May 03, 1999

Some financial commentators are puzzled by recent exchange rate movements. Some argue the euro has been a failure because it has depreciated approximately 10% since its launch. Yet many of the same people are perplexed that the decline has not fueled inflationary expectations. This is in contrast to the experiences of the devaluations that have taken place in the emerging markets--all of which have been followed by increased inflation. Interestingly, contrary to what would be expected, the ensuing inflation in the devaluing countries has not matched the magnitude of the devaluation. The paradigm commonly used to analyze currency devaluation does not appear to be working as it did in the 1970's.

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