The Incomplete Currency

Chapter 1The Building Blocks of the Single European Currency

This first chapter will introduce the reader to some basic economic and financial concepts that are necessary to fully understand how the Eurozone works and the fundamental determinants of the Euro monetary system. In § 1.1, with simple words the reader will learn the way a financial product is designed and evaluated, by exploiting the intuitive concepts of uncertainty, probability and risk. Then the most widespread and popular financial products (bonds, swaps, CDS), broadly publicised by the media coverage, are presented and explained with examples and charts.

These tools do not remain in the abstract world but they are immediately put to work in the real world to describe the elementary working mechanisms of the Euro currency area. In § 1.2 we will explore the concept of credit risk with specific reference to a sovereign issuer: we will see that the riskiness of a country is closely related to the size of its public debt (especially when measured in terms of GDP) and that the sustainability of the debt depends on some key factors, inflation being surely one of the major ones. In § 1.3 the single interest rate curve is described by giving its rationale and recalling the history of its birth. In § 1.4 the reader is introduced to the functioning of the monetary policy and discovers the real mandate of the ECB and the striking differences it has with the other central banks. Finally, § 1.5 gives a tutorial overview on ...