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