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The Rising Value Of The Euro

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The Euro has been strong in recent months. These are some of the factors that explain a strong Euro and whether the ECB should be worried about the rising value of the Euro

Why is the Euro been strong recently?

  1. Interest rates relatively higher than main trading partners. The US has been cutting rates aggressively to stave off recession. Japan still has very low interest rates; therefore, the Eurozone has become an attractive target for saving money. This causes hotmoney flows and an appreciation in the Euro.
  2. The Eurozone is viewed to have good economic prospects. The ECB have a good track record of low inflation. Economic growth is also relatively strong, which is likely to lead to higher rates in the future. However, this economic optimism may be misplaced. Some countries especially in the south, are showing signs of economic weakness. E.g. many property markets like Spain are overvalued and house prices could easily fall.
  3. Relative to other countries, the EU has a healthy balance of payments which tends to cause an appreciation in the exchange rate because money is flowing into the economy.
  4. Euro seen as an alternative to the dollar. The weakness of the dollar is causing many speculators to hold currency in the Euro, rather than the dollar, which is in long term decline.
     

Should the ECB worry About A Rising Value of the Euro?

If there is an appreciation in the Euro, then exports become more expensive and imports cheaper.

Therefore, if demand is elastic there will be a fall in value of exports and this will lead to lower aggregate demand and economic growth. The appreciation will particularly harm the exporting industries. To some extent they may be able to cut costs, but, if the Euro keeps rising they will make lower profits and have to lay off workers, causing a rise in unemployment.

An appreciation helps to reduce inflation. Firstly there will be lower demand pull inflation . Secondly, import prices are cheaper causing lower cost push inflation. Thirdly, the appreciation may encourage firms to cut costs and strive to increase efficiency. This reduction in inflation is very beneficial and may enable the MPC to cut interest rates, which will boost economic growth and investment.

The impact of an appreciation depends on other factors. For example, if the Eurozone sees a fall in consumer spending (caused by a housing crash) then the negative effect on AD will be significant. There are worries that the EU is not as strong as many would like to believe. There are fears over the EU housing market, for example Spain's housing market is quite weak.


About the Author

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits an Economics Blog focused on UK and US economies: http://www.economicshelp.org/econ.html


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Article Published/Sorted/Amended on Scopulus 2008-06-10 11:06:03 in Economic Articles

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