Designing EU-US Atlantic Monetary Relations: The Impact of Exchange Rate Variability on Labor Markets on both Sides of the Atlantic

Abstract

The Euro/dollar rate is one of the most closely watched exchange rates in the world, much as the DM/dollar rate was in the past. Its gyrations, which are at times difficult to understand on purely economic grounds, are often perceived to be politically costly. But why should politician s and economists care about exchange rate variability? The superficial answer has usually been that exchange rate variability discourages trade. Unfortunately, a large empirical literature on this issue has not been able to document a strong link between exchange rate variability and the volume of trade. However, we would argue the volume of trade is not an important variable in itself. From a normative point of view other variables, such as (un-) employment are much more important. In particular one would not consider undertaking concrete policy steps to reduce trans-Atlantic exchange rate variability if the result were only an increase in the volume of trade. However, if one could obtain a reduction in (un-) employment such a policy might become much more attractive.