27 Feb 1998

Evidence on the Costs of Intra-European Exchange Rate Variability

Daniel Gros / Ansgar Belke

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This paper finds that intra-European exchange rate variability has a statistically strong – and economically non-negligible – negative impact on (un)employment and investment for most EU member countries (including France and Germany). No similar effect was found for dollar variability. Robustness tests show that this result holds up in the presence of policy instruments (e.g. interest rates) and cyclical variables (e.g. GDP growth) that might have also an impact on exchange rate variability. A simple model of the ‘option value of waiting’ suggests that even short term spikes in volatility can have a strong impact on investment and employment.

JEL Classifications: E22, E24, F41
Keywords: European Monetary Union, exchange rate variability, hysteresis, investment, option value, uncertainty, (un-) employment
ERN Classifications: European Economics, Macroeconomics