COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 31.10.1995 
COM(95) 503 final 
COMMUNICATION FROM THE COMMISSION 
THE IMPACT OF CURRENCY FLUCTUATIONS 
ON THE INTERNAL MARKET 

The impact of currency fluctuations on the internal market 
Communication from the Commission 
to the European Council 
Foreword 
The European Union has seen considerable currency fluctuations since the summer of 1992. 
In three years, five currencies have depreciated by 20% or more against the most stable 
currencies in the EMS. 
The scale and speed of these changes have justified this question being raised at the highest 
political level. At its meeting in Cannes in June, the European Council requested the 
Commission to "carry out a detailed examination of those problems and to report on its 
conclusions in the autumn". 
In response to this request from the European Council, the Commission has attempted to 
identify the impact of intra-Community currency fluctuations on economic growth and on 
the internal market. It is also ready to present this report to the appropriate institutions of 
the Union. 
I. Constraints 
However detailed it may be, any study of this type comes up against a number of difficulties: 
some of the key data for the period after 1994 are not yet available; 
the effects of the fluctuations on investment decisions and employment are difficult to 
quantify; 
it is too early to draw definitive conclusions as to the ultimate consequences of these 
fluctuations, especially as relatively long periods can elapse before firms react; 
it has only been possible to analyze certain sectors in detail; 
II. Findings 
Despite these constraints, a number of phenomena can be identified: 
a deceleration of growth 
According to the estimates of the Commission's services - confirmed by other international 
institutions - the currency turmoil and the sudden changes in current or anticipated profitability 
stemming from it have engendered uncertainty and a wait-and-see attitude among economic agents, 
leading to a slowdown in growth in 1995 of the order of 0.25 to 0.5 of a percentage point (dollar 
related effects included). Sustained growth in Europe is an essential precondition for reducing 
excessive unemployment. 
1^ 
a variable effect on cost competitiveness 
The effects of the currency fluctuations between 1992 and 1995 on long-term cost competitiveness 
vary. Of those Member States whose currencies have depreciated, some recorded appreciable gains 
in cost competitiveness between 19871 and 1995 (Italy, Sweden), while others experienced falls 
(Spain) and yet others recorded no change (United Kingdom). Of those Member States whose 
currencies have appreciated, some saw their cost competitiveness decline between 1987 and 1994 
(Germany), while others remained stable (France). 
a secondary effect on,trade balances... 
Member States' trade balances seem to be less influenced by currency fluctuations than by 
structural factors and the growth differential between one country and its trading partners. Over 
a lengthy period (1987-94), France and Spain recorded an increase in market-shares in value terms 
for manufacturing industry, Germany a marked reduction, and Italy and the United Kingdom a 
slight fall. 
... but an appreciable effect on profit-margins 
One of the reasons why the visible macroeconomic effects seem to be limited is that exporters in 
countries whose currencies have depreciated have improved their margins since 1992 whereas 
exporters in the other countries have reduced their margins. The consequences of this profit-
margin behaviour are difficult to foresee. On the one hand, firms in countries whose currencies 
have depreciated could be tempted in future to pursue more aggressive commercial policies. On 
the other, these variations in profitability may have an impact on corporate investment and 
development. 
a more visible impact at sectoral and regional levels 
The impact of the currency fluctuations is more marked when individual branches of activity are 
analyzed. In the car and clothing industries, for example, an erosion of margins and a fall in 
exports in volume terms are noted in countries with stable currencies. Some frontier regions close 
to countries whose currencies have depreciated are also experiencing specific difficulties. 
III. What conclusions should be drawn? 
difficulties for the Union economy 
January 1987 saw the last general realignment within the EMS and relative exchange-rate 
equilibrium. It therefore constitutes a logical reference date for studies of this type. The 
choice of another equivalent reference date (1983) does not alter the conclusions. 
-* b 
On the basis of these findings, the Commission concludes that currency fluctuations are creating 
certain difficulties for the Union economy, although these are in no way attributable to the 
elimination of trade barriers or to the internal market rules. 
In general, the uncertainty arising from these changes may lead to a misallocation of resources and 
create difficulties in terms of the location of production activities. It is particularly clear that this 
uncertainty is having a negative effect on economic operators, is curbing investment and is 
slowing growth. 
Furthermore, in those countries whose currencies have remained stable the speed and scale of the 
changes which have occurred since September 1992 are posing difficult adjustment problems for 
certain sectors and regions. Even where the currency fluctuations are merely compensating for 
earlier cost-competitiveness differentials, they are causing disruption which firms cannot easily 
absorb at a moment's notice. 
At the same time, in those countries whose currencies have depreciated the fluctuations are causing 
a resurgence of inflation and a rise in interest rates, to the detriment of healthy and sustained 
growth. "Past experience with devaluations shows that they have not brought lasting success in 
economic-policy terms. 
the need to attack the causes of the fluctuations 
Given these difficulties, new measures designed to correct the effects of the currency fluctuations 
on those sectors and regions affected might aggravate the problems: re-fragmentation of the single 
market, curbs on trade and a further slowdown in growth at the expense of employment. 
In some cases, the currency fluctuations could have the effect of aggravating the problems of 
sectors or regions already affected by structural difficulties; these effects would then be examined 
-like the effects of any other cause- within the limits of the existing Community rules and 
mechanisms. In no circumstances shall this examination put into question either the allocation of 
structural funds between Member States or between objectives, or their programming rules. 
