The early years after the launch of the euro were a turbulent period in which monetary policy had to react to unusually adverse economic disturbances. These included the aftermath of the Asian and Russian crises, the bursting of the dotcom bubble, terrorist acts, geopolitical tensions, and soaring food prices due to hostile weather and animal diseases. Monetary policy is now again facing difficult times, with a temporary surge in inflation coming from food and oil prices in world markets, and financial turbulence caused by the sub-prime crisis creating risks to financial stability.
Four policy episodes can be distinguished in monetary policy since the launch of the euro.
- At the start, the ECB fixed its main rate at 3%; this was then cut in spring 1999 in relation to a reduction in inflation risks in the wake of the Asian and Russian crisis. Rates then returned to their initial level in autumn 1999.
- The ECB gradually moved official interest rates to a peak of 4 3/4% in autumn 2000; this was aimed at stemming upside risks to price stability amid a buoyant economy.
- Starting in early 2001, the deterioration in economic outlook triggered a series of rate cuts; then from summer 2003 until end 2005 the official rate was kept unchanged at 2%.
- As the economy gradually recovered, the ECB raised its policy rate from December 2005 to the current (April 2008) 4% in a drive for interest rate 'normalisation.' In the meantime, inflation picked up well above the ECB definition of price stability, while economic prospects are uncertain in view of the US downturn.
As far as exchange rates are concerned, after the launch of the euro in 1999, the euro fell quickly against other major currencies. Against the dollar it reached a low in summer 2001 at USD 0.85 to 1 euro. It started to recover in mid-2002 and, while the appreciation came to a temporary halt in 2005, it quickly resumed its upward trend, reaching 1.60 USD in March 2008.
Occasionally there have been concerns over excessive volatility in the euro exchange rate, but this is not borne out by actual developments. In fact, the amplitude of quarterly swings of the nominal effective exchange rate (NEER) of the participating economies decreased from the 1980s to the 1990s and fell further with the introduction of the euro. The development in the NEER appears to have been broadly in line with fundamentals, such as interest rate and growth differentials.