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How to fix conversion rates

The biggest question-mark over the introduction of the euro is how to fix its rate against existing currencies. Paul De Grauwe suggests some solutions.

Life under the euro

At the start of Emu on January 1 1999, the exchange rates of the participating currencies will have to be fixed irrevocably in terms of the new currency, the euro. From then on, the national currencies will simply be particular denominations of the euro, until they are phased out at the start of 2002. How should the conversion rates be selected?

Politicians who signed the 1992 Maastricht Treaty (and who took decisions at the Madrid Summit meeting of 1995) have already given an answer to this question but, in doing so, they have created new problems. The answer is that the conversion rates that will be applied on January 1 will be equal to the Ecu market rates of the previous day at closing time. Thus if on December 31 1998 the Ecu/Deutschmark rate reaches 1.96842, this will be the fixed rate at which the Deutschmark converts into euro from January 1 1999.

This looks like a simple rule. Yet politicians seem to have delegated to the market the arduous task of choosing the conversion rates that will be irrevocably fixed.

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