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The Euro in 2009

The Euro in 2009 By A.V. Vedpuriswar February 28, 2009 Brief introduction European Economic Community European Common Market Exchange Rate Mechanism, 1992 Euro officially adopted on 16 December 1995.

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The Euro in 2009

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  1. The Euro in 2009 By A.V. Vedpuriswar February 28, 2009

  2. Brief introduction European Economic Community European Common Market Exchange Rate Mechanism, 1992 Euro officially adopted on 16 December 1995. On 1 January 1999, it replaced the former European Currency Unit (ECU) at a ratio of 1:1. Physical coins and banknotes entered circulation on 1 January 2002.

  3. Current status The euro is the official currency of 16 out of 27 member states of the European Union (EU). The currency is also used in a further five European countries, with and without formal agreements . Outside the EU, the euro is also the sole currency of several European micro states and Kosovo and Montenegro. 23 states and territories have currencies that are directly pegged to the euro .

  4. Member Countries Ireland Greece Portugal Spain Luxembourg Italy Cyprus Malta • Netherlands • France • Belgium • Finland • Austria • Germany • Slovakia • Slovenia

  5. Potential entrants into Euro Zone

  6. Background The euro was established by the provisions in the 1992 Maastricht Treaty. Member states had to meet strict criteria such as a budget deficit of less than three per cent of their GDP, a debt ratio of less than sixty per cent of GDP, low inflation, and interest rates close to the EU average. The United Kingdom and Denmark opted out of monetary union .

  7. The euro is managed and administered by the ECB and the Eurosystem (composed of the central banks of the Eurozone countries). The ECB has sole authority to set monetary policy. The Eurosystem participates in the printing, minting and distribution of notes and coins in all member states, and the operation of the Eurozone payment systems. Functioning

  8. Historical perspective The rates were determined by the Council of the European Union, based on the market rates on 31 December 1998. They were set so that one European Currency Unit (ECU) would equal one euro. The ECU of course was only an accounting unit used by the EU, based on the currencies of the member states.

  9. Euro rollout The currency was introduced in non-physical form (travellers' cheques, electronic transfers, banking, etc.) at midnight on 1 January 1999, when the national currencies of participating countries (the Eurozone) ceased to exist independently. Their exchange rates were locked at fixed rates against each other. The notes and coins for the old currencies, however, continued to be used as legal tender until new euro notes and coins were introduced on 1 January 2002. The changeover period during which the former currencies' notes and coins were exchanged for those of the euro lasted about two months, until 28 February 2002

  10. Euro Bets, Hopes and aspirations Economic integration Stable currency to rival the US Dollar Devaluation ruled out Tinkering with monetary policy ruled out Tinkering with fiscal policy difficult due to Mastricht treaty All this would foreclose easy options, lead to discipline Thereby unleashing a wave of reforms Leading to improvements in productivity

  11. Reality Euro has resulted in exchange rate stability. ECB has controlled inflation as effectively as the highly respected Bundesbank. ECB has demonstrated its independence. Benefits of Euro have been evident for the weaker economies. Smaller economies outside the Eurozone have been affected by recent financial crisis. Eg., Iceland, Denmark, UK, Hungary In contrast, Ireland, Spain, Belgium escaped currency turmoil. Euro has emerged as a rival to the dollar. But anticipated structural reforms have not come. Serious economic imbalances remain.

  12. Euro as a reserve currency

  13. Dollar vs the Euro Dollar enjoys the incumbency effect. Outside EU, bulk of cross border sales are invoiced in dollars. Euro area bond markets are smaller and less liquid compared to American Treasuries. 16 separate bond markets exist in the Euro zone. The mettle of reserve currency is tested during bad times. The dollar has come out better.

  14. Cracks in the Eurozone Rising wage costs & lower competitiveness in Greece, Ireland, Italy, Portugal and Spain. Greece, Portugal, Spain, Ireland, Italy struggling with public debt. Ten year government bond yields have diverged sharply.

  15. No option to devalue : Rising wages mean lower competitiveness

  16. Fiscal indiscipline is raising yields in weaker economies

  17. Separating the men from the boys : Diverging bond yields

  18. Conclusion Touted strengths of euro zone were more apparent than red. Imbalances within Euro zone have always existed. Huge internal divide exists between Germany (excess savings) and others (like Spain & Greece). Rigidities in labour, product markets have not been addressed effectively. Fiscal discipline has been missing. ECB has focused on inflation; has been behind the curve in cutting interest rates. Euro area growth continues to lag behind other developed countries like the US.

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