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| NOVEMBER 28, 2001 SPECIAL REPORT: THE AGE OF THE EURO
Why? The introduction of euro notes and coins for ordinary retail transactions, which starts on Jan. 1, will muddy the waters. More than twice as much currency as usual will have to be in circulation to ensure enough euros to go around at the beginning of the changeover. This switch will temporarily swell money-supply figures, push up prices, and distort the financial data the ECB relies on for interest-rate decisions. Economists at HSBC Investment Bank in London predict that M1--the narrowest definition of the money supply--will soar by 400 billion euros, or 18%, in January alone, after rising by only 7% or so over the previous 12 months (chart). Meanwhile, the cost of living could temporarily trend upward as retailers use the conversion process as an excuse to round up prices. "There's a risk you could get a multiplier effect that could fuel inflation," says Robert Prior-Wandesforde, an economist at HSBC. To complicate matters, distrust of the new money could persuade some investors outside the euro zone to switch marks, francs, and other legacy currencies into dollars rather than the euro, which could force down the new currency's value on foreign exchange markets. It all adds up to a lot of uncertainty. "In such an environment, policymakers in Frankfurt might prefer to sit on their hands rather than follow an activist approach to monetary policy," says Prior-Wandesforde. Things should be back to normal by the end of February, when the changeover is complete. But it could be a bumpy ride until then.  By David Fairlamb in Frankfurt Edited by Peter Coy |
