly related to cyclical divergences, turned out to be only loosely correlated to the exchange rate.

An equally striking parallel, although one that has attracted less comment, can be drawn between the evolution of the euro exchange rate and the oil price. Production is nowadays far less oil-intensive than in the early 1970s but large oil price swings still have a direct impact on inflation, output and current accounts, and therefore on exchange rates. In addition, the rising oil price led to increased euro/dollar conversions by euro area based buyers, putting more downward pressure on the euro. On the other side of the oil trade, oil producers likely exchanged only small proportions of their dollar proceeds into euros, therefore doing little to support Europe’s currency.

Another set of theories has concentrated on equity markets. Higher US rates of return were said to draw investment out of the euro area, weakening the euro. But in 1999-2000, European stock markets outperformed US stock markets in own-currency terms. The relationship between stock prices and exchange rates is in any event hard to interpret since both react to interest rate movements.

One rationale for the large net capital outflows from the euro area has been “eurosclerosis”. But while market rigidities and high tax levels have been more prominent in Europe than in the United States for a long time, there is little evidence that they have become relatively worse since the launch of the euro in 1999. Furthermore, the surge in foreign direct investment (FDI) outflows from the euro area in the late 1990s was accompanied by an equally spectacular rise in FDI inflows, and in 2000, FDI inflows almost matched FDI outflows.

On the other hand, the surprisingly vigorous performance of the US economy until late last year prompted many analysts to raise their estimate of US potential growth, while such revisions have been more scattered and timid as regards the euro area. This may have weakened the perceived euro equilibrium exchange rate.

A completely different explanation for the euro’s fall is poor communications. Statements in the early days from European Central Bank (ECB), national central bank and government officials were clearly insufficiently co-ordinated. Euro area finance ministers agreed during 1999 to exercise restraint in their comments about the exchange rate, and now generally base their pronouncements on language agreed in common, in co-operation with the ECB. In any event, while dissonant official messages may add to exchange rate volatility in the very short run, they are unlikely to drive exchange rate trends over longer time spans.

Finally, some analysts consider that the euro’s depreciation was at least partly due to the herdlike behaviour of the market. The dollar’s appreciation would thus be viewed as evidence of the strength of the US economy, while the focus as regards Europe would be on rigidities. These beliefs would reinforce the euro’s depreciation, which in turn would consolidate those beliefs. The process could last for a while, as it did in the first half of the 1980s when the dollar’s appreciation seemed unstoppable, until the credibility of the beliefs starts to be eroded by the widening discrepancy between fact and perception. A small trigger could then reverse the process, as the Plaza Agreement by the G5 countries seems to have done in 1985. In such a case, it is critical to try and ensure an orderly reversal of the previous misalignment, to avoid overshooting in the opposite direction.

As the euro kept falling, proponents of central bank intervention on the foreign exchange markets became more vocal, emboldened by the fact that at well over 250 billion euros, the reserves of the Eurosystem are among the highest in the world. During the first 20 months following the euro’s launch, intervention was merely verbal, but on 22 September, 2000 the ECB announced a joint G7 intervention, citing “shared concern about the potential implications of recent movements in the euro exchange rate for the world economy”.

This was the first transatlantic co-ordinated intervention since 1995 and came as a surprise both because of its timing – ahead of, rather than after, a G7 meeting in Prague – and because of US participation in the run-up to presidential elections. Some 6 billion euros were bought. Within hours, the euro jumped from 85 to 90 US cents. It then settled at around 88 cents for about a week, but depreciation soon resumed and by mid-October the euro had dropped below its previous lows. A round of unilateral ECB interventions followed in early November, but this time the euro reacted less markedly.

It is difficult to assess the effectiveness of these interventions, although they did succeed in instilling some uncertainty in market participants’ minds, showing that the Eurosystem stood ready to intervene either multilaterally or bilaterally and without having to wait for specific government instructions. The euro has rebounded somewhat since last autumn, but given the external imbalances between the three major currency areas, it would seem to have ample room to appreciate further, although whether it will, and at what speed, remain anybody’s guess. Among other things, this may depend on the impact of the introduction of cash euros at the beginning of 2002.

References

• OECD, Economic Survey of the Euro Area, Paris, 2001.

• Koen, V., Boone, L., de Serres, A., and Fuchs, N., "Tracking the euro", OECD Economics Department Working Paper, forthcoming.

