Tracking the Euro's Progress

Abstract

The evolution of the euro since its inception has appeared inexplicable. This paper develops a monetary model of the euro/US dollar exchange rate to track the progress of the currency, both before and after Stage 3 EMU. The relationship between the exchange rate, money stocks, GDP, interest and inflation rates, and prices is identified. The observed patterns of behaviour during the 1990s are used to predict the euro's value up to mid-2000; a consistent finding is that the euro is over-predicted by 23-30%. This finding is robust to the use of alternative sample periods and alternative estimation methodologies, as long as each of the variables is treated as endogenous.This monetary model does not give much weight to factors such as productivity. However, the past evolution of European exchange rates suggests that productivity trends are indeed important. Some estimates suggest that an annual one percentage point in the intercountry differential in tradablenontradable productivity causes a 0.85-1.7% real appreciation of a currency. *This article is based upon revised results from 'The Empirical Determinants of the Euro', a paper presented at the Deutsche Bundesbank conference Equilibrium Exchange Rates of the euro (27-8 March 2000), organized by Bernd Schnatz. Portions were written while Chinn was a visiting scholar at Sonderforschungsbereich 373 at Humboldt University in Berlin. We thank the editor Benn Steil, an anonymous referee and Robert Z. Lawrence for their helpful comments. Financial support of faculty research funds of the University of California is gratefully acknowledged. The views expressed are solely those of the authors, and do not necessarily represent those of the institutions the authors are associated with.Since recent sectoral productivity data are unavailable, we rely upon potential GDP measures to assess likely trends in the euro. We conclude that without an upward shift in Euroland potential growth, the euro will tend to depreciate over time.

Macroeconomic News and the Euro/Dollar Exchange Rate

“…This result is in line with some recent findings by Andersen et al (2003) and Conrad et al (2002). Fourth, there is considerable time variation, revealing interesting 1 See, for example, Alberola et al (1999), Borowski and Couharde (2000), Chinn and Alquist (2000), Clostermann and Schnatz (2000) and Duval (2000). These studies generally found that the euro was undervalued, but the results vary substantially.…”

Conventional and unconventional approaches to exchange rate modelling and assessment

“…There is ample interest in the post-1999 behaviour of the euro, particularly its initial depreciation and subsequent sharp appreciation, which provided the basis for previous studies, as in Nautz and Offermans (2006), Heaney and Pattenden (2005), Mussa (2005), Schnatz et al (2004), and Chinn and Alquist (2000). Second, we examine the relative performance of a model incorporating a role for net foreign assets, as suggested in Gourinchas and Rey's (2005) financial adjustment channel and Lane and Milesi-Ferretti (forthcoming).…”

A two-country NATREX model for the euro/dollar

“…It follows that in addition to monetary aggregates and base money, further determinants of the exchange rate are factors that influence the demand for money such as income, interest rates and inflation rate. Monetary models for the euro/dollar exchange rate have been developed and estimated by Chinn and Alquist (2002) and van Aarle et al (2000).…”