Currency fluctuations are essentially a macroeconomic phenomenon, even if the effects are felt at 
sectoral or regional level. The solutions adopted cannot: and should not tackle their consequences 
but should attack their causes. These causes are directly linked to the insufficient progress made 
towards convergence, particularly as regards the reduction of government deficits. 
single currency and convergence of economies 
The definitive solution to this turmoil lies in the convergence of economies - this being necessary 
for the introduction of a strong and stable single currency - and particularly in durable compliance 
with the inflation and government-deficit criteria set out in the Treaty, It should be pointed out 
in this connection that the single currency is destined to become the currency of the whole of the 
Union as soon as possible. 
1 c 
In both the short and the long term, reinforcement of the convergence process is thus essential for 
preserving and strengthening the internal market. Furthermore, with or without a single currency, 
a reduction in deficits is necessary if the sanction of the markets and higher interest rates are to 
be avoided. Progress on the convergence front will also serve to establish a sound 
macroeconomic framework for promoting growth and combating unemployment. This is one of 
the key points of the European strategy for employment, which also aims to enrich the 
employment content of growth through micro-economic and structural measures. 
strengthening of convergence 
Within this framework, the Commission will ensure that the mechanisms provided for in the Treaty 
for strengthening convergence are rigorously applied. It will also ensure that effective means are 
used to achieve this objectif. It will finally ensure that the rules governing the operation of the 
internal market as a whole are strictly implemented. 
This strengthening of convergence will also establish the foundations for reinforced monetary 
solidarity. These two points are indissociable, particularly in the context of the third stage of 
economic and monetary union, when a mechanism to replace the current EMS will have to be 
introduced for those Member States unable to adopt the single currency from the outset. 
It is in this spirit that the Commission is now preparing, for the European Council meeting in 
Madrid, its contribution to the interim report in the context of the request from Cannes on the 
future exchange-rate relationship between the european currency and the currencies of the other 
countries in the Union. 
The conclusion of this report is that the Commission considers that the single currency is the 
essential complément to the single market. Economic and monetary Union is the appropriate 
response to the difficulties caused by monetary fluctuations to the European economy. Any other 
solution would risk being worse than the problems which it seeks to resolve. 
All the efforts and progress being made in the convergence process ahead of monetary union are already 
helping to cushion the conséquences of the currency fluctuations and to establish a sound macroeeonomic 
framework that is condïieive to growth and job creation. 
1 d 
I. INTRODUCTION 
1. At its summit meeting in Cannes, the European Council emphasized that "if the recent 
currency turmoil continues, it might affect the proper operation of the single market and put 
a brake on the process of harmonious and balanced growth". It requested the Commission 
to "carry out a detailed examination of those problems and to report on its conclusions in 
the autumn" (SI (95) 500, 27 June 1995). This request has to be placed in the context of 
Article 109m of the Treaty on European Union, which stipulates that "each Member State 
shall treat its exchange-rate policy as a matter of common interest". 
2. Since the crisis in the EMS exchange-rate mechanism in September 1992, a number of 
European currencies have depreciated sharply against the German mark. Such was the case 
between August 1992 and August 1995 with the Italian lira (31% depreciation), the 
Swedish krona (27%), the Spanish peseta (24%) and the pound sterling (18%). This period 
of turbulence on the foreign-exchange market has been marked by three important events: 
the departure of the pound sterling and the Italian lira from the EMS exchange-rate 
mechanism in September 1992, the decision in August 1993 to widen the mechanism's 
margins of fluctuation to 15%, and the sharp depreciation in the US dollar in February and 
March 1995, which contributed to the depreciation of a number of European currencies. 
The depreciation of these European currencies is the result of pressures exerted by the financial 
markets. However, even if not determined politically, these depreciations represent a penalty 
imposed by the markets in response to insufficiently tight macroeconomic policies. 
3. In theory, exchange-rate movements can affect trade within the EU in two different ways. 
Firstly, short-term movements may - because of the uncertainty they engender - lead to a fall 
in the volume of trade. Secondly, certain medium-term movements can also affect trade flows 
and international specialization on account of the changes in competitiveness that they 
engender. 
4. Generally speaking, exchange-rate movements can also have major macroeconomic effects. 
Firstly, uncertainty can have a substantial negative impact on the growth prospects of the 
Community as a whole through its harmful effect on investment and consumption decisions. 
Secondly, exchange-rate changes can lead to a redistribution of economic growth and inflation 
between those countries whose currencies appreciate and those whose currencies depreciate, 
with the latter experiencing in the short run an increase in growth but an upsurge in inflation. 
5. The Commission's departments have carried out an examination of the impact of recent 
exchange-rate movements on the operation of the internal market and on the economic growth 
of the Union and its Member States. In carrying out their examination, they encountered a 
number of difficulties of a methodological and empirical nature. On the methodological front, 
it is clearly a very complex task to isolate exchange-rate effects from other economic events 
occurring over the same period. The difficulty is accentuated by the fact that the available 
observation period is short, which makes it impossible to take account of all the effects. 
