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The Launch of the Euro
Carol C. Bertaut and Murat F. Iyigun, of the Board’s
Division of International Finance, prepared this
article. Tim Troha provided research assistance.
The introduction on January 1, 1999, of the euro—
the single currency adopted by eleven of the fifteen
countries of the European Union—marked the begin-
ning of the final stage of Economic and Monetary
Union and the start of a new era in Europe. This
historic achievement was the culmination of a lengthy
process that began in March 1957, when six Euro-
pean nations—Belgium, France, Germany, Italy, Lux-
embourg, and the Netherlands—signed the Treaty of
Rome, thereby founding the European Economic
Community (EEC).
1
The Treaty came into effect on
January 1, 1958, exactly forty-one years before the
inception of the new single European currency.
2
Although the Treaty of Rome created a closer
economic union among member countries, these
countries did not at the time envisage an actual
monetary union. In 1971, a group of European ex-
perts developed a proposal for coordinated or harmo-
nized monetary policy among EEC members; this
proposal was made explicit in the Werner plan. Fur-
ther progress toward monetary integration was set in
motion by the establishment in 1979 of a system of
stable, but adjustable, exchange rates known as the
European Monetary System. The first major revision
to the Treaty of Rome was the Single European Act,
signed in 1986, which affirmed old objectives and set
new ones, including the establishment of a European
single market and the gradual realization of monetary
union. In 1989, specific stages toward achieving Eco-
nomic and Monetary Union (EMU) were detailed in
the Delors Committee report, and in December 1991
in the Dutch city of Maastricht, European Union
(EU) nations produced the Treaty on European
Union.
3
This treaty, generally referred to as the Maastricht
Treaty, became the effective ‘‘constitution’’ for EMU,
providing the criteria for judging macroeconomic
convergence and laying the groundwork for the even-
tual establishment of the European Central Bank.
4
In
early May 1998, the heads of state or government
of the fifteen EU countries agreed that eleven coun-
tries (Austria, Belgium, Finland, France, Germany,
Ireland, Italy, Luxembourg, the Netherlands, Portu-
gal, and Spain) should move forward into the final
stage of EMU, creating an economic area comparable
in size to that of the United States (table 1). The
European Commission of the European Union and
the European Monetary Institute evaluated each
country’s readiness for entry on the basis of the
1. The Treaty of Rome was preceded in 1951 by the Treaty of Paris
to which the same six European nations were signatories; the Treaty
of Paris established the European Coal and Steel Community, which
aimed at the more-limited objective of pooling the coal and steel
resources of member countries.
2. Over the years, membership in the EEC, which was renamed the
European Union, grew from the initial six countries to fifteen, with
Denmark, Ireland, and the United Kingdom becoming full members in
1973, Greece in 1981, Spain and Portugal in 1986, and Austria,
Finland, and Sweden in 1995.
3. For further background on the stages leading up to EMU, see
Herve´ Carre´ and Karen H. Johnson, ‘‘Progress toward a European
Monetary Union,’’ Federal Reserve Bulletin, vol. 77 (October 1991),
pp. 769–83; Peter Kenen, Economic and Monetary Union in Europe:
Moving beyond Maastricht (Cambridge University Press, 1995), and
Robert Solomon, Money on the Move: The Revolution in International
Finance since 1980 (Princeton University Press, 1999).
4. The Maastricht Treaty also provided the legal basis for the
European Central Bank and protocols for the European System of
Central Banks (ESCB) and the European Monetary Institute (EMI).
The ESCB comprises the European Central Bank and the fifteen
EU-member national central banks. The EMI was the precursor to the
ECB. During its transitory existence between January 1994 and July
1998, the EMI worked to strengthen cooperation and monetary policy
coordination among national central banks and to facilitate prepara-
tions for the establishment of the ESCB.
1. Comparison of the euro area and the United States
Percent except as noted
Item Euro area United States
Population (1997, millions) ............... 282 268
Nominal GDP (1998, trillions of dollars) .. 6.6 8.5
Inflation (June 1999, twelve-month
percent change)
1
.................... .9 2.0
Unemployment rate (July 1999)
2
......... 10.3 4.3
Exports as a share of GDP (1998) ......... 33.7 11.3
Excluding intra-euro-area trade ......... 13.5 . . .
Imports as a share of GDP (1998) ......... 31.5 13.0
Excluding intra-euro-area trade ......... 12.1 . . .
1. Euro-area harmonized inflation is calculated from a weighted average of
harmonized consumer price indexes for individual countries. The harmonized
indexes are constructed by standardizing some aspects of statistical practice and
eliminating categories from national consumer price indexes, leaving indexes
with basically identical coverage across countries.
2. Euro-area unemployment estimates are based on the results of the Euro-
pean Community Labour Force Survey.
. . . Not applicable.
performance criteria for inflation, fiscal policy, long-
term interest rates, and exchange rates and on the
conformity of each country’s national central bank
legislation with the Maastricht Treaty. The European
Central Bank came into formal existence on June 1,
1998, and took over responsibility for the monetary
policy of the EMU member states on January 1,
1999.
The creation of a single currency and a single
monetary policy has provided both extraordinary
challenges and exceptional opportunities within
Europe. A new financial infrastructure was necessary
to handle transactions in the new currency. Although
the euro does not yet exist as a physical currency—
bank notes and coins will not be introduced until
2002—the euro is traded in financial markets, new
issues of securities are denominated in euros, and
official statistics in the euro area are quoted in the
euro (table 2). For financial firms, the creation of the
euro required conversion of numerous existing
accounts and systems for trading, risk analysis, and
liquidity management to the new currency. Although
development of these systems had been ongoing for
several years, the actual switchover took place over
the long ‘‘conversion weekend’’ from the close of
business on December 31, 1998, through the opening
of business on January 4, 1999. Round-the-clock
efforts in major financial centers were necessary for
handling the complexities of re-denominating euro-
area government bonds to the new currency, convert-
ing financial accounts, and doing final testing of the
system for interbank payments. Now that the initial
transition has been successfully completed, the estab-
lishment of the single monetary area and the removal
of currency risk among member countries is expected
to provide unprecedented opportunities for cross-
border trading, portfolio expansion, and mergers and
acquisitions among European companies.
