US financial markets have started to react significantly to market
developments in the euro area since the new currency was launched in 1999.
At the same time, financial markets in the euro area have become
substantially more and not less dependent on developments in the United
States since economic and monetary union (EMU).
These are the key findings of new research by Michael Ehrmann and Marcel
Fratzscher of the European Central Bank, published in the October 2005
issue of the Economic Journal. Their study also shows that the increased
financial interdependence of the two economies has at least in part been
caused by a significantly higher degree of real integration over the past few
years.
EMU has created a new currency area that is much larger and more closed
than the economies of the individual member countries: the euro area is now
similar to the United States in both size and economic openness. This raises
two key questions:
• Does this fundamental regime change imply that the euro area has
become a more important player in global financial markets, so that US
markets now react more strongly to developments in the euro area
than they did in the past?
• Similarly, have euro area financial markets become more independent
from developments elsewhere in the world, and in particular more
immune from economic and financial developments in the United
States?
To gauge the degree of financial interdependence between the euro area and
the United States, this study analyses the general linkage of money markets
and the effects of the release of macroeconomic news and monetary policy
decisions in the two economies. Using daily money market rates for the period
1993-2003, the empirical results indicate that:
• There has been substantially increased interdependence with EMU:
developments in the euro area markets generally spill over to the
United States and vice versa.
• Whereas European markets had been reacting to US developments
prior to EMU, the ‘spillovers’ from Europe to the United States appear
only with the start of EMU.
• A ‘breakpoint’ test dates this increased linkage to June 1998, that is, at
a time when markets were certain that EMU would become a reality.
• Spillovers from the United States to Europe also strengthened around
the formation of EMU: breakpoint tests detect this effect in May 1999.
• Beyond this general effect, European markets react to certain
macroeconomic news about the US economy, namely those regarding
retail sales, consumer confidence, industrial production and
purchasing. Interestingly, these effects have generally become
significant only since the advent of EMU.
In the final step of the analysis, the paper attempts to shed some light on the
question why the US and euro area money markets have become so much
more interdependent, and in particular why some US news have turned into
such important determinants of euro area interest rates in recent years.
The researchers find that the correlation of US and corresponding euro area
and German announcements has increased strongly over the past five years.
Since US announcements are almost always released in a more timely
fashion than their European counterparts, this suggests that US
announcements have developed strong leading indicator properties for the
euro area economy over time.
This indicates that the higher interdependence of US and euro area money
markets in recent years may at least in part be explained by an increased real
integration of the two economies, a development that has led investors to pay
increasing attention to US news in order to learn about the prospects for the
euro area economy.
ENDS
Notes for editors: ‘Equal Size, Equal Role? Interest Rate Interdependence
between the Euro Area and the United States’ by Michael Ehrmann and
Marcel Fratzscher is published in the October 2005 issue of the Economic
Journal.
The authors are at the European Central Bank, Kaiserstrasse 29, D-60311
Frankfurt, Germany.
For further information: contact Michael Ehrmann on +49-69-1344-7327
(email: Michael.Ehrmann@ecb.int); Marcel Fratzscher +49-69-1344-6871
(email: Marcel.Fratzscher@ecb.int); or RES Media Consultant Romesh
Vaitilingam on 0117-983-9770 or 07768-661095 (email:
romesh@compuserve.com).