Moreover, a certain degree of caution is required particularly as the relatively long period of 
time that elapses between monetary fluctuations and the responses of enterprises to those 
fluctuations may be such that these responses are not captured owing to the shortness of the 
observation period. At the empirical level, the introduction of the single market has caused 
a break in the statistical series for trade and has delayed their publication. In effect, the 
introduction of a new system for data collection has affected the comparability of intra-
Community trade statistics before and after 1993. Given these difficulties, the Commission's 
departments have used a range of indicators the findings of which are set out below. 
II. CURRENCY FLUCTUATIONS AND THEIR IMPACT ON GROWTH AND TRADE 
Macroeconomic impact on growth 
6. At the macroeconomic level, the recent exchange-rate movements between Union currencies 
are a cause for concern. Since the beginning of 1995, growth and investment in the 
Community as a whole has slowed somewhat, partly as a result of the purely economic 
consequences of these exchange-rate movements and partly as a result of a loss of confidence 
by economic agents in the face of currency uncertainties. This general statement masks 
divergent effects between those countries whose currencies have depreciated and those whose 
currencies have appreciated. In the case of the former, the benefits in terms of economic 
growth have been accompanied by a surge in prices and nominal interest rates, which has, to 
some extent, accentuated households' uncertainty. By contrast, in the case of the latter (whose 
weight in GNP terms within the Union easily exceeds 50%), the slowdown in growth has been 
accompanied by a reduction in inflation. It should be pointed out that, within both groups, the 
magnitude of the effects varies according to the degree to which the currencies have 
appreciated or depreciated. 
On the basis of economic simulations and the latest information, the Commission's departments 
estimate that currency turbulence may reduce Community growth and investment by between 
0.25 and 0.5 of a percentage point in 1995 (including the dollar effect). For Italy, the 
simulations indicate a further increase in prices of 1.5 percentage points and an increase in 
short-term nominal interest rates of 2 percentage points. For the countries with appreciating 
currencies, the simulations indicate a decline in inflation and in short-term nominal interest 
rates of between 0.5 and 1 percentage point (the simulations are based on the assumption that 
real short-term interest rates are constant). Generally speaking, these findings are confirmed 
by other international organizations, e.g. the OECD. 
It must be stressed that the situation regarding exchange-rate changes between the European 
currencies is partly the result of movements in the dollar. In February and March 1995 the 
dollar fell sharply against Community currencies, and this has led to wider divergences 
between European currencies and to greater instability. Over the period from 1992 to 1995, 
for example, the movements in the DM/$ and the DM/LIT exchange-rate parities have been 
parallel (significant correlation). It is therefore very difficult to assess the effects of 
fluctuations between European currencies independently of the dollar effect. 
Exchange-rate movements and cost competitiveness 
7. On the trade front, the first problem is to establish to what extent the movements in nominal 
exchange rates have affected Member States' cost competitiveness. The concept of cost 
competitiveness traditionally used by international organizations should not be confused with 
the more general concept of competitiveness. The concept used here is a measure based purely 
on the unit cost of labour for a country relative to its trading partners. Cost-competitiveness 
indicators entail the arbitrary choice of a reference year. The Commission's departments have 
principally adopted the first quarter of 1987 as the reference period because it constituted a 
period of exchange-rate stability which ended with the September 1992 crisis. Choosing an 
alternative period (1983) does not alter the main conclusions drawn from the 
cost-competitiveness analyses. 
8. The period from 1987 to 1992 was characterized both by relatively stable nominal exchange 
rates and by contrasting patterns of inflation and productivity the overall result of which was 
divergent cost-competitiveness trends among Member States. Over the period from the third 
quarter of 1992 to the third quarter of 1995, a number of countries saw their nominal effective 
exchange rates appreciate. Such was the case in Germany, Denmark, France, the Netherlands, 
Austria, Belgium and Finland, which recorded rates of appreciation ranging from 15% 
(Germany) to 7% (Finland). By contrast, Italy, Sweden, Spain, Greece, the United Kingdom, 
Portugal and Ireland saw their nominal effective exchange rates depreciate by amounts ranging 
from 26% (Italy) to 2% (Ireland). 
9. These changes in nominal exchange rates have had differing effects on cost competitiveness, 
depending on the country in question. In some cases, they have offset the cost-competitiveness 
gains or losses recorded over the period from 1987 to 1992. In others, they have led to net 
gains or losses in cost competitiveness compared with the trends over that period. 
10. In those countries whose cost competitiveness had deteriorated sharply between 1987 and 1992 
the nominal changes which occurred over the period from the third quarter of 1992 to the third 
quarter of 1995 have more than compensated for the previously recorded losses in some cases 
(Sweden) and have partially compensated for the losses in others (Spain). For Greece and 
Portugal, these nominal changes have not led to any improvement in cost competitiveness, 
which has continued to worsen. This has not necessarily entailed a deterioration in their overall 
competitiveness since Portugal, for example, has seen an expansion in its intra-Community 
market shares. 
For France and Austria, whose cost competitiveness improved appreciably between 1987 and 
1992, the nominal changes occurring between 1992 and 1995 have eliminated to a great extent 
the previous gains. 
Amongst those countries experiencing limited movements in cost competitiveness over the 
period from 1987 to 1992, the nominal changes from 1992 to 1995 have enabled Italy to 
record a major gain in cost competitiveness (24% over the period from the first quarter of 
1987 to the third quarter of 1995). By contrast, those changes have led to a fairly considerable 
loss in cost competitiveness for Germany (20%) and, to a lesser extent, Denmark (9%) and the 
BLEU (7%). In the United Kingdom and the Netherlands, the changes in cost competitiveness 
have been relatively slight over the entire period from the first quarter of 1987 to the third 
quarter of 1995. 
