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The euro and the international economy
In this working document, the European Commission presents a first analysis of the likely impact of the euro on developments in the international economy and, more specifically, on the international monetary system.
Commission working document of 23 April 1997 on the external aspects of Economic and Monetary Union [SEC (97) 699 final - Not published in the Official Journal].
Given the economic importance of the euro area, the introduction of the single currency will have significant effects, not only on the Member States which will not be participating but also on countries outside the European Union. This external aspect of the euro is the subject of increasing discussion in international forums such as the Organisation for Cooperation and Development (OECD) and the International Monetary Fund (IMF).
Supposing that all the Member States participate in the euro area, the economic and monetary union (EMU) will have the following characteristics:
- Its economic and commercial weight will be comparable to that of the United States and larger than that of Japan;
- If intra-Community trade is excluded, the degree of openness of the euro area is 10.2%, i.e. equivalent to that of the United States and Japan;
- Greater synchronisation of the economic cycles in the different Member States due to better coordination of economic policies will make economic developments in the euro area more important to the rest of the world;
- As a result of the disappearance of tensions between European currencies (which used potentially to stem from shocks occurring outside the European Union), the economic performance of the euro area will be less sensitive to exchange-rate fluctuations.
With the completion of EMU, the European financial market will become truly integrated:
- the development of an efficient trans-border payment system (TARGET) connecting financial centres;
- the harmonisation of financial instruments and convergence towards the most efficient means of financing;
- a unified money market implying more intense competition between banks and financial intermediaries;
- the elimination of the exchange-rate risk between participating countries.
Despite this integration, financial markets can be expected to retain some national characteristics.
The size of EMU, the stability of the currency and the wide financial market underpinning it should promote international use of the euro.
As an invoicing currency for trade, the euro should be widely used in trade relations involving the European Union directly but also, to a certain extent, in commercial transactions not involving the Member States of the Union.
As a result of the independence of the European Central Bank (ECB) and its stability-oriented policies, the euro should constitute an important reserve currency and play a key role in portfolios of financial assets on an international scale. If these same factors were to make the euro more attractive in the eyes of private investors, it would be more difficult to predict how important the euro would be in the composition of private portfolios.
The transformation of the euro into an important international currency will take place gradually; it should first show itself in the countries which have close economic links with the European Union.
The internationalisation of the euro will mean that ECB action has international repercussions. However, it will initially complicate the conduct of monetary policy as a result of the influence on monetary aggregates of decisions by external agents.
The changeover to the euro brings with it the potential risk of a period of exchange-rate instability between the euro and other major currencies due to a number of factors:
- The perception of the future direction of the ECB´s monetary policy: the bank´s place at the centre of the European System of Central Banks (ESCB), its regulatory independance and its statutory objective of maintaining price stability should however immediately establish its credibility;
- A possible excess stock of dollars in central banks: since the latter are fully aware of the potential impact of their transactions on exchange markets, it can be expected that operations to reduce excessive dollar holdings, if any, will be carried out gradually and in close cooperation;
- Reallocations of private portfolios following the introduction of the euro are a complex matter: however, opposing effects should combine to balance out the net effects.
In the long term, exchange rates are determined mainly by economic fundamentals (growth, inflation, productivity, budget balances, current balances, etc.), which are in turn influenced by the economic policies of the Union and also those of its partners.
The economic policy framework laid down in the Treaty should allow for easy monetary conditions while maintaining an appropriate exchange rate. European economic policies will therefore constitute a valuable point of reference in international economic affairs.
The completion of EMU is likely to lead to important developments in the international monetary system, principally by making it more symmetrical: the potential gains from macroeconomic coordination will tend to be more uniformly distributed among the partners.
Finally, EMU will also have implications for how international institutions such as the IMF operate matters concerning the representation of the Union within these organisations will have to be discussed and the compatibility of current practice with the provisions of the Treaty will have to be verified.