This article reviews the organization, objectives,
and targets of the euro area’s new central bank and
discusses some of the early challenges it has faced in
setting and implementing monetary policy with the
new common currency. It discusses the initial func-
tioning of the payment system and the interbank
market and reviews the effects to date of the single
currency on European bond and equity markets, on
the banking system, and in euro-area transactions.
ORGANIZATION OF THE NEW EUROPEAN
CENTRAL BANK AND THE EUROSYSTEM
With the start of the final stage of EMU, monetary
policy is no longer set individually at each of the
national central banks of the euro-area countries.
Instead, monetary policy is determined for the euro
area as a whole by the Eurosystem. The Eurosystem
comprises the new European Central Bank (ECB) at
its center as well as the national central banks of the
eleven countries currently participating in the mone-
tary union.
5
The Maastricht Treaty grants the ECB
full constitutional independence. It explicitly states
that neither the ECB nor any member of its decision-
making bodies shall seek or take instructions from
European Commission institutions, from any govern-
ment of a member state, or from any other organiza-
tion or institution. The primary decisionmaking bod-
ies of the ECB are the Executive Board and the
Governing Council. The Executive Board consists of
the president and vice president of the ECB and four
other members (table 3). These members are ap-
pointed by common agreement among the govern-
ments of EMU member states on a recommendation
from the EU Council after consulting with the Euro-
pean Parliament. The members of the Executive
Board are also members of the Governing Council,
along with the governors of the national central banks
of the eleven EMU member countries. The primary
responsibility of the Governing Council is the setting
of monetary policy within the euro area. The primary
responsibility of the Executive Board is to implement
monetary policy and to issue instructions as neces-
sary to the national central banks in accordance with
the guidelines of the Governing Council. Although
required by law to meet at least ten times a year, the
Governing Council in practice meets every two
5. The ESCB includes the ECB and the national central banks from
all fifteen EU member states. At the time that the Maastricht Treaty
was signed, it was generally understood that all EU countries would
enter into EMU at the same time, and the Maastricht Treaty refers to
the ESCB and not the Eurosystem. The national central banks of the
member states that do not participate in the Eurosystem are members
of the ESCB but have a special status; they are allowed to conduct
their respective national monetary policies, and they do not take part
in the decisionmaking regarding euro-area monetary policy and its
implementation.
2. Official currency conversion rates
Country Currency Currency units per euro
Austria ............... schilling 13.7603
Belgium ............. franc 40.3399
Finland .............. markka 5.94573
France ............... franc 6.55957
Germany ............. mark 1.95583
Ireland ............... punt .787564
Italy ................. lira 1936.27
Luxembourg ......... franc 40.3399
Netherlands .......... guilder 2.20371
Portugal ............. escudo 200.482
Spain ................ peseta 166.386
Source. European Central Bank.
656 Federal Reserve Bulletin October 1999
weeks, a schedule similar to that employed by the
German Bundesbank through December 1998.
Objectives and Targets
As specified in the Maastricht Treaty, the primary
objective of the ECB is to ‘‘maintain price stability.’’
Without jeopardizing this objective, the ECB is also
expected to support the general economic policies of
the European Commission. In this respect, the man-
date of the ECB is similar to that of the Bundesbank.
Section 3 of the Deutsche Bundesbank Act, which
was signed into law in 1957 and later amended to
comply with the Maastricht Treaty, names the main
duties of the central bank as the regulation of the
amount of money in circulation and of credit supplied
to the economy with the aim of ‘‘safeguarding the
currency.’’ In practice, safeguarding the currency was
interpreted to mean price stability. In comparison, the
Federal Reserve Act states that U.S. monetary policy
should seek ‘‘to promote effectively the goals of
maximum employment, stable prices, and moderate
long-term interest rates.’’
The ECB’s published definition of price stability is
inflation, measured as the twelve-month change in
the harmonized index of consumer prices for the euro
area, of below 2 percent—with no explicitly defined
lower bound.
6
Although the ultimate goal of euro-
area monetary policy is clearly specified as price
stability, the Governing Council of the ECB has
adopted a flexible approach toward achieving this
goal. Unlike the Bundesbank, which followed a
specific intermediate target for a broad monetary
aggregate, the Governing Council would—as Wim
Duisenberg, president of the ECB, announced in
October 1998—take into consideration a ‘‘reference
value’’ for growth of a monetary aggregate and a mix
of other indicators defined as ‘‘a broadly-based
assessment of the outlook for future price develop-
6. Harmonized inflation for the euro area is calculated from a
weighted average of harmonized consumer price indexes for indi-
vidual countries. The harmonized indexes are constructed by standard-
izing some aspects of statistical practice and eliminating categories
from national consumer price indexes, leaving indexes with basically
identical coverage across countries.
3. Comparison of the organizational structure of the Eurosystem and the Federal Reserve System
Item Eurosystem Federal Reserve System
Staffing
Total 53,000+ 24,500+
At headquarters 500+ 1,700+
Monetary policy decisionmaking
committee The Governing Council The Federal Open Market Committee
Number of members on the
monetary policy committee Seventeen: six members of the Executive
Board plus eleven governors of the national
central banks of EMU member states.
Twelve: seven members of the Board
of Governors, plus the president of the
Federal Reserve Bank of New York, and
four of the remaining eleven regional
Federal Reserve Bank presidents rotating
on a one-year basis.
Geographic representation No specific requirements for the six
Executive Board members. No more than one member of the Board
of Governors may be selected from any
of the twelve Federal Reserve Districts.
Meeting frequency At least ten meetings per year required
by law. In practice, bi-monthly, every
other Thursday.
At least four meetings per year required
by law. In practice, eight times per year.
