A few thoughts about the euro

This is it! You now need 1 dollar to buy 1 euro.

To get this picture below, I used the FRED connection with Mathematica 13.1, as I explained it in a previous blog. The Wolfram documentation is very clear and self-explaining. You have to register on the FRED website.

Beyond these practical aspects, let us come back to the economic meaning of the parity between the euro and the US dollar. Between 2000 and 2003, the euro was below the one dollar threshold, the late John Williamson explained in this article that is it was only a stochastic blip. The rest of the 2000s seem to validate this view, as the euro has known a continuous appreciation during this period. The current account balance of the euro has slight surplus and the real effective exchange rate of the euro was close to equilibrium at the level of the whole Economic and Monetary Union.

Quite weak, isn’t it? FRED with Mathematica 13.1

As explained by Paul Krugman in his newsletter of July 15, 2022, most of the modern analysis of exchange rate is based on the Overshooting Model of Rudi Dornbush. If the short-term interest rate is higher in the US relatively to those of the ECB, it will attract investors and raise the value of a US dollar per euro. In the long run, the nominal exchange rate of the US dollar will decline to be consistent with its fundamental value, as described here. Thus, the bigger the expected losses on the dollar, the bigger the appreciation of the dollar.

Is this the whole story? Perhaps not, as I showed in this article, the exchange rate reverts towards its fundamental value and, as explained by Rudi Dornbusch, the level of exchanges rates tends to settle at which the country’s industry is competitive on the world markets. Are there some real factors that let us think that the European industry’s competitiveness, especially Germany’s competitiveness, will be permanently affected by the current event (energy crisis, reconfiguration of global value chains)?

Krugman thinks that we will observe a long run decline in the euro-dollar exchange rate that reflects the decline of the European industry. He is quite pessimistic for the European economy.

Is he right? Time will tell.

Further reading

  • Valérie Mignon, La hausse des taux d’intérêt va-t-elle déboucher sur une nouvelle crise de la zone euro ? The Conversation, 22 juin 2022, URL

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