This paper studies the determinants of the euro exchange rate during the European sovereign debt crisis, allowing a role for macroeconomic fundamentals, policy actions and the public debate by policy makers. It finds that the euro exchange rate mainly danced to its own tune, with a particularly low explanatory power for macroeconomic fundamentals. Among the few factors that are found to have affected changes in exchanges rate levels are policy actions at the EU level and by the ECB. The findings of the paper also suggest that financial markets might have been less reactive to the public debate by policy makers than previously feared. Still, there are instances where exchange rate volatility was increasing in response to news, such as on days when several politicians from AAA-rated countries went public with negative statements, suggesting that communication by policy makers at times of crisis should be cautious about triggering undesirable financial market reactions.
JEL Code: E52, E62, F31, F42, G14
Keywords: exchange rates, fundamentals, announcements, sovereign debt crisis.
Michael Ehrmann (European Central Bank, firstname.lastname@example.org), Chiara Osbat
(European Central Bank, email@example.com), Jan Strasky (Organisation for Economic
Co-operation and Development, firstname.lastname@example.org), and Lenno Uusküla (Bank of Estonia, email@example.com).
We thank Paolo Gambetti for research assistance, editorial board and an anonymous referee of the ECB Working Paper Series as well as participants at seminars at the ECB, the Bank of Estonia, and workshop at the Bank of Italy for useful comments.
This paper presents the authors’ personal opinions and does not necessarily reflect the views of the European Central Bank, the Bank of Estonia, the Eurosystem or the OECD.