Publication of minutes Minutes accessible after thirty years. In
special cases, the Governing Council may
shorten this period. The president and the
vice president hold a press conference
following the first Governing Council
meeting of each month.
Minutes released a few days after the
next regularly scheduled FOMC meeting.
Lightly edited transcripts of all meetings
for a complete year released after a lag
of five years.
Regulatory and supervisory
responsibilities Most of the key prudential regulations
are harmonized in the EU. The primary
responsibility for supervision remains at
the national level. European Banking
Supervisory Committee of the ECB aims
to ensure coordinated supervision.
Primary responsibility for supervising
and regulating all bank holding compa-
nies and their nonbank foreign subsidi-
aries, state-chartered banks that are
members of the Federal Reserve and
their foreign branches, and Edge Act
and agreement corporations.
The Launch of the Euro 657
ments.’’
7
The relevant reference value for the central
bank’s monetary growth target, which was announced
in December 1998 and is effective through December
1999, is for areawide M3 growth of 4
1
⁄
2
percent, as
measured by a three-month moving average of the
twelve-month percent change. In January 1999, the
ECB noted that, among other things, the mix of other
indicators will include wages, bond prices, the yield
curve, measures of real activity, business and con-
sumer surveys, and the exchange rate.
8
To an important degree, the ECB’s adoption of a
flexible and pragmatic approach to monetary policy
was influenced by a number of transitory constraints.
During the initial stages, ECB officials were con-
fronted with euro-area data that at times were incom-
plete and not fully harmonized, especially regarding
historical data. Moreover, because national statistical
agencies continued to publish the bulk of national
statistics, there was a risk that financial markets might
pay undue attention to developments in individual
countries instead of those in the euro area as a whole.
These constraints noted, the availability of timely and
accurate euro-area data grew considerably in the first
months of 1999. However, the ‘‘structural break’’
associated with monetary union provided another
complication for interpreting and projecting basic
economic relationships in the medium run, because
both inflation and money growth relationships rely,
explicitly or implicitly, on an understanding of the
historical relationship between aggregate economic
variables and the price level. Thus, the ECB’s choice
of a flexible approach to monetary policymaking was
pragmatic. The need for the ECB to be flexible in the
short run makes its policy setting less transparent.
However, given the uncertainties about structural eco-
nomic relationships during the transition, the ECB
has chosen not to specify any intermediate target—at
least, not until experience provides sufficient evi-
dence that such a step would be productive.
Implementation of Monetary Policy at the ECB
Although decisions regarding monetary policy are
made centrally by the Governing Council of the
Eurosystem, the operational aspects of monetary pol-
icy implementation—including open market opera-
tions, administration of the minimum reserve system,
and management of the standing facilities—are un-
dertaken in a decentralized fashion at the eleven
national central banks. The main features of the Euro-
system’s operating procedures are similar in many
respects to those employed by the Bundesbank and
other national central banks in the euro area in recent
years (see the box ‘‘Comparison of Eurosystem
Monetary Operating Procedures with Those of the
Bundesbank and the Federal Reserve System’’). The
Eurosystem provides liquidity to the euro-area bank-
ing system primarily through a weekly refinancing
operation with a two-week maturity.
9
Beginning with its first weekly tender settled on
January 7, the ECB has offered only fixed-rate
tenders at its weekly refinancing operations. These
tenders are bids by eligible banks for credit at the
interest rate specified by the ECB. The Eurosystem
then allocates the amount it decides to provide among
the bids it has received.
10
Individual banks are not
restricted as to the volume of their bids, and they are
required to have sufficient collateral to cover only the
actual amount allocated. Additional liquidity is pro-
vided through longer-term monthly tenders that are
conducted as variable-rate tenders with a three-month
maturity. ‘‘Fine-tuning’’ operations may also be used
to make further adjustments to the amount of liquid-
ity in the market, although through June 30, no such
operations had been undertaken.
The Eurosystem also has two standing facilities to
provide and absorb overnight money and to provide a
‘‘corridor’’ for the market-determined interbank rate:
the marginal lending facility and the deposit facility.
The marginal lending facility provides overnight
credit to all eligible credit institutions with sufficient
collateral, and its interest rate usually serves as a
ceiling for the overnight interbank rate. There is no
stigma associated with borrowing at the marginal
lending facility. However, such borrowing takes place
at a penalty rate, in that the interest rate on the
marginal lending facility is generally set between
7. For more details on Germany’s use of monetary targets, see
Linda S. Kole and Ellen E. Meade, ‘‘German Monetary Targeting: A
Retrospective View,’’ Federal Reserve Bulletin, vol. 85 (October
1995), pp. 917–31.
8. For further information on the ECB’s monetary strategy, see
‘‘The stability-oriented monetary strategy of the Eurosystem,’’ Euro-
pean Central Bank Monthly Bulletin (January 1999), pp. 39–51.
9. The underlying securities for the weekly refinancing operations
are predominantly euro-area government bonds and notes, but they
also include shorter-maturity government securities and some private-
sector securities. Each week, the ECB announces the list of securities
that are eligible for use in monetary operations.
10. In this article, the terms bank and banking system are intended
to include all euro-area credit institutions that are eligible to conduct
operations with the Eurosystem. For further details, see European
Central Bank, ‘‘The Single Monetary Policy in Stage Three: General
documentation on ESCB monetary policy and procedures’’ (Septem-
ber 1998).
658 Federal Reserve Bulletin October 1999
100 and 150 basis points above the official weekly
refinancing rate. The overnight interbank rate usually
trades close to the weekly refinancing rate, giving
banks an incentive to borrow in the interbank market
if possible. Intra-day credit that is not repaid by the
end of the day automatically rolls over to overnight
lending through the marginal lending facility.
