Fundamentals, International Role of Euro and 'Framing' of Expectations: What are the Determinants of the Dollar/Euro Exchange Rate?

Pompeo Della Posta
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Pompeo Della Posta: University of Pisa

No 24, Working Papers de Economia (Economics Working Papers) from Departamento de Economia, Gestão e Engenharia Industrial, Universidade de Aveiro

Abstract: The predictions made by economists of the value of the euro prior to its introduction were essentially based on the expected portfolio adjustment resulting from the role that it might play as an international currency. As a result, most analysts agreed that the euro would be a strong currency, appreciating against the US dollar. The first years of life of the ‘virtual’ euro contradicted such a forecast. Economists therefore abandoned predictions based on the euro as a ‘global’ money and directed their focus almost exclusively towards traditional, ‘fundamentals-based’ explanations. Among these explanations, several authors mentioned the unsatisfactory structural and institutional set up of the EMU. Nevertheless, later on, when the euro started appreciating, a different set of fundamentals had to be isolated in order to account for such behaviour. It is possible to argue, then, that the EMU economic structure and institutions are, or at least are currently perceived as, capable of supporting a strong euro, which plays the role of international money. ‘Framing’ of expectations, however, still keeps driving the behaviour of the exchange rate, so that the same structural and institutional set up may be subject to different evaluations, depending on the particular state of expectations of the international currency markets. Finally, since the available evidence suggests that the euro is starting to play an international role, I argue that the ‘international money’ and the ‘framing’ of expectations approaches explain the behaviour of the dollar/euro exchange rate better than the ‘fundamentals' one.

Keywords: Euro; Dollar; Fundamentals; International currency; Portfolio adjustment (search for similar items in EconPapers)
JEL-codes: E58 F02 F31 F33 G15 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2005-08
References: View references in EconPapers View complete reference list from CitEc
Citations:

Forthcoming in Torres, Francisco, Amy Verdun and Hubert Zimmermann (2005), EMU Rules: The Political and Economic Consequences of European Monetary Integration, Baden-Baden: Nomos Verlagsgesellschaft.

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