South-Western College Publishing - Economics  
Euro In-Waiting
Subject Euro
Topic International Finance
Key Words Currency Union, Exchange Rates, Economic Growth, Euro
News Story

The euro was introduced on January 1, 1999 and advertised as a strong contender for the global economy's foremost currency. Measured against this standard, the euro today would have to be considered a disappointment. However, currencies do not generally leap to the front; rather they tend to gradually rise. The euro should not be dismissed as a challenger to the dollar. The strong U.S. economy has kept the dollar in the forefront and if the American economy were to slow there is potential for the euro to rise.

The popularity of the euro is dependent upon many factors. As a means of payment, the euro is available in checking accounts, traveler's checks and credit card purchases, but availability is not the same as usage. Tourists are reporting that dollar-denominated traveler's checks are more readily accepted than checks in euros. There is not even complete acceptance of the euro by euro countries. For example, government securities issued by the 11 euro countries are not euro-denominated. Before the euro can rival the dollar, European financial markets will have to become more unified. Familiarity and confidence in the euro will lead to increasing acceptance.

One of the key issues in assessing the impact of an increase in the popularity of the euro on the U.S. economy, is the attractiveness of investments in Western Europe compared with the U.S. To the extent that there is a shift away from U.S. Treasuries to European investments, interest rates in the U.S. could climb, causing a slowdown in the economy. Concern over the size of the American trade deficit, some analysts argue, could cause such a shift.

(Updated June 1, 1999)

Questions
1. What are some of the determinants of the exchange rate between the dollar and the euro? Suppose that there is an increased demand for euros. What would happen to the exchange rate? How would this affect rade between the U.S. and Europe?
2. Some economists argue that if the U.S. economy were to experience inflation similar to that of the 1980s that this would cause the dollar to decline realtive to the euro. Explain how inflation could cause the dollar to decline relative to the euro.
3. What impact would an increase in U.S. interest rates have on the exchange rate?
Source Louis Uchitelle, "Euro Has Plenty of Time To Challenge the Dollar", The New York Times, April 25, 1999.

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