Euro Exchange Rate Research Articles

Managing the Euro

For a year following the launch of the euro, the European Central Bank (ECB) seemed indifferent to the currency's depreciation. Then the ECB changed to a policy position of trying to bolster the external value of the euro. This paper seeks to explain these patterns of positions on the ECB's external monetary policy. I argue that the ECB's policy on the exchange rate is a function of its commitment to domestic price stability in the euro zone. In other words, the ECB's concern with the euro's exchange rate centers solely on what that exchange rate can do to inflation. This focus on price stability is a function of the interests of the ECB in maintaining its own image of competence in European society.

ANTICORRELATIONS AND SUBDIFFUSION IN FINANCIAL SYSTEMS

Statistical dynamics of financial systems is investigated, based on a model of a randomly coupled equation system driven by a stochastic Langevin force. It is found that in a stable regime the noise power spectrum of the system is 1/f-like: ∝ ω- 3/2 (where ω is the frequency), that the autocorrelation function of the increments of the variables (returns of prices) is negative and follows the power law: ∝ - τ- 3/2 (where τ is the delay), and that the stochastic drift of the variables (prices, exchange rates) is subdiffusive: ∝ tH (where t is the time, H ≈ 1/4 is the Hurst, or self-similarity, exponent). These dependencies correspond to those calculated from historical $/EURO exchange rates.

Choosing the Rate

Choosing the Rate

Measuring the Euro Exchange Rate Risk Premium: The Conditional International CAPM Approach

This paper derives measures for the bilateral euro exchange rate risk premia vis-a-vis the US dollar and the UK pound sterling, as well as the US and the UK equity market risk premia using the perspective of a european investor. We carry out the estimations applying the conditional International Capital Asset Pricing Model (ICAPM). The ICAPM is estimated for both constant and time-varying prices of risk, using weekly data on the equity and foreign exchange returns for Europe, the UK and the US. In estimating the time-varying prices of risk, we propose a new set of instrumental variables that take both business cycle and market volatility considerations into account. Consequently, our risk premium estimates are more intuitive, picking up most of the individual events that moved the markets between 1986 and 2001.

European Currency Volatility After Economic and Monetary Union

Corporate and institutional foreign exchange market participants are sensitive to the effects of volatility on their day-to-day trading activities and so an important question is whether the introduction of the euro had an impact on foreign exchange rate volatility. Rather than compare individual currencies with the Euro we compare the pre 1999 volatility of three synthetic euro exchange rate series with the volatility of the actual euro starting from the 1 st of January 1999. Volatility tests are undertaken within a GARCH framework. There is evidence of a statistically significant increase in transatlantic exchange rate volatility following the introduction of the euro. Acknowledgements We would like to express our thanks to the staff in the School of Finance and Applied Statistics at the ANU, particularly Dr Chris Bilson for his support and guidance.

A Small Macroeconomic Model of the EU-Accession Countries*

This paper develops a small macro-economic model of the CEECs to analyze various aspects of integration with the current EU and the role of monetary and exchange rate strategies during the (pre-) accession phase. The model gives insight into both the adjustment of the internal balance (as for output and employment) and the external balance (as for exports and competitiveness) in the accession countries. The model provides more insight into the basic macroeconomic relationships governing macroeconomic adjustment in the accession countries and also the role of the integration with the EU in that adjustment. We perform empirical simulations of different scenarios and analyze the resulting macroeconomic adjustment. In particular, we compare how a macroeconomic shock in the current EU is transmitted to the accession countries under flexible and fixed euro exchange rates, respectively.