In conclusion, it should be emphasized that there is no strict relationship between variations in 
nominal exchange rates and variations in cost competitiveness. The former do not necessarily 
affect the latter as currency fluctuations are not the only factor causing variations in cost 
competitiveness. Improvements in unit wage costs denominated in national currency that stem 
from increased productivity changes and efforts to moderate wage increases can also influence 
cost competitiveness (Table 1). 
Impact of exchange-rate movements on current-account and trade balances 
11. The second question is to what extent these changes in cost competitiveness have affected 
current-account and trade balances. The figures so far available, covering the period up to the 
end of 1994, do not show major distortions in trade. Even though it is true that the 
current-account balances of countries whose currencies have depreciated have improved (except 
in the case of Portugal), the same applies to most countries whose currencies have appreciated, 
the two exceptions being Austria and particularly Germany. In the latter case, the deterioration 
noted is due mainly to the effects of unification. It can therefore be concluded from these 
developments that current-account balances have not been influenced simply by the 
cost-competitiveness trend; cyclical and structural factors have also played an important part. 
To sum up, it transpires that exchange-rate fluctuations have not had a significant impact on 
current-account balances. 
With regard to trade balances, although cost competitiveness may have had a real effect, this 
has to a large extent been cushioned by changes in profit margins. Furthermore, analysis 
shows that the relative growth of domestic demand is an important determinant of trade 
balances. The relative weakness of domestic demand in a number of countries whose 
currencies have depreciated (notably Italy and Sweden) has contributed to the improvement 
in their trade balances. Furthermore, trade balances have been influenced by such notable 
events over the last decade as the accession of Spain and Portugal to the European Union, 
German unification and the creation of the European single market. 
Sectoral and regional effects of exchange-rate movements 
12. The third and final question is whether certain Member States and/or sectors have been 
especially affected by the changes in exchange rates and cost competitiveness. In the case of 
manufacturing industry, changes in production prices expressed in ecus over the period from 
1987 to 1994 broadly confirm the results obtained in terms of cost competitiveness. This new 
indicator (production prices), together with the cost-competitiveness indicators, therefore 
provides coherent results. 
Over the whole period from 1987 to 1994, Portugal recorded the highest increase in 
manufacturing prices compared with the Community average (+39%). It was followed by 
Greece (+8%), Germany (+5%), the BLEU (+5%) and Denmark (+3%), all of which also 
recorded increases in production prices. By contrast, Italy (-13%) and, to a lesser extent, 
Spain (-4%) and France (-1%) saw a relative fall in their production prices. The other 
countries show trends similar to the Community average (Table 3) 
13. The pattern of market shares in value terms for manufacturing industry shows that structural 
factors largely dominated exchange-rate effects over the period from 1987 to 1994. The 
analysis could not be extended to 1995 owing to the delay in data being made available. 
Within the Union, France and Spain saw a steady improvement in their market shares over the 
period from 1987 to 1992 (+2.5 percentage points for France, +1.3 percentage points for 
Spain). By contrast, Germany recorded a loss of 3.3 percentage points and Italy one of 0.8 
of a percentage point over the same period. Between 1992 and 1994 the situation in Germany 
showed a continual marked decline (-3.4 percentage points), whereas that in Spain continued 
to improve (+0.5 of a percentage point). In France there was some break in the trend after 
1992, its market share having diminished by 0.6 of a percentage point. But this loss is still 
small compared with the gains over the previous period. In Italy, however, there was no real 
break in the tendency for its market shares to decline. 
Outside the Union, the conclusions are not fundamentally different. However, Germany's 
market-share losses and Spain's gains have been more limited than those recorded within the 
Union. Over the period from 1987 to 1992, France's market-share gains outside the Union 
were slightly lower than within, but its losses over the period from 1992 to 1994 were greater 
outside the Union than within. In the case of Italy, market shares remained stable over the 
whole period from 1987 to 1994, with a slight improvement between 1992 and 1994 (Table 2). 
14. The pattern of total exports of industrial products in volume terms over the period from 1987 
to 1994 confirms that changes in production prices in a common currency are not the most 
important determining factor. Cyclical and structural factors also played a very important role. 
Compared with the Community average, Spain and Portugal enjoyed the highest levels of 
export-volume growth (+60% and +32% respectively), mainly as a result of the modernization 
of their economies and the removal of trade barriers within the Community. France (+12%) 
performed appreciably better than its European partners over the period from 1987 to 1994, 
although it did less well than its European partners over the period from 1992 to 1994. By 
contrast, German exports fell by 16% compared with the Community average, partly as a result 
of the unification process, which has reinforced a long-term trend. Italy's export-volume 
growth was systematically lower than the Community average (-2%) over the period from 
1987 to 1994. The catching-up recorded between 1992 and 1994 failed to offset the relative 
losses suffered over the previous period (Table 3). 
