What the financial crisis reveals about the euro

Research suggests that a common currency area is viable if real exchange rate variability is small and similar across countries, the real exchange rate shock adjustments are relatively fast, and monetary policy is coordinated. The euro was introduced into the European Union (EU) in an effort to reduce the cost trade and coordinate monetary policy efforts across the EU. Recent political events in Europe however have brought into question the membership of the European Union and the possible longevity of the euro. Some political voices have questioned whether maintaining the euro as the sole currency is in the best interest of all nineteen countries.

This paper will offer an assessment of the euro since its inception and the real exchange response to the 2008-2009 financial shock, using data from the Europa database provided by the European Commission. This paper will measure real exchange rate variability and the adjustment time to real exchange rate shocks for the nineteen European Union countries that have adopted the euro as their sole currency. Germany was selected for measuring real exchange rate variability since the German mark was the par currency before the euro was introduced. The paper will also examine monetary policy coordination by comparing interest rate differentials between the eighteen countries and Germany. The data will use monthly and quarterly data from January 1999 through December 2016. This paper will also examine the results over two time periods, before and after the financial crisis.

The variability of real exchange rates will compare the standard deviation and variance of the error relative to Germany and then relative to the Eurozone. To measure the persistence of real shocks, the seasonally adjusted real exchange rate changes will be regressed on the autoregressive coefficients. The more economically integrated the economics, the less likely real exchange rate fluctuations will persist over time. To assess the variability of real exchange rate shocks and monetary policy coordination, the differences in short-term and long-term market rates relative to German and Eurozone averages will be examined.

JEL Categories: E42; F33