Evolution of the Trans-Atlantic exchange rate before and after the birth of the Euro and policy implications

The establishment of the Euro could present a challenge to the hegemony of the US Dollar as the predominant international currency. The fact that the unipolar US Dollar dominated international monetary system can be unstable in the presence of large shocks presents an opportunity for the Euro to promote systemic stability. The present study pursues this conjecture by exploring with cointegration and Error Correction Method techniques, the interdependence between the dynamics of the Dollar/Euro exchange rate and economic fundamentals in the context of a monetary exchange rate model. Our results suggest that both short-run (price stickiness) and long-run (secular growth) fundamentals affect the exchange rate path. These findings support a relatively broad-based policy approach to promote the collective economic interest of the EU-zone. To the extent that such policies succeed in strengthening and stabilizing the Euro-zone economy, they are likely to buttress and possibly accelerate the internationalization of the Euro.