15. However, there are appreciable differences according to whether markets outside or inside the 
Community are considered. Over the period from 1987 to 1992, intra-Community exports of 
industrial products rose much more quickly in volume terms than exports to non-Community 
markets (+4.7% per year on average in volume terms compared with 1.5%). There was a 
reversal of this situation between 1992 and 1994 (+0.1% per year in the case of 
intra-Community markets as opposed to +9.2% in the case of non-Community markets). These 
trends are clearly explained by the stronger relative growth of demand in the EU compared 
with trading partners between 1987 and 1992, whereas the situation was reversed between 
1992 and 1994. Some countries whose currencies depreciated between 1992 and 1994 
benefited from this situation on markets outside the Community. This was particularly the 
case with Italy (+14.2%), Spain (+17.8%), Greece (+12.9%) and the United Kingdom 
(+12.3%), which recorded very sharp increases in their exports to markets outside the 
Community between 1992 and 1994 (Table 3). 
16. One of the reasons why the impact of production-price changes on export volumes was 
relatively limited in the case of intra-EU trade is that exporters in countries whose currencies 
depreciated increased their profits instead of reducing their export prices. For industrial 
products generally, exporters in certain European countries whose currencies depreciated 
increased their export margins and did not take the opportunity to expand their market shares. 
This was particularly the case in Italy and Spain. 
The observation period since the beginning of the currency turmoil has, of course, been short 
(a little more than two years), making it impossible to take account of all the effects. It is 
probable that not all the direct and indirect effects of the exchange-rate movements have yet 
been felt. In countries whose currencies have depreciated, exporters' strategies regarding 
export margins could change. Once their profit margins have been restored, they could adopt 
a more aggressive strategy in terms of market shares unless, as is often the case after a 
depreciation, production costs (import prices, wages) rose sharply. In countries whose 
currencies have appreciated, those exporters who have reduced their margins in order to hold 
on to market shares could rapidly encounter profitability difficulties. This could jeopardize 
their capacity to finance investment. 
17. The situation varies according to the sector of activity and the degree of competition between 
producers. The Commission's departments have made an in-depth study of several sectors that 
were chosen because of their importance in intra-Community trade. It transpires that some of 
6 
these sectors are particularly sensitive to monetary fluctuations: cars, textiles and clothing (a 
sector in which SMEs play an important role) and certain agricultural products. In these three 
sectors, enterprises from countries whose currency has appreciated have expressed concern to 
the Commission about the falls in their export margins and the contraction in market shares. 
For these sectors, it would seem that countries whose currencies have appreciated have had 
difficulty in penetrating the markets of Community countries whose currencies have 
depreciated. Conversely, the latter have generally not improved their positions on the markets 
of Community countries whose currencies have appreciated, even though some of them have 
improved their positions on markets outside the Union. 
In the case of cars, exporters in those major countries whose currencies depreciated between 
1992 and 1994 (Italy, the United Kingdom and Spain) have not increased their market shares 
to any appreciable extent in those EU countries whose currencies have appreciated. They have 
instead boosted their profits from the Community market. However, they have performed 
remarkably well in volume terms in non-member countries of the EU. This is partly explained 
by lower increases in export prices on markets outside the Community than on markets in the 
Union. 
By contrast, exporters in countries whose currencies have appreciated have encountered 
difficulties in countries whose currencies have depreciated. This is particularly the case with 
German and French exports to Italy, where reductions in German mark and French franc 
prices, entailing an erosion of profit margins, have still not been sufficient to prevent a fall in 
exports in volume terms. However, the exchange-rate effect seems to be much more marked 
in France than in Germany, where other factors have affected exports. Unlike the Italian 
market, the United Kingdom market has remained very active (strong growth of 
domestic demand). This has enabled French and German exporters to increase their exports 
to the United Kingdom despite the depreciation of the pound sterling. 
It should be pointed out, however, that some of the geographical reorientation of exports 
observed during the period 1992-94 constitutes a continuation of a trend already established 
during the period 1987-92 (for example, the decline in the importance of the Italian market 
for French exporters). 
18. In the clothing sector, firms in some countries whose currencies have depreciated (Spain, the 
United Kingdom and Italy) saw their export volumes increase strongly between 1992 and 1994, 
particularly on markets outside the Union. By contrast, firms in most of the countries whose 
currencies have appreciated experienced an appreciable fall in export volumes between 1992 
and 1994, particularly on the Community market (cases of France and Germany). 
Trends in this sector over the period 1992-94 are at odds with those discernible during the 
period 1987-92. In the earlier period, France and Germany recorded higher rates of growth 
for clothing exports in volume terms than Spain, the United Kingdom and Italy. 
19. In the case of agricultural products, the situation is significantly different from other economic 
sectors, owing to the existence of institutionally set prices and aid, fixed in ecus, and of 
"green" exchange rates used to convert these amounts into domestic currencies. In principle, 
movements in these "green" exchange rates follow market-determined exchange rates but, in 
view of the desirability of stable prices and aid, only with a certain lag. 
The effect of exchange-rate movements depends, of course, on whether or not institutional 
prices exist. For products covered by intervention systems, exchange-rate movements affect 
the prices of products proportionally, sometimes with the aforementioned* lag. Given that 
institutional prices are the same for all Member States, exchange-rate movements have little 
impact on trade flows, except sometimes in the short-term. For products not covered by 
intervention systems, the situation in price terms is comparable to that of non-agricultural 
products. 