Subset Autoregressive Filtering Using the Forgetting Factor for Financial Simulations

Statistical filter researchers for time-series systems are often concerned that the coefficients of their established filters may not be constant over time, but vary when the filters are disturbed by changes arising from outside environmental factors. This concern has motivated researchers to develop sequential estimation algorithms that allow for the coefficients to evolve, such as a recursive estimation of an autoregressive (AR) filter [see Hannan and Deistler (1988)], and a recursive updating procedure for the training process of a multiplayer neural network [see Azimi-Sadjadi et al (1993)]. These studies utilise the fixed forgetting factor (henceforth called the forgetting factor) in the filtering and simulations of nonstationary time series. Conventional methods for determining the forgetting factor for AR filters are mostly based on arbitrary or personal choices. In this paper we use the bootstrap to select the forgetting factor for financial simulations. We also apply the forgetting factor to a time-update recursive algorithm for subset autoregressive filtering. In one illustration using real exchange rates, we demonstrate in Section 4.1 the effect of the forgetting factor in subset AR filtering on ex ante forecasting of nonstationary financial time series. In a second illustration the time-update recursions are applied in Section 4.2 to detect the direct cause-and-effect relationships between the movements of the Euro's exchange rate and the money supply.

Determinants of the Effective Real Exchange Rate of the Synthetic Euro: Alternative Methodological Approaches

On the basis of historical data aggregated over the period 1973 to 2000, we have experimented with four different approaches to estimate the synthetic euro's equilibrium exchange rate. Using a number of competing models with the same data set, variable definitions and sample period offers the possibility to assess the uncertainty surrounding such equilibrium levels, both from an empirical (different estimates) and a theoretical viewpoint (different specifications). In this exercise, the ‘Rest of the World’ is proxied by the US, the UK, Japan and Switzerland, aggregated on the basis of trade weights.We employed reduced form co–integration models, a structural VAR, a NATREX model (estimated in structural form) and the ECB's small–sized euro area wide macro–econometric model. In this order the approaches feature an increasing degree of ‘structure’, in the sense of the constraints based on economic theory embedded in the econometric models that were estimated. The results confirm the high likelihood for the euro having been undervalued in Q4 2000, while stressing the significant empirical and theoretical uncertainty with respect to the equilibrium exchange rate level.

Equity Markets, Block Realignments and the UK Exchange Rate

In recent weeks, equity markets have been very weak and the euro exchange rate has risen by more than 10 per cent against the dollar. The UK's effective exchange rate has also depreciated, removing some, but not all, of the overvaluation we identified in the April Review. We report on recent movements in table 1, and their implications are discussed in the UK and World forecast chapters in this Review. To an extent the movements in the US stock markets and the exchange rate are linked, but there does seem to be some ‘excess strength’ in the euro, which will in turn contribute to the weakness of Euro Area equity prices.

ECB Foreign Exchange Intervention and the EURO: Institutional Framework, News and Intervention

Using a unique intervention news data set, this paper investigates the impact of ECB intervention and intervention-related news (newswire reports) on the euro exchange rate. A time-series study of news generated by ECB officials and market participants regarding intervention and the value of the euro as well as an event study of firm reports of ECB intervention is conducted. Both studies find significant short-run effects on the euro value, while only negative statements (official statements denying past intervention or ruling out future intervention) appear to have persistent effects.

The future of the dollar–euro exchange rate

Monetary unification in Europe is expected to produce a major new international currency, which may compete with the U.S. dollar as the currency of choice in foreign exchange transactions, financial asset markets and central bank reserves. This study considers two important issues regarding the euro: its global role as medium of exchange, unit of account, and store of value and its position relative to the U.S. dollar. Among the main considerations are differences in cyclical behavior, inflation differentials, trade patterns and capital flows, and risk-return assessments. External diversification of private portfolios and of central banks’ reserve holdings will play a key role in determining the euro’s exchange rate. Overall, despite its rough start, we argue that the euro may emerge as a challenger to the U.S. dollar.

