This paper investigates the available literature on fluctuation of the Euro and European market prices. It elucidates the factors that necessitated the establishment of the European Central Bank with the introduction of common currency. Currently, 17 member states of the European Union use Euro as a single currency. Since its inception on January 1st ,1999, there have been 11 member states which replaced their old currencies with the Euro.
Introducing the Euro was a major success of the European integration. However, Denmark and the United Kingdom signed a treaty exempting them from using the Euro. Many of the newest members of the European Union have yet to fulfill conditions set for adoption of the Euro. Examples of countries using the Euro include Greece, Austria, Germany, Ireland, Spain, France, Italy, Portugal, Finland and Slovakia. Fluctuations are the changes between one currency relative to another country (Walker and Forelle 32).
The Euro, like many other currencies is prone to fluctuation. This is clearly noticeable during the international travel. For example, for 5 Euros, one can buy a cup of coffee in one country but a steak in a five star hotel in another country. However, investors feel the impact of currency fluctuation more because of huge profits and losses that are based on the exchange rate of one currency in relation to another currency. I will examine some factors that might affect demand of a currency (Bruce page 20).
The first factor is political instability. The currency begins lose its value when there are civil wars in the particular country, hence the supply of that currency in the global market becomes high. This is because people won’t buy a currency that is very likely to be worthless tomorrow. If investors lack confidence in a new government, hardly will they invest in that currency. Political instability may cause short-term or long-term effects. Economic instability is the second factor. For example, during the 2008 to 2009 financial crisis, the United States Dollar (a safe haven Currency) was not safe anymore to investors so they exchanged the U.S dollars for the Euros. Thus, the U.S. dollar lost its value as compared to the Euro (Walker and Forelle 32).
If an investor holds on to the falling currency, he or she may get substantial profit if the country recovers and thus the relative value of the currency increases. The employment levels affect the growth of a country. High rate of unemployment in a country means that the unemployed people have less money at their disposal to buy goods and services which are non-basic and the employed individuals reduce their spending habits to save for the future. The currency is devalued because there is lack of confidence in the currency, and currency demand is low. When currency demand is low, currency supply is high (Cohen 14).
Balance of trade is the value which is a result of subtracting the total value of imports from the total value of exports. If the balance of trade is a positive number, the country is said to have a favorable balance of trade. This increases the demand for that country’s currency, since foreign buyers must exchange their home currencies in order to purchase goods in that country. If the result is negative, the country is termed as having a trade deficit. This might result in increase of supply of the currency causing devaluation if supply exceeds demand to a greater extent. The Central bank of a country can influence fluctuation through some measures.
For example, buying the government bonds and other assets from financial institutions to provide liquidity to the banking systems is commonly referred to as a quantitative easing which is the last resort when lowering of the interest rates fails to boost the economy. The resultant risk of using quantitative easing is that by increasing the supply of the currency, the currency may lose value (Schwartz and Jolly 43).
As already noted, the Central Bank of Europe was formed with the main aim of ensuring the stability of prices within the Euro-zone. In other words, the bank has the sole purpose of keeping the rates of inflation within certain limits and ensuring the cost of living. Initially, it was due to these ideals could not be achieved in a free market. However, only few months since its adoption, the Euro Central Bank recorded significant gains with the 2% margin being achieved in October, 1998. According to the Governing Council of the Euro Central Bank, the stability of prices is only achieved if the rates of inflation are kept within the 2% margin.
Although this bank draws a lot from the United States Federal Reserve Bank, it slightly differs in that it puts a greater focus on checking the rates of inflation than on the other fiscal policies. This has been made clear in several occasions by the Governing Council with the popular phrase that the bank’s main aim is to check inflation rates below 2% as the region pursues stability of its commodity prices (Bruce Walker page 20).
The bank has undoubtedly been of a great help to European countries, especially during times of banking crisis. For instance, the bank was instrumental in buying the debts of its member nations when global economic crisis worsened in 2010. In fact, this bold step has since increased the call to have a collective bond issue for the European countries. According to the proponents of this idea, it would enable the central bank to introduce their model of the US Treasury Bills. However, this proposal has received a strong resistance from the German government. According to them, such a move was uncalled for, as it only sickened to rescue nations with dysfunctional banking systems (Walker and Forelle 32).
In conclusion, the bank operates strictly under the European legal system. This implies that its operations are completely immune to the corporate laws, although its basic model has a great resemblance to a finance corporation. So far, the bank has a total of five billion Euros as its operating capital. According to the policies of the bank, the capital allocation should be based on population and GDP of individual member states. Although this money is held by the central banks of member states, they are not allowed to use as collateral or transfer it. This measure was put in place to ensure that no individual state gets undue advantage over others. Although there has been limited agreement on most things concerning the bank, its location was never contested. Since its inception, the bank has been based in Frankfurt, where it is regarded as the major financial centre in the entire Euro-zone (Bruce Walker page 20).
Cohen, Sabrina. “Italian Unions Criticize Austerity Plan”. Wall Street Journal, 2011. Print.
Schwartz, Nelson D and David Jolly. “European Bank in Strong Move to Loosen Credit”. The New York Times, 2011. Print.
Walker, Bruce. “Greek Debt Crisis Worsens”. The New American, 2010. Print.
Walker, Marcus and Charles Forelle. “Bailout Deal Fails to Quell EU rifts”. Wall Street Journal, 2010. Print.