Exchange-rate movements affect farmers' incomes and therefore the long-term competitiveness 
of agricultural products. Besides their effect on prices, exchange rates have a direct impact 
on aid, which outpaces inflation when there is a strong depreciation or declines when the 
currency appreciates. However, farmers do benefit from mechanisms designed to protect them 
against certain shortfalls in aid denominated in national currency and are eligible for 
compensation for any falls in income consequent upon price reductions attributable to 
monetary factors. 
20. The Commission's departments have examined the trend in trade in two products not covered 
by intervention systems: vegetables and pigmeat. The effects of exchange-rate movements are 
clearly dominated by structural factors (such as the growing economic stature of Spain) and 
by stochastic factors linked to climatic conditions. Thus, in the case of vegetables, Spanish 
exports to France and Germany had already increased well before the depreciation of the 
peseta, while the long-term decline in Italian exports to France and Germany was not checked 
to any significant degree by the depreciation of the lira. 
21. In the case of certain services (construction and public works, distributive trades and tourism), 
surveys carried out at local level show that successive depreciations of the peseta and the lira 
seem to pose adjustment problems for the economies of certain frontier regions. This is 
particularly the case for France and Austria. Consumers in frontier regions of countries whose 
currencies have appreciated frequently cross the frontier to make purchases since the additional 
transport cost is offset by substantial savings due to price differences. Furthermore, 
construction firms in countries whose currencies have depreciated benefit from the relatively 
low cost of labour and are awarded contracts in frontier regions of countries whose currencies 
have appreciated. Finally, diversion effects occur when tourists in the same region choose to 
spend their holidays in the area with the lowest prices. 
III. ECONOMIC-POLICY IMPLICATIONS 
22. In contrast to the stability experienced in the period 1987-92, nominal exchange rates have 
undergone sharp and significant changes since September 1992. This has often been 
accompanied by changes of a similar nature in cost competitiveness. 
This upheaval is at the root of a number of problems which have arisen, on the one hand, in 
respect of the operation of the internal market and, on the other hand, in the macroeconomic 
context. In the case of the internal market, the speed and scale of the changes which have 
occurred since September 1992 are posing difficult adjustment problems for certain sectors and 
regions (which had enjoyed cost-competitiveness advantages between 1987 and 1992). 
Furthermore, the uncertainty arising from these changes may have led to a misallocation of 
resources in terms of the location of production activities and investment decisions. As regards 
the macroeconomic context, economic agents have displayed an uncertainty and a wait-and-see 
attitude - particularly following the 1995 currency fluctuations - which have had a negative 
impact on investment and growth. In addition, the reduction in growth in countries whose 
8 
currencies have appreciated is having a relatively major impact on the EU given their weight 
in the Union. 
These problems affecting the operation of the internal market and growth have been made all 
the more difficult to handle by the fact that the Community economy was experiencing cyclical 
recession in 1993. 
23. However, trade movements measured over the entire period 1987-94 show that the 
exchange-rate fluctuations recorded since 1992 have not hitherto been of major importance at 
the aggregate level. Over the long term, structural factors have played a clearly dominant role: 
accession of Spain and Portugal, decline in Germany's relative export weight accentuated by 
the unification process, increased export orientation of the French economy, etc. 
24. However, the suddenness and scale of the exchange-rate movements since September 1992 
entail - because of the adjustment problems they have created - a number of risks for the 
operation of the internal market. Some firms are tempted to erect barriers to trade, while the 
public authorities come under pressure to intervene to help sectors or regions particularly 
affected. 
25. With regard to corporate behaviour, firms may be tempted to introduce trading restrictions to 
protect their margins. In the car industry, widening price differentials between Member States 
linked to exchange-rate movements have led consumers in frontier regions to cross frontiers 
to buy their cars. Since the beginning of 1995, the Commission's departments have received 
numerous complaints regarding alleged refusals to sell to non-national consumers or the 
possible rationing of such sales. These complaints will be analysed in the light of the 
Community rules in force, and in particular the Regulation on selective distribution. At the 
same time, the distributors' associations have drawn attention to the financial problems facing 
some of their members. 
26. The public authorities in countries whose currencies have appreciated are coming under 
pressure from the sectors or regions most affected to rectify the situation. This applies 
particularly to textiles, clothing, shipbuilding, cars and frontier regions bordering Spain or 
Italy. Such pressure can only intensify if there are further devaluations. 
Any policy designed to compensate for currency fluctuations through specific measures might 
lead first to an escalation of public expenditure, with each Member State reacting to the 
measures of others by providing new national support. Such an escalation would be 
particularly damaging to public finances and will, in the final analysis, serve only to aggravate 
the difficulties faced by the firms concerned. Furthermore, such fluctuations are essentially 
a temporary phenomenon in which winners and losers are constantly changing. Finally, even 
within a given sector, it is extremely difficult to determine the precise nature of the damage 
caused by a devaluation: while some market segments may be permanently affected, others 
may retain key comparative advantages. 
For some time now, the Community and its Member States have implemented structural 
adjustment mechanisms to facilitate the transition of sectors or regions confronted with 
structural difficulties: for example, the Structural Funds and certain Community initiative 
programmes; ECSC funds for the conversion of certain industrial areas; state aid for rescuing 
or restructuring industries; regional aid, such as that subject to Commission frameworks or 
codes. 
