The Euro was created at midnight on 1st January 1999 when members of the Eurozone fixed their currencies against each other, but it did not become a legal tender until 1st January 2002. The creation of the Euro was seen to be a step towards the political and social unification of Europe through economic means: the means being an optimal currency area (OCA) – a theory developed by Robert Mundell. An OCA is a geographical area where the benefits of having a monetary union exceed the costs, which occurs because of high factor mobility. When economists express their opinions about the creation of the Euro, much of their skepticism is centered around the theory of the OCA, as it is often argued that the Eurozone is, in fact, not an OCA and that it does not necessarily meet Mundell’s criterion. However, these economists cannot argue that their beliefs have been entirely justified since the creation of the Euro as unforeseen circumstances, particularly the financial crisis, have exacerbated the flaws in its design.
When the Euro was created, economists who believed that the creation of the Euro was a bad idea tended to also argue that the Eurozone was not an OCA. An OCA has many benefits: reduced transaction costs, greater transparency and the removal of currency risk theoretically encourages growth within the monetary union. The predominant costs, however, are a one-size-fits-all monetary policy and the absence of an exchange rate mechanism, which could be used to boost growth during a downturn. The absence of an exchange rate mechanism leaves the area vulnerable to asymmetric shocks, where the effects of an economic event differ in one part of a currency area to another. Without an exchange rate mechanism and independent monetary policy, it is difficult to correct the asymmetric shocks as prices and wages have to be adjusted in an alternative manner.
When Mundell stated that high factor mobility is required for the benefits to exceed the costs, he implied labour mobility in particular as workers can easily move towards where the jobs are located, therefore wages and prices do not need to change. However, there are 19 countries who are members of the Eurozone, consisting of multiple dialects and independent cultures. Therefore, cultural barriers reduce labour mobility within the Eurozone, leading to economists believing that it is not an OCA. If it was argued that the Eurozone was not an OCA, it would imply that the costs of the common currency exceed its benefits, which led to these economists’ decision that the creation of the Euro was a bad idea.
Moreover, economists who were against the creation of the Euro were unconvinced with the reasoning behind its creation. Friedman describes how the motivation behind the creation of the Euro has been “to link Germany and France so closely as to make a future European war impossible.” The creation of the Euro has been a component of a greater European scheme to unite the continent, politically and socially. It is this aspect economists dislike; the purpose of using an economic system should be for economic benefit – not a political or social one. A common currency is a complex economic undertaking that should be managed towards an economic end rather than a political end, as there is a risk that policies will become unfavourable and troublesome to the extent that it could jeopardise the political unity it sets out to achieve. Instead, economists argued that Europe should be trying to achieve political unity through political methods, and once it is achieved, then it is a better time for monetary unity to be implemented.
The fears that some economists predicted have somewhat materialised. The political unity that Europe strived for has been set back by the sovereign debt crisis, which resulted in strained intra-European relations amongst the central countries, often the creditors, and the peripheral countries, often the debtors. Relations between Germany and Greece were notably sour: in 2013, Yanis Varoufakis, that Greek finance minister at the time, said Greece should “stick the finger to Germany and say, ‘you can solve this problem by yourself.’” When the sovereign debt crisis broke out, the plan to unify Europe was hindered, therefore the warnings that economists issued against creating a common currency for a political objective, rather than an economic one, were proven true.
However, the presence of exogenous economic events that have taken place since the creation of the Euro, and the responses to them, weakens the argument that the fears of many economists have been proven correct. The financial crash and the bursting of the real-estate bubble in the late 2000’s significantly contributed to the generation of the European sovereign debt crisis as European Governments bailed out private-sector banks, turning the private-sector debt into public-sector debt. The financial crisis was indeed unfortunate and unprecedented but the austerity measures that followed, and which were sometimes enforced (in Greece’s case), in order to reduce debt may have in fact worsened the problem. Austerity measures were introduced at a time when the European economies were barely recovering from the financial crisis. The result of this was restricted economic growth – studies have since suggested the real GDP in the Eurozone was 7.7% lower than what it would have been without fiscal consolidation – which would have led to significantly reduced government revenues.
Furthermore, the European Central Bank (ECB) decided to raise interest rates in April 2011 and again in July, reacting nonsensically to what was believed to be a short-term spike in commodity prices. The ECB’s decision to raise interest rates coincided with European austerity measures to drastically hinder growth, which dropped from almost 1% to almost -0.5% in the Eurozone over the period and further reduced government revenues. Although the creation of the Euro has made simple problems much more complex and difficult to resolve, the logic behind the arguments of economists who believed the Euro was a bad idea from the start would have likely differed from what has truly happened to the Euro since its creation.
The creation of the Euro has indeed caused economic and political problems in Europe, although it is important to remember that the project is still ongoing. When the Euro was created, Europe was going through a period of optimism as its visions of unity were becoming realised. However, it is possible that this sense of euphoria encouraged economists and politicians share the European vision, whilst overlooking, to some extent, its potential dangers. This could possibly be exhibited by the fact that American economists – e.g. Stiglitz, Krugman, Mankiw – were often the most cynical of the project, who had no reason to share the European optimism and could see the project for what it truly was.
I believe that the Euro has, overall, been a failed project as, not only has it failed to achieve political unity, but it has also given rise to economic problems that could have been avoided had the Euro not existed. Nonetheless, I do not believe that the Euro was a failed project from its creation, as many economists suggested at the time, as unanticipated economic events and poor policymaking have contributed to its lack of success. However, it is important to realise that the notion of ‘proving the fears of economists correct’ is subjective, and it is likely to remain subjective unless the Euro is dismantled, in which instance, their fears would indeed be proved correct.