The Strength of the Euro – Challenges for ECB Monetary Policy

Abstract

This paper comments on the main challenges stemming from the strong Euro for ECB monetary policy. For this purpose, it starts with a detailed analysis of the current macroeconomic background and the related statements by ECB President Mario Draghi during the three most recent press conferences at the event of the monthly ECB Governing Council meetings. It then deals with a couple of challenges relating to the question whether the ECB should gear its unconventional monetary policies towards the Euro exchange rate. Does exchange rate orientation of monetary policy represent a violation of the ECB’s mandate? Searching for the exchange rate benchmark: what exactly is the equilibrium rate to target? Influencing the euro’s real exchange rate through changes of the nominal rate: will markets be invited speculate about the ECB’s “Euro bottomline”? Don’t devaluations through unconventional monetary policies prevent necessary structural adjustment – because structural reforms more effective than devaluations? What are the driving forces behind the request for a Euro devaluation - one-sided political interests? How to cope with the ineffectiveness of devaluations to fight a business cycle trough, denoted by the so-called J-curve effect?In its final part, the paper dwells extensively on the potential effects of envisaged Quantitative Easing on current and expected interest rates in the Eurozone and thus finally via the asset portfolio channel also on the external value of the euro.