The second standing facility, the deposit facility,
usually provides a floor for the interbank rate. This
facility is available for banks to deposit excess funds
Comparison of Eurosystem Monetary Operating Procedures
with Those of the Bundesbank and the Federal Reserve System
EUROSYSTEM
Primary Operations
The refinancing tender is a weekly repurchase operation
with a two-week maturity. The tenders may be offered at
a fixed or variable interest rate. To date, only fixed-rate
tenders have been offered at the weekly refinancing opera-
tions. Allocated credit must be collateralized; eligible coun-
terparties include all credit institutions subject to the Euro-
system’s minimum reserve requirements that have sufficient
collateral and that satisfy the operational criteria required
by individual national central banks. The underlying securi-
ties for the weekly refinancing operations are predomi-
nantly euro-area government bonds and notes but also
include shorter-maturity government securities and some
private-sector securities. Each week, the ECB announces
the list of securities that are eligible for use in monetary
operations. Additional liquidity is provided through
monthly refinancing operations. These are repurchase trans-
actions at a three-month maturity, offered as variable-rate
tenders of a fixed amount.
Standing Facilities
Marginal Lending Facility. The marginal lending facility is
open to all eligible credit institutions with sufficient collat-
eral for overnight credit from the Eurosystem. To date, the
normal setting for the interest rate on the marginal lending
facility is 100 to 150 basis points above the weekly refi-
nancing rate.
Deposit Facility. The deposit facility is open to all eli-
gible credit institutions for depositing excess funds over-
night. To date, the normal setting for the interest rate on the
deposit facility is 100 basis points below the refinancing
rate.
BUNDESBANK (before January 1, 1999)
Primary Operations
From December 1993 through December 1998, the Bundes-
bank’s primary monetary operations were conducted
through weekly repurchase tenders with a two-week matu-
rity, using either a fixed- or a variable-rate tender. The
resulting ‘‘repo’’ rate was regarded as the most-important
official interest rate. In general, the Bundesbank tended to
use a variable-rate tender except during periods when it
wanted to provide guidance to market interest rates.
Between February 1996 and December 1998, the Bundes-
bank conducted only fixed-rate tenders.
Standing Facilities
Marginal Lending (Lombard) Facility. The Lombard facil-
ity was available for overnight credit from the Bundesbank
for eligible credit institutions with sufficient collateral. The
interest rate on the Lombard facility was normally set about
150 basis points above the repo rate. No stigma was associ-
ated with borrowing at the Lombard rate, but the facility
was not intended as a permanent source of funding.
Discount Facility. Discount lending provided an addi-
tional source of liquidity at a subsidized rate, normally set
about 100 basis points below the repo rate. Over time, the
importance of the discount facility diminished; by 1996, it
accounted for about one-third of central bank liquidity,
down from nearly two-thirds in the mid-1980s.
FEDERAL RESERVE SYSTEM
Primary Operations
In contrast to the European Central Bank, the Federal
Reserve System does not have an official repurchase rate at
which it provides credit to the banking system. Instead, the
Federal Reserve specifies as a target an intended level for
the federal funds rate, which is the market overnight inter-
bank borrowing rate, and conducts open market operations
to influence the level of liquidity in the funds market to
achieve that interest rate on average. Open market opera-
tions are conducted several times a week primarily in the
form of variable-rate repurchase transactions of government
securities, with a maturity ranging from one day to ninety
days. Outright transactions in Treasury bills are also occa-
sionally used.
Standing Facility
Discount Window. The discount window is a source of
below-market-rate borrowing; borrowing at the discount
window is normally restricted to banks that cannot obtain
funds elsewhere at reasonable cost.
The Launch of the Euro 659
that earn interest, although excess funds are not auto-
matically swept into it. Normally, the interest rate on
the deposit facility is 100 basis points below the
refinancing rate. Thus, in normal times, the corridor
provided by the marginal lending and deposit facili-
ties is quite wide, at 2 percent to 2.5 percent. From
January 4 through January 21, however, interest rates
on the two standing facilities were set only 50 basis
points apart—25 basis points on either side of the
refinancing rate—to help ease distortions in the
money market during the initial weeks of operations
under the single currency.
MACROECONOMIC BACKGROUND
AND RECENT ECONOMIC DEVELOPMENTS
IN THE EURO AREA
The euro came into existence in an economic envi-
ronment that turned out to be less than hospitable.
Considerable downside risks to real economic activ-
ity were evident around the globe in the fall of 1998,
stemming mainly from the Russian financial crisis in
mid-1998, but also from the latter stages of the finan-
cial crisis in Asia and the signs of turmoil in Latin
America. At the same time, the prolonged stagna-
tion in Japan showed no signs of abating in the near
term, and in the United Kingdom—a potential future
entrant into the euro area—growth had slowed
sharply from its previous robust pace. In contrast,
U.S. economic activity continued to expand rapidly.
11
Moreover, most European countries that were striv-
ing to meet the criteria of the Maastricht Treaty for
EMU membership in the first round had undertaken
significant fiscal tightening in 1997, the lagged effects
of which, to some extent, carried over to 1998. The
fiscal tightening, coupled with the negative effects of
the Asian and Latin American crises on European
foreign trade, brought early signs of a slowdown in
Europe in the last quarter of 1998—the period in
which final preparations for the launch of the euro
were being made. Thus, given the robust pace of
activity across the Atlantic, differences in cyclical
economic positions set the stage for significant poten-
tial downward pressure on the exchange rate of the
yet-to-be-born currency against the dollar.
Cyclical differences among countries heading into
the final stage added another complication to the
economic picture. Economic activity in some coun-
tries, such as Germany and Italy, grew at only a
moderate pace in 1998, while the economies of some
other countries, notably Finland and Ireland,
expanded rapidly. These differences could be seen in
the increasing divergence in output gaps, a measure
of unused capacity in the economy (chart 1). The
differences became all the more relevant for the set-
ting of monetary policy in light of the lower nominal
interest rates brought about by convergence of offi-
cial interest rates to levels prevailing in Belgium,
France, Germany, and the Netherlands in the months
leading up to January 1, 1999 (chart 2). Long-term
interest rates had largely converged by early 1998,
bringing forward some of the benefit of EMU
(chart 3). In countries in which activity was already
11. To preserve the ongoing economic expansion in the United
States, the Federal Open Market Committee responded to the increas-
ing risks associated with weakening economic activity abroad and
volatile conditions in financial markets in the autumn by reducing the
intended federal funds rate a total of 75 basis points.