©OECD Observer No 226/227, Summer 2001 




Economic data

GDP growth: +0.6% Q4 2017 year-on-year
Consumer price inflation: 2.6% May 2018 annual
Trade: +2.7% exp, +3.0% imp, Q4 2017
Unemployment: 5.4% Mar 2018
Last update: 06 Jul 2018

E-Newsletter

Stay up-to-date with the latest news from the OECD by signing up for our e-newsletter :

Twitter feed

Suscribe now

<b>Subscribe now!</b>

To receive your exclusive paper editions delivered to you directly


Online edition
Previous editions

Don't miss

  • Watch the webcast of the final press conference of the OECD annual ministerial meeting 2018.
  • International co-operation, inclusive growth and digitalisation lead the themes of the 2018 OECD Forum in Paris on 29-30 May, under the banner of What brings us together www.oecd.org/forum. It is held alongside the annual OECD Ministerial Council Meeting on 30-31 May, chaired this year by France with a focus on multilateralism www.oecd.org/mcm.
  • Listen to the "Robots are coming for our jobs" episode of The Guardian's "Chips with Everything podcast", in which The Guardian’s economics editor, Larry Elliott, and Jeremy Wyatt, a professor of robotics and artificial intelligence at the University of Birmingham, and Jordan Erica Webber, freelance journalist, discuss the findings of the new OECD report "Automation, skills use and training". Listen here.
  • Do we really know the difference between right and wrong? Alison Taylor of BSR and Susan Hawley of Corruption Watch tell us why it matters to play by the rules. Watch the recording of our Facebook live interview here.
  • Has public decision-making been hijacked by a privileged few? Watch the recording of our Facebook live interview with Stav Shaffir, MK (Zionist Union) Chair of the Knesset Committee on Transparency here.
  • Can a nudge help us make more ethical decisions? Watch the recording of our Facebook live interview with Saugatto Datta, managing director at ideas42 here.
  • Ambassador Aleksander Surdej, Permanent Representative of Poland to the OECD, was a guest on France 24’s English-language show “The Debate”, where he discussed French President Emmanuel Macron’s speech at the World Economic Forum in Davos.
  • The fight against tax evasion is gaining further momentum as Barbados, Côte d’Ivoire, Jamaica, Malaysia, Panama and Tunisia signed the BEPS Multilateral Convention on 24 January, bringing the total number of signatories to 78. The Convention strengthens existing tax treaties and reduces opportunities for tax avoidance by multinational enterprises.
  • Rousseau
  • Do you trust your government? The OECD’s How's life 2017 report finds that only 38% of people in OECD countries trust their government. How can we improve our old "Social contract?" Read more.
  • Papers show “past coming back to haunt us”: OECD Secretary-General Angel Gurria tells Sky News that the so-called "Paradise Papers" show a past coming back to haunt us, but one which is now being dismantled. Please watch the video.
  • When someone asks me to describe an ideal girl, in my head, she is a person who is physically and mentally independent, brave to speak her mind, treated with respect just like she treats others, and inspiring to herself and others. But I know that the reality is still so much different. By Alda, 18, on International Day of the Girl. Read more.
  • Globalisation’s many benefits have been unequally shared, and public policy has struggled to keep up with a rapidly-shifting world. The OECD is working alongside governments and international organisations to help improve and harness the gains while tackling the root causes of inequality, and ensuring a level playing field globally. Please watch.
  • Read some of the insightful remarks made at OECD Forum 2017, held on 6-7 June. OECD Forum kick-started events with a focus on inclusive growth, digitalisation, and trust, under the overall theme of Bridging Divides.
  • Checking out the job situation with the OECD scoreboard of labour market performances: do you want to know how your country compares with neighbours and competitors on income levels or employment?
  • Trade is an important point of focus in today’s international economy. This video presents facts and statistics from OECD’s most recent publications on this topic.
  • The OECD Gender Initiative examines existing barriers to gender equality in education, employment, and entrepreneurship. The gender portal monitors the progress made by governments to promote gender equality in both OECD and non-OECD countries and provides good practices based on analytical tools and reliable data.
  • Interested in a career in Paris at the OECD? The OECD is a major international organisation, with a mission to build better policies for better lives. With our hub based in one of the world's global cities and offices across continents, find out more at www.oecd.org/careers .
  • Visit the OECD Gender Data Portal. Selected indicators shedding light on gender inequalities in education, employment and entrepreneurship.

Most Popular Articles

OECD Insights Blog

NOTE: All signed articles in the OECD Observer express the opinions of the authors
and do not necessarily represent the official views of OECD member countries.

All rights reserved. OECD 2018