The Price Elasticity of the Euro to Movements in Foreign Reserves through European Central Bank Intervention

Since its introduction on 1 January 1999, the Euro has become the second most widely traded currency, behind the US Dollar and ahead of the Japanese Yen. Over the first three years of 1999-2001, the weakness of the Euro was a significant feature of foreign exchange markets. The Euro's weakness confounded earlier general expectations that it would trend upward relative to the US Dollar. Movements in exchange rates can be affected by Central Bank intervention. This paper investigates the price elasticity of the Euro to potential European Central Bank intervention. The paper uses a new time-series approach to examine the relationship between the Euro exchange rate and the level of foreign reserves. Conventional methods to test for Granger causal relations among variables, which affect the movements of forex markets, can be undertaken with vector error-correction (VECM) modelling. However the standard VECM approach is traditionally focused on full order time-series structures, which are based on nonzero elements in all elements of all coefficient matrices. Specifically, in tests of indirect causality and/or Granger non-causality in a VECM, the outcome of the causality detection is crucially dependent upon finding zero coefficients where the true structure does indeed include zero coefficients. This VECM, with allowance for possible zero entries in the coefficient matrices, is referred to as a zero-non-zero (ZNZ) patterned VECM. This paper employs ZNZ patterned VECM modelling to investigate Granger causal relations among foreign reserves, the European Monetary Union money supply and the Euro exchange rate. The findings confirm that foreign reserves may influence movements in the Euro's exchange rate. Further, ZNZ patterned VECM modelling with exogenous variables (VECMX modelling) is used to estimate the amount of foreign reserves currently required in order to again achieve a targetted Euro exchange rate, such as the initial rate existing at 1 January 1999.

Model Uncertainty and the Equilibrium Value of the Real Effective Euro Exchange Rate

On the basis of historical data aggregated over the period 1973 to 2000, we estimated four different equilibrium exchange rate models for the synthetic euro. Using the same data set, variable definitions and sample period offers the possibility to assess the uncertainty surrounding such equilibrium levels, both from a statistical and a theoretical perspective. We employed reduced form co-integration models, a structural VAR, a Natrex model (estimated in structural form) and the ECB's small-sized euro area wide macro-economic model. In this order the approaches feature an increasing degree of structure, in the sense of the constraints based on economic theory embedded in the econometric models that were estimated. The results confirm the high likelihood for the euro having been undervalued in Q4 2000, while stressing the significant empirical and theoretical uncertainty with respect to the equilibrium exchange rate level.

The Irish Economy : From Lame Duck to Celtic Tiger

Ireland's recent economic growth - the Celtic Tiger phenomenon - has attracted world attention. This paper outlines the changes it has effected on people's lives through enhanced prosperity, greater availability of jobs and lower poverty. The economic transformation is attributed to several factors that proved mutually self-reinforcing : a booming US economy, EU structural funds and other support, stabilisation of government finances and low taxes and social partnership. Challenges to the more prosperous Ireland are also analysed, including the prospect of soon becoming a net donor to the EU, and danger of a loss of competitiveness due to rising pay costs, lower productivity growth and an unpredictable euro exchange rate. The No vote in the Nice referendum last year led to a reappraisal of Ireland's reputation as a good European and reversing that decision will take considerable effort. Ireland has been hit by the slowdown in the world economy, and the Celtic Tiger growth rates of the 1990s are unlikely to be repeated. Nevertheless important structural change in the economy has occurred and this bodes well for the future.

The Euro and the International Financial System

This paper analyses the issues raised by EMU for the relationships between the euro area and the international financial system. The depreciation of the euro exchange rate since the beginning of EMU has attracted most attention. The paper argues that none of the conventional explanations is supported by theory or the data and that a substantial appreciation will be required to bring the rate to a sustainable long-run equilibrium. It discusses exchange-rate intervention and suggests that the authorities should take a more active policy stance. The paper assesses the role of the euro as an international currency and the underlying developments in the capital markets and foreign exchange markets. It concludes with discussion of policies towards the international role of the euro, in areas such as: data needs; financial market developments; euroisation; EMU and the international financial architecture; and the role of the Euro Group of finance ministers.

