The Indeterminacy of the Euro Conversion Rates. Why It Matters and How It Can Be Solved

On January 1, 1999 the conversion rates of the euro into the national currencies of the EMU-countries will be fixed irrevocably. Two conditions have been attached to this conversion process. First, the Maastricht Treaty stipulates that the adoption of the irrevocably fixed conversion rates should not modify the external value of the ecu. Second, at the Madrid Summit Meeting of December 1995 it was decided that at conversion time one euro should be equal to one ecu. These two conditions severely constrain the choices about how to set these conversion rates for stage three. In a nutshell, the constraint is that the euro conversion rates used on January 1, 1999 will have to be the market rates of the ecu observed at the end of the previous day. In addition, it will not be possible to announce in advance the euro conversion rates that will be applied on January 1, 1999. The reason is that the ecu rates of the participating currencies will continue to fluctuate until the last day because the ecu contains non-participating currencies (e.g. the pound sterling). This will create problems. In particular, if the authorities rely on the market to decide about these conversion rates an indeterminacy problem will arise (see Begg, et al. (1997) and De Grauwe & Spaventa (1997)). This can be described as follows. The ecu rate of say the DM before conversion time will be determined by the expectations the market has about the future euro conversion rate of the DM. The latter, however, will be equal to the last day’s ecu rate of the DM.