1. Output gaps for selected euro-area countries, 1996–98
1996 1997 1998
3
2
1
0
–
+
1
2
3
Percent
France
Germany
Italy
Finland
Netherlands
Ireland
Note. The output gaps are the deviations of actual GDP from potential GDP
as a percentage of potential GDP.
Source. OECD Economic Outlook, June 1999.
2. Short-term interest rates for selected euro-area countries,
January 1997–March 1999
1997 1998 1999
3
4
5
6
7
Percent
France
Germany
Italy
Spain
Ireland
Note. The data are monthly averages. Short-term interest rates are three-
month interbank rates.
660 Federal Reserve Bulletin October 1999
robust, such as Ireland, the convergence process pro-
vided some additional marginal stimulus.
12
Recent Economic Developments and Policy
Actions
From mid-September through the end of December
1998, the currencies of the eleven euro-area countries
appreciated significantly against those of some trad-
ing partners, particularly against the U.S. dollar. After
its inauguration on January 4, 1999, however, the
new currency depreciated fairly steadily against other
major currencies. By the end of July, the exchange
value of the euro against the dollar had depreciated
more than 13 percent from its initial value of
1.167 dollars per euro (see chart 4); recently it has
reversed some of this depreciation.
13
For the most part, the euro’s steady weakening
against the dollar was driven by differences in cycli-
cal conditions between the euro area, where eco-
nomic activity in the largest countries remained sub-
dued, and the United States, where economic activity
was still robust. The weaker euro provided some
stimulus to euro-area foreign trade, although in evalu-
ating the potential effects of the depreciation of the
euro against other major currencies, namely the U.S.
dollar and the U.K. pound, it is useful to note that
once intra-euro-area trade is excluded, the euro-area
economy is relatively closed compared with the indi-
vidual economies of the eleven countries before the
adoption of the euro (see table 1). Thus, larger move-
ments in the value of the euro may be necessary
to affect areawide economic activity than the move-
12. In early October, central banks in Spain and Portugal reduced
official rates 50 basis points, and the Central Bank of Ireland cut rates
125 basis points. The Bank of Italy waited until December 28 before
cutting its official rates 50 basis points to complete the process of
convergence. A coordinated interest rate reduction by all prospective
euro-area national central banks on December 3 provided additional
stimulus. By January 1, the total weighted-average decline in euro-
area rates that had occurred since September 1998 was about 75 basis
points.
13. The fixing value of 1.16675 dollars per euro was determined by
the value of the dollar–ECU exchange rate on December 31, 1998.
However, when European financial markets opened on January 4,
1999, the euro traded at 1.1789 dollars per euro, an appreciation of
about 1 percent relative to its fixing rate.
3. Long-term interest rates for selected euro-area countries,
January 1997–August 1999
1997 1998 1999
4
5
6
7
Percent
France
Germany
Italy Spain
Ireland
Note. The data are monthly averages. Long-term rates are nominal ten-year
(or closest available maturity) government bond yields.
4. Exchange rate of the euro against the U.S. dollar,
January 1996–August 1999
1996 1997 1998 1999
1.0
1.1
1.2
1.3
Monthly average, dollars per euro
Fixing rate1
Note. The data are monthly averages. The exchange rate monthly data use
the restated German mark before January 1999.
1. The fixing rate was set on December 31, 1998, at 1.16675 U.S. dollars per
euro.
5. Monetary Union Index of Consumer Prices (MUICP)
for the euro area, January 1997–June 1999
1997 1998 1999
.5
1.0
1.5
2.0
Twelve-month percent change
Note. The data are monthly averages. The MUICP is calculated as a
weighted average of harmonized consumer price indexes of the euro-area
countries. The harmonized indexes are constructed by standardizing some
aspects of statistical practice and eliminating categories from national consumer
price indexes, leaving indexes with basically identical coverage across coun-
tries. Country weights are calculated every year from the country’s share of
private final domestic consumption expenditure in the euro-area total (from
Eurostat).
The Launch of the Euro 661
ments that had to occur for national currencies to
affect their respective national economies.
At its meeting on April 8, the Governing Council
of the ECB responded to the emerging evidence of
weaker activity in the euro area by cutting official
interest rates. The Governing Council reduced the
refinancing rate 50 basis points, to 2
1
⁄
2
percent, which
was more than market participants had expected, and
also cut the marginal lending rate and deposit rates
100 basis points and 50 basis points, respectively, to
3
1
⁄
2
percent and 1
1
⁄
2
percent. These actions marked
the first change in the policy stance by the ECB,
although official interest rates had been reduced to
3 percent last December by the national central banks
of prospective members of the Eurosystem. The
moves were made possible to a significant extent by
the lack of price pressures in the euro area, as con-
sumer price inflation remained well below the ECB’s
official ceiling of 2 percent (chart 5). Although euro-
area M3 growth hovered around 5 percent on a
twelve-month basis, slightly above the ECB refer-
ence value of 4
1
⁄
2
percent for M3 growth (chart 6),
the Governing Council noted that these developments
likely reflected the unwinding of special factors relat-
ing to the start of EMU and consequently did not
consider them to be a signal of future inflationary
developments.
Early Developments in Money Markets
Besides the challenges of determining the appropriate
monetary stance for the euro area as a whole in the
uncertain environment of early 1999, Eurosystem
officials faced challenges in ensuring that monetary
policy was implemented smoothly and effectively
throughout the Eurosystem. Early in 1999, overnight
market interbank rates in the euro area, as measured
by the euro overnight index average (eonia), traded
close to the official marginal lending rate, suggesting
some interbank liquidity strains (chart 7). Also,
according to ECB President Duisenberg, the spread
6. Harmonized M3 growth for the euro area,
October 1997–June 1999
1997 1998 1999
3
4
5
6
7
Three-month moving average
ECB reference
value
Note. The data are monthly averages. Euro-area harmonized series are
compiled by the European Central Bank based on monthly reporting by mone-
tary financial institutions in each country.