It cannot be ruled out that severe currency turmoil can make sectors or regions already affected 
by structural or cyclical crises even more fragile. However, monetary fluctuations cannot be 
used to justify any violation of Community mechanisms or rules. If these fluctuations were 
to aggravate the difficulties of a sector or region appreciably, their effects would be examined, 
like the effects of any other cause, within the limits of the existing Community rules and 
mechanisms. In no circumstances shall this examination put into question either the allocation 
of structural funds between Member States or between objectives, or their programming rules. 
At any event, the Commission will seek to ensure strict application of the rules governing the 
functioning of the internal market in its entirety and a regime of undistorted competition. 
The introduction of anti-competitive practices in the form of limits on parallel imports or state 
aid linked to exchange-rate movements (except in the case mentioned at point 191) would 
clearly contravene Community rules on competition and would not conform to internal-market 
rules. Such measures risk setting off a process of refragmentation of the internal market, a 
reduction in intra-Community trade and a slackening of growth in Europe. They would 
therefore jeopardize the efforts being made to complete the internal market. The internal 
market is the cornerstone of European construction. The Commission and the Member States 
must therefore consolidate the internal market and make every effort to prevent such 
refragmentation. 
27. To this end, the Commission and the Member States must work together to establish an area 
of relative currency stability as an accompaniment to the harmonious development of the 
internal market. This calls for political will that must be reflected in action at internal and 
external levels. 
28. Internally, currency stability requires Member States to exercise greater discipline. Past 
experience with devaluations shows that they have not brought lasting success in 
economic-policy terms. They have a cost in terms of inflation, risk premiums, high interest 
rates, and, more generally, credibility. The currency turmoil that the EU has recently 
experienced does not stem from a deliberate wish of certain Member States to make 
cost-competitiveness gains but from weaknesses in those economies, especially their 
macroeconomic management. 
The solution to the problems posed by currency turmoil therefore lies primarily in the 
appropriate treatment of such weaknesses, particularly at the macroeconomic management 
level. In the context of EMU, the convergence process holds the key to preserving the internal 
market. Furthermore, progress towards convergence serves to recreate a healthy 
macroeconomic climate which benefits growth and the fight against unemployment. This is one 
of the pillars of European employment strategy, which also aims to increase the employment 
content of growth by microeconomic and structural means. 
The margin for manoeuvre provided by the current upturn must therefore be exploited to 
reinforce efforts to consolidate public finances. In this connection, analyses indicate a link 
between exchange-rate stability and public-deficit levels, with countries whose currencies have 
depreciated generally showing the highest public deficits. Budgetary consolidation is essential 
if credibility is to be improved and a sound basis for growth re-established. 
The conditions which would permit the introduction of a single currency represent the only 
For the agricultural sector, sec Article 42 of the Treaty. 
10 
permanent answer to the risks associated with currency turbulence within the single market. 
Moreover, as requested by the Cannes European Council, it is necessary to examine future 
exchange-rate relationships between the European currency and the currencies of the other 
Members of the Union. The Commission is preparing its contribution to the interim report for 
the Madrid European Council in the light of this request. In this respect, the Commission 
underlines the importance of ensuring that such relationships are based on reinforced 
convergence. 
29. Externally, it is necessary to promote the coordination and monitoring of economic and 
monetary policies at international level. Currency turbulence is not simply an internal matter 
for the Community economies; weaknesses in the dollar tend to create great strains between 
European currencies. The dangers of the internal market refragmenting therefore increase the 
need for the Union to speak with one voice in international forums. 
II 
Table 1: Nominal effective exchange rates1 and cost competitiveness2 
CHANGE (%) 
BLEU 
DK 
D 
GR 
E 
F 
IRL 
I 
NL 
A 
P 
FL 
S 
UK 87ql/83ql 
Nominal effective 
exchange rate 
6.4 
6.2 
17.5 
-47.4 
-12.0 
-2.8 
-6.7 
-8.1 
10.0 
11.1 
-42.8 
1.7 
-2.2 
-14.9 Cost 
Competitiveness 
3.5 
21.4 
11.3 
-15.3 
-6.4 
Ô.l 
-19.0 
-4.7 
-6.3 
5.8 
-7.6 
-1.8 
3.6 
-113 92q3/87ql 
Nominal effective 
exchange rate 
2.7 
Ô.4 
3.2 
-39.8 
11.0 
Ô.6 
1.4 
-6.8 
2.3 
2.3 
-9.2 
-ll.Ô 
-0.8 
0.3 Cost 
Competitiveness 
-2.6 
-3.Ô 
3.0 
13.1 
29.1 
-1Ô.4 
-23.2 
2.6 
-8.4 
-10.4 
18.6 
-17.3 
13.0 
6.7 95q3/92q3 
Nominal effective 
exchange rate 
9.9 
12.6 
15.0 
-14.2 
-15.9 
11.9 
-2.1 
-26.4 
10.7 
1Ô.7 
-7.5 
6.8 
-20.3 
-11.2 Cost 
Competitiveness 
1Ô.4 
12.8 
16.5 
12.7 
-16.Ô 
8.7 
-9.0 
-26.% 
4.Ô 
9.6 
6.8 
Ô.3 
-24.1 
-6.8 95q3/87ql 
NominaTTflecHvé 
exchange rate 
12.8 
13.Ô 
18.7 
-48.4 
-6.7 
12.6 
-0.7 
-31.4 
13.3 
13.2 
-16.0 
-5.0 
-20.$ 
-1Ô.9 Cost 
Competitiveness 
7.5 
9.5 
20.0 
27.5 
8.5 
-2.6 
-30.1 
-24.4 
-4.7 
-1.7 
26.6 
-17.1 
-14.2 
-Ô.6 
N 
The nominal effective exchange rate allows comparison of the evolution of each Member State's exchange rate with those of other Member States. 