Internal and external transmissions of monetary and fiscal policies in the EMU

With the introduction of Economic and Monetary Union (EMU), the sovereignty of national monetary institutions has been replaced by a common monetary institution, the European Central Bank (ECB) and national currencies have been replaced by a common currency, the euro. EMU therefore implies the loss of national monetary policy autonomy and internal exchange rate flexibility inside the EMU area. However, external exchange rate adjustment, i.e. adjustment of the euro exchange rate, remains a feasible adjustment mechanism. This paper analyses how internal and external exchange rate flexibility affect macroeconomic adjustment in EMU and non-EMU countries. To do so, a model is constructed in which three countries interact: two countries that decide to form a monetary union and a third country that does not participate in the monetary union. Numerical simulations of a representative example are used to characterise the adjustment dynamics induced by monetary and fiscal policies before and after the start of the EMU.

False Euro (FEUR) exchange rate correlated behaviors and investment strategy

We have searched for correlations and anticorrelations with respect to currencies as CHF, DKK, JPY, and USD in order to understand the EUR behavior. In order to do so we have invented a false euro (FEUR) dating back to 1993 and have derived simulated exchange rates of the FEUR. Within the Detrended Fluctuation Analysis (DFA) statistical method we have obtained the power law behavior describing the rms. deviation of the fluctuations as a function of time. We have compared the time-dependent exponent for these four exchange rates, and observe the role of the DEM, and the other currencies forming the EUR. A simple investment strategy based on the local DFA technique shows one can obtain appreciable gains, even taking into account some modest transaction fee. We compare the time dependent α exponent of the DFA for various exchange rates as in a correlation matrix for estimating respective influences.

Causal Analysis of the Major Factor Influencing the Euro and Its Impact on the Hong Kong Stock Market

With the introduction on 1 January 1999 of the European single currency, the Euro has become the second most widely used currency at the international level, behind the US dollar and ahead of the Japanese yen. However the scenario for a strong Euro has yet to eventuate. Over the test period January 1999 to October 2000 the Euro’s weakness confounded earlier general expectations that it would trend upwards relative to the US dollar [see ECB(2000)]. Money supply in the Euro area is measured by the standard stock of money (M3). Since the average annual growth rate of M3 – 5.1% for three-month average over April to June 1999 – is higher than the reference value of 4.5% set by the Governing Council of the European Central Bank [see ECB(1999)], and so M3 exceeds the ECB benchmark for that period. In this paper the zero-non-zero (ZNZ) patterned vector autoregressive (VAR) modelling, using the pre-windowed approach, has been utilised to investigate direct Granger causal relations between M3 and the Euro exchange rate with the US dollar. The Granger causality testing was undertaken for periods commencing in January 1999. The five consecutive tests were carried out for periods ending in July 2000 through to October 2000. It is found that M3 directly influences the Euro. Further, movements in the way the Euro exchange rate with the US dollar influences M3 are detected at T=20 and 21, suggesting a structural change which corresponds to the September-October period is identified. It is interesting to note that the European Central Bank announced its first intervention in the Euro exchange

Forecasting the Euro exchange rate using vector error correction models

Forecasting the Euro Exchange Rate Using Vector Error Correction Models. — This paper presents an exchange rate model for the Euro exchange rates of four major currencies, namely the US dollar, the British pound, the Japanese yen and the Swiss franc. The model is based on the monetary approach of exchange rate theory which uses fundamental macroeconomic variables to explain the exchange rate. A crucial point when using such a model is its proper estimation through cointegration analysis. The euro exchange rate model is therefore estimated in the form of a Vector Autoregressive (VAR) model with cointegrating vectors (VECM). We find that when cointegration analysis is undertaken properly, the naive random walk prediction can be out-performed for the US dollar, the British pound and the Japanese yen, but not for the Swiss franc.

The exchange rate and monetary conditions in the Euro area

The Exchange Rate and Monetary Conditions in the Euro Area. — Using information from a variety of sources, this paper suggests that the exchange rate will play an important role in the transmission of the impact of monetary policy on the real economy and inflation in the euro area. As a first approximation it would be reasonable to assume that an increase in the real 90-day interest rate of 100 basis points would have the same effect on demand two years later as a 3.5 percent fall in the real euro exchange rate. This implies that the euro area will tend to behave like a large open economy rather than a closed economy and hence that it would be helpful in informing monetary policy to construct a Monetary Conditions Index (MCI).