7. Eurosystem interest rates, January–August 1999
Jan. Feb. Mar. Apr. May June July Aug.
1999
.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Percent
Marginal lending rate
Deposit rate
Refinancing rate
eonia1
Note. The data are monthly averages.
1. Euro overnight index average.
8. Daily use of Eurosystem standing facilities,
January–August 1999
Jan. Feb. Mar. Apr. May June July Aug.
1999
5
10
15
5
10
15
20
25
Billions of euros
Marginal lending facility
Deposit facility
662 Federal Reserve Bulletin October 1999
between interbank rates in different countries was
larger than should be considered normal for a single
currency area: The spread was as much as 21 basis
points on January 4; by January 18, however, it had
narrowed to less than 10 basis points. Initially, the
use of both standing facilities, especially that of the
marginal lending facility, was high (chart 8). In part,
the unusually heavy use of the marginal lending
facility likely reflected the relatively high cost of
funds in the interbank market as well as some start-up
difficulties with the Eurosystem’s wholesale payment
system. Heavy use of the deposit facility also indi-
cated payment system problems. As these difficulties
have been resolved, use of the marginal lending
facility and the deposit facility has decreased, and the
overnight rate has generally traded close to the refi-
nancing rate, with major deviations only at the ends
of reserve maintenance periods.
DEVELOPMENTS IN EUROPEAN FINANCIAL
SYSTEMS AND MARKETS
Wholesale Payment Systems
One of the biggest challenges for the successful
implementation of monetary policy under the single
currency was the creation of a wholesale payment
system that would enable transactions to be con-
ducted quickly and efficiently across borders and
would facilitate integration of money markets in the
euro area. Since January, the majority of the domestic
and cross-border euro payments have been sent
through the TARGET (Trans-European Automated
Real-time Gross-settlement Express Transfer) sys-
tem. TARGET consists of a real-time gross settle-
ment (RTGS) system for funds transfer in each of the
fifteen EU countries (including the EU countries not
currently participating in EMU), the ECB’s payment
mechanism, and an interlinking among all the compo-
nent systems.
14
Credit institutions in member countries may obtain
central bank credit only from the national central
bank in the country in which they are based, but they
may use TARGET to conduct interbank operations
across the EU area. About 5,000 credit institutions
have direct access to one of the fifteen euro RTGS
systems in the EU and, through the TARGET inter-
linking, to each other. Some of the distortions that
arose in the money market during the first few
weeks reflected ‘‘teething problems’’ with TARGET,
as noted by ECB President Duisenberg. Payments
occasionally were incorrectly routed or otherwise
mishandled and subsequently rejected by TARGET,
and resulting positions at the relevant banks were
often not resolved until the end of the day, requiring
the banks to resort to the automatic conversion of
intraday drafts to overnight loans at the marginal
lending facility. In response to some of these pay-
ment system difficulties, TARGET settlement was
extended an hour each day for most of January, but a
penalty was imposed to discourage late settlement.
15
Overall, the functioning of TARGET as an EU-wide
payment system has been quite successful: In the first
quarter of 1999, it processed a daily average of more
than 150,000 transactions valued at 966 billion euros
($1,081 billion).
16
Securities Settlement Systems
In contrast to the relatively quick establishment of a
wholesale payment system to handle a large volume
of cross-border transactions, the consolidation of se-
curities settlement systems remains limited. Most
systems serve only their domestic securities markets,
with multiple systems existing within some countries.
Differences across the euro area in legal arrange-
ments applying to securities holdings and transac-
tions have also made integration of securities settle-
ment systems more difficult. To help compensate for
inadequacies in market structures and to ensure that
all banks in the euro area have equal access to eli-
gible collateral when borrowing from the national
central banks (NCBs), the Eurosystem has estab-
lished a system to transfer securities through the
so-called Correspondent Central Bank Model. Under
this arrangement, a bank in one country may pledge
securities eligible for collateral but held in another
country by arranging for those securities to be trans-
ferred to a custodial account at the NCB of that
country and notifying the home NCB of its intent.
Once the home NCB receives acknowledgment from
the custodial NCB that the securities transfer is com-
14. Alternative payment systems include non-RTGS German and
French systems, which run frequent net settlements throughout the
day, and the EU-wide Euro1 system run by the Euro Banking Associa-
tion, which is an end-of-day, multilateral net settlement system.
15. For further details on TARGETand developments in wholesale
payment and securities settlement systems, see Bank of England,
Practical Issues Arising from the Euro (June 1999).
16. By way of comparison, over the same period, the Federal
Reserve System’s Fedwire service, available to approximately 10,000
U.S. depository institutions, processed a daily average of more than
400,000 funds transfers with a daily average value of $1,343 billion.
The Launch of the Euro 663
plete, it authorizes the credit. However, increasing
integration of European capital markets and greater
demand for cross-border securities trading and settle-
ment are expected in time to lead to an integrated
European securities settlement system. In particular,
the Eurosystem has encouraged the development of
links among securities settlement systems. Twenty-
six links already allow for transfers of securities from
one system to another, and further links and other
projects to integrate the securities settlement struc-
ture are under development.
17
Debt Markets
To date, debt markets have reacted favorably to the
new currency.
18
The value of new issues of euro-
denominated international bonds and notes accounted
for about 38 percent of all new international bonds in
the first two quarters of 1999.
19
The share is consider-
ably larger than in 1998, when new issues of interna-
tional bonds denominated in the eleven national
legacy currencies and the ECU accounted for about
27 percent of all new international issues.