Real effective exchange rate based on unit wage costs in the manufacturing industrial sector. The minus sign indicates an improvement in cost competitiveness. 
No comparable information is available for the new Member States over this period. Source: COMEXT (EUROSTAT) Table 2: Export-market shares of EU countries1 
INTRA-EU 
BLEU 
DK 
D 
GR 
E 
F 
IRL 
I 
NL 
P 
UK 
EUR-12 
EXTRA-EU 
BLEU 
DK 
D 
GR 
E 
F 
IRL 
I 
NL 
P 
UK 
EUR-12 1987 
11.15 
1.70 
30.95 
0.75 
3.75 
15.18 
2.00 
13.22 
10.06 
1.38 
9.86 
100 
1987 
5.12 
2.99 
38.37 
0.55 
3.71 
14.65 
1.00 
13.93 
4.81 
0.73 
14.14 
100 1988 
10.92 
1.61 
29.82 
0.52 
3.99 
16.69 
2.06 
12.85 
9.92 
1.37 
10.25 
100 
\m 
5.45 
2.74 
36.57 
0.43 
3.81 
15.88 
1.05 
13.58 
4.96 
0.71 
14.82 
100 1989 
10.83 
1.53 
29.42 
0.59 
4.16 
16.86 
2.14 
12.82 
10.05 
1.49 
10.12 
100 
\m 
5.76 
2.56 
35.98 
0.53 
3.78 
16.16 
1.06 
14.36 
4.79 
0.81 
14.20 
100 1990 
10.86 
1.60 
28.10 
0.54 
4.55 
16.93 
2.05 
13.06 
9.78 
1.61 
10.90 
100 
1990 
5.44 
2.67 
36.40 
0.48 
3.75 
16.12 
1.07 
14.19 
4.68 
0.84 
14.36 
100 1991 
10.53 
1.71 
27.51 
0.55 
4.92 
17.50 
2.04 
12.06 
9.23 
1.62 
11.41 
100 ^p 
5.34 
2.57 
56.90 
0.48 
3.93 
16.47 
1.14 
13.77 
4.80 
0.79 
1172 
100 1992 
10.24 
1.82 
27.62 
0.60 
5.02 
17.63 
2.17 
12.43 
9.81 
1.70 
10.96 
100 
1^2 
5.21 
2.66 
36.30 
0.51 
4.04 
16.68 
1.24 
13.80 
5.50 
0.82 
13.23 
100 1993 
11.54 
1.87 
24.89 
0.56 
5.20 
17.34 
2.35 
12.00 
9.73 
1.67 
11.96 
100 
1993 
5.60 
2.45 
35.01 
0.52 
4.15 
15.74 
1.51 
14.08 
5.60 
0.67 
14.67 
100 1994 
11.37 
1.72 
24.26 
0.49 
5.48 
17.03 
2.48 
12.28 
11.21 
1.55 
12.14 
100 
1994 
6.00 
2.50 
35.16 
0.50 
4.13 
15.46 
1.53 
14.09 
5.53 
0.64 
14.46 
100 
Table 3: The impact of exchange-rate movements on EU manufacturing industry1 
BLEU 
DK 
D 
GR 
E 
F 
IRL 
I 
NL 
P 
UK 
EU PRODUCTION PRICES 
(in ecus) 
1987 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 1992 
99.1 
99.4 
98.8 
103.8 
107.5 
97.9 
100.9 
97.6 
95.5 
138.6 
102.7 
100 1994 
105.1 
103.3 
104.7 
108.1 
96.4 
98.6 
100.2 
87.4 
102.1 
138.7 
102.9 
100 TOTAL EXPORT VOLUME 
1987 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 
100 1992 
100.9 
110.7 
91.4 
117.6 
136.6 
118.9 
134.4 
89.7 
99.4 
137.1 
95.4 
100 1994 
113.5" 
102.3 
84.3 
98.3J 
159.9 
112.5 
144.9J 
97.9 
110.6 
131.6 
96.1 
100 EXPORT GROWTH2 
1992-94 
intra EU 
5.8 
-4.8 
-6.3 
-11.5 
8.7 
-2.5 
0.1 
2.2 
9.3 
0.8 
3.6 
0.1 extra EU 
17.9J 
7.3 
6.1 
12.9J 
17.8 
3.6 
23. V 
14.2 
11.7 
0.9 
12.3 
9.2 
Source: European Commission 
The data on production prices and total export volumes are indexed with base 1987 (= 100) and base the Community average (EU = 100). For example, 
the figure of 105,1 for production prices in 1994 in BLEU means, by comparison with 1987, that they have increased 5.1% more than the Community 
average. 
< 
No comparable information is available for the new Member States over this period. 
Average annual growth rate. 
Estimate. 
ISSN 0254-1475 
COM(95) 503 final 
DOCUMENTS 
EN 10 09 
Catalogue number : CB-CO-95-558-EN-C 
ISBN 92-77-95275-X 
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