20
Of all
new issues denominated in the euro, most are domes-
tic bonds issued by euro-area governments. Although
yields on long-term government bonds of the mem-
ber countries continued to converge through 1998,
some differentials remain, reflecting differences
across member countries in credit ratings and market
liquidity (table 4). The introduction of the single
currency has led to competition for ‘‘benchmark’’
status among euro-denominated bonds.
21
At the mo-
ment, ten- and thirty-year German government bonds
are emerging as the euro benchmark issues, although
some market firms use French government securities
for reference at shorter maturities.
In general, European corporate debt markets are
less developed than those in the United States, and
corporate financing is more heavily weighted toward
bank financing. Corporate debt markets account for
only about 26 percent of corporate financing in the
EU area, compared with 68 percent in the United
States. Creation of the single currency area appears to
be helping development of this sector, with recent
increases in issuance of less-than-AA-grade bonds,
especially in the second quarter, although issuance of
so-called junk bonds remains uncommon.
22
Financing of heavy merger and acquisition activ-
ity, brought about in large part by the cross-border
opportunities provided by EMU, has also led to
increased corporate issuance, while low bond yields
in the first half of the year made bond issuance
especially attractive. The introduction of the euro has
also benefited the German Pfandbriefe market for
‘‘secured’’ asset-backed bonds issued primarily by
banks and mortgage institutions. Jumbo issues of
17. Some of the legal issues surrounding securities transactions
should be clarified by the Settlement Finality Directive, due to be
implemented by all EU members by December 1999. This directive
addresses systemic risk in payment and settlement systems primarily,
but it also covers some legal aspects of cross-border use of collateral.
18. For further details on developments in euro-area debt and
equity markets, see Bank of England, Practical Issues Arising from
the Euro (June 1999) and European Central Bank, ‘‘The international
role of the euro,’’ European Central Bank Monthly Bulletin (August
1999), pp. 32–53.
19. New issues of U.S. dollar-denominated bonds accounted for
almost half of all new international issues in the first two quarters of
1999, a share slightly lower than that in 1998. Conclusions about the
relative shares of euro- and U.S. dollar-denominated new issues are
influenced importantly by the definitions of bonds included in the
comparison. The definition used in this article includes issues denomi-
nated in a currency other than that of the country in which the
borrower resides, and issues in domestic currency where the targeted
investor resides outside the country of the issuer’s residence. For
further details, see Bank for International Settlements, Quarterly
Review: International Banking and Financial Market Developments
(August 1999).
20. The official ECU was a weighted market basket of twelve EU
currencies established in connection with the EMS. The composition
of the basket was fixed in January 1994, and currencies of countries
that joined the EU subsequent to January 1994 (the Austrian schilling,
the Finish markka, and Swedish krona) were not included in the ECU.
Thus, the ECU currency basket included nine euro-area currencies as
well as the British pound, the Danish kroner, and the Greek drachma.
On January 1, 1999, holdings of the official ECU were converted one
for one to the euro.
21. Benchmark bonds are traditionally of very high credit quality
and are easily and widely traded. They tend to be larger issues, which
are usually more liquid at any given maturity.
22. Junk bonds are bonds rated BB+ or lower by Standard and
Poor’s or Ba1 and lower by Moody’s.
4. Sovereign credit ratings and government bond spreads
for euro-area countries
Country
Credit rating,
long-term debt
Spread over
German
long-term
government
bonds
(basis points,
June 1999
average)
Moody’s Standard &
Poor’s
Austria ........... Aaa AAA 18
Belgium ......... Aa1 AA+ 28
Finland .......... Aaa AA+ 22
France ........... Aaa AAA 11
Germany ......... Aaa AAA . . .
Ireland ........... Aaa AA+ 23
Italy ............. Aa3 AA 26
Luxembourg ..... Aaa AAA 1
Netherlands ...... Aaa AAA 15
Portugal .......... Aa2 AA 28
Spain ............ Aa2 AA+ 25
. . . Not applicable.
664 Federal Reserve Bulletin October 1999
more than a billion euros have become more com-
mon, and the distribution is much wider than it was
previously. Foreign investors are increasingly active
in this market; they hold 15 percent to 20 percent of
the total outstanding in these jumbo bonds and have
increased their investment in recent issues.
Among nondomestic currency issues, European
countries outside the EU accounted for many of
the new euro-denominated issues in the first quarter
of 1999. More recently, several emerging-market
governments have substantially increased euro-
denominated issues, especially in the second quarter,
reflecting higher yields and more volatility in the
dollar market. In early July, Brazil successfully
launched a sizable euro-denominated issue, and
Argentina indicated that for the remainder of the
year, it did not intend to issue debt in U.S. dollars and
would turn instead to the euro market.
Equity Markets
Early indications are that EMU is also serving as a
catalyst for changes in equity markets. Traditionally,
divergence has been considerable across the euro
area in the mix of bonds versus equities in institu-
tional portfolio allocations, with a relatively low aver-
age share for equities of less than 10 percent in
Germany and a considerably higher share, of about
50 percent, in other euro-area countries such as the
Netherlands. Surveys suggest that European fund
managers intend to rebalance portfolios or redirect
new flows of funds, in terms of both the bond–equity
split and geographic diversification. Increasing inter-
est in Europe-wide investment opportunities has led
to a proliferation in equity indexes in the past couple
of years, both in euro-area indexes and in ‘‘Pan-
European’’ indexes that also include Swiss and U.K.
companies; however, as yet no index has emerged as
a clear benchmark.
Developments in European Banking
Most of the developments in banking in the euro area
have taken the form of consolidation within indi-
vidual euro-area countries, and from the mid-1980s,
the number of European credit institutions declined
substantially. Between 1985 and 1997, for example,
the number of banks declined 24 percent in Germany,
38 percent in France, 40 percent in Spain, and 19 per-
cent in Italy.
23
Most of these merger and acquisition activities
involved relatively small institutions, such as savings
banks, credit cooperatives, and mutual banks. More
recently, however, merger and acquisition activity
involving larger institutions has become increasingly
important, and from the 1991–94 period to the
1995–98 period, the average value of merger and
acquisition transactions increased almost tenfold.
Although bank mergers in the larger continental
European countries continue to occur primarily
within national boundaries, cross-border bank acqui-
sitions between banks in geographically close coun-
tries have become more common in the past four
years. Intra-European transactions have been under-
taken mainly in the Nordic and Benelux countries,
leading to the emergence of regional banking markets
in these areas. In addition, several cross-border pur-
chases of equity holdings in banks have recently
occurred: Large Dutch, German, and French banks
have purchased important stakes in large Spanish and
Italian banks. Although less spectacular than recent
large acquisitions within some countries, these pur-
chases signal further steps toward the integration of
European banking.
Such developments in European banking have been
driven by several fundamental forces of change that
swept through the international financial system,
including financial liberalization, technological
advances, and global diversification of savings and
investment portfolios. These factors are likely to con-
tinue to reshape banking in Europe. The final stage of
European economic and monetary union, which has
already helped raise the potential profitability of
economies of scale and scope across Europe, is likely
to lead to further structural changes and more compe-
tition in the banking sector.
USE OF THE EURO FOR TRANSACTIONS
AND AS A RESERVE CURRENCY
Euro-area countries expect to circulate euro-
denominated notes and coins beginning January 1,
2002. Until then, and for six months following that
date, national currencies will continue to circulate as
legal tender. Because the euro does not yet exist in
physical form, it can be used only for noncash trans-
actions. However, prices may be quoted in euros, and
cash transactions can be conducted in the national
currencies using the official convergence rates
(table 2). In the current transition period before the
introduction of euro currency, businesses are encour-
aged to quote prices in both the national currency and
euros. Surveys suggest that the current use of euro
23. By way of comparison, the number of banks decreased 37 per-
cent in the United States during the same period.
The Launch of the Euro 665
pricing remains limited and that considerable differ-
ences exist across countries. For example, Dun and
Bradstreet in April 1999 found that only about 30 per-
cent of the 2,040 businesses surveyed in the euro area
responded that they had started quoting prices in
euros, ranging from a high of about 40 percent in
Luxembourg and Austria to only about 10 percent
in Portugal. A majority of businesses responded that
they planned to begin pricing in euros by the end of
2000, but few expected to be pricing solely in euros
before 2002. Anecdotal evidence suggests that dual
pricing is more prevalent in the financial sector and at
the retail level.
The creation of a single European currency has led
to speculation that the euro could eventually chal-
lenge the U.S. dollar in importance as an international
reserve currency. In terms of official reserves, at the
end of 1998 the U.S. dollar accounted for about
60 percent of total official holdings of foreign
exchange. Holdings of the legacy currencies of the
euro-area countries accounted for about 14 percent,
with the single largest share of such currency hold-
ings in the deutsche mark. About 1 percent of
reserves were also held in market instruments de-
nominated in the ECU.
24
Although no comprehensive
details are currently available on total official hold-
ings of the euro so far this year, the share of the euro
in total official holdings has probably declined rela-
tive to the share held in the legacy currencies and in
ECUs. A significant portion of official reserves held
in these currencies, primarily in the deutsche mark,
was held by other euro-area NCBs, and with the
conversion of these assets to the euro, they are no
longer classified as foreign exchange reserves. How-
ever, holdings of the euro currently account for about
half of U.S. official reserves and are an even larger
share in the official foreign exchange portfolios of
some nonparticipating EU countries, such as the
United Kingdom.
25
In private-sector use, the dollar remains the pre-
eminent currency in international financial transac-
tions. The Bank for International Settlements trien-
nial central bank survey in 1998 of foreign exchange
and derivatives market activity reports that a signifi-
cant majority (87 percent) of ‘‘traditional’’ foreign
exchange transactions involved exchanges of U.S.
dollars for another currency.
26
Use of the deutsche mark accounted for about
30 percent of ‘‘traditional’’ transactions. In the
smaller, but rapidly growing, over-the-counter deriva-
tives market, transactions involving the deutsche
mark grew especially quickly in recent years.
Because many of these transactions were between the
deutsche mark and other euro-area legacy currencies,
it is difficult to infer from these statistics the current
importance of the euro in international financial
transactions.
Over time, the use of the euro as a means of
making international payments may well increase.
For example, with the introduction of euro notes and
coins in 2002, residents of countries with emerging
financial markets that currently conduct financial
transactions using the U.S. dollar may begin to use
the euro instead, especially in countries that are near
the euro area and that trade more extensively with the
euro area than with the United States. Recent devel-
opments in European financial markets are also
encouraging for the euro’s future prospects as a ma-
jor international currency. As euro-area markets
become more fully integrated, the euro is likely to
play an increasing role in international financial
transactions.
24. On December 31, 1998, the Eurosystem converted into gold
and U.S. dollars the official ECUs that had been issued to EU central
banks through revolving swaps in exchange for 20 percent of their
gross gold holdings and U.S. dollar reserves. Such ECUs amounted to
about 4 percent of international official reserves at the end of Septem-
ber 1998.
25. For details on the currency composition of U.S. official foreign
exchange reserves, see Laura F. Ambroseno, ‘‘Treasury and Federal
Reserve Foreign Exchange Operations,’’ Federal Reserve Bulletin,
vol. 85 (September 1999), pp. 616–20. For details on U.K. official
foreign exchange reserves, see the U.K. Treasury press release, ‘‘Quar-
terly Report on UK Official Holdings of Foreign Currency and Gold:
April–June 1999.’’
26. To some extent, this figure is inflated by the rise in the
exchange value of the dollar in recent years. In constant-dollar terms,
the dollar’s role on one side of foreign exchange transactions still
remains slightly above 75 percent of all transactions. For further
details on the survey, see Bank for International Settlements, ‘‘Central
Bank Survey of Foreign Exchange and Derivatives Market Activity
1998’’ (May 1999).
666 Federal Reserve Bulletin October 1999
