On January 1st 1999, the EU unveiled their new currency to the world: the euro. A currency that was supposed to promote economic growth, stability and integration, it has now become the scapegoat of the EU’s failures. Amid growing Euroscepticism and division by way of the pandemic, has a currency that was supposed to sow unity between European nations actually caused tragedy?
Originally, the euro was an overarching currency used for exchange between countries within the union, while people within each nation continued to use their own currencies. However, by February 2002, 12 member states established it as an everyday currency and replaced each of their domestic currencies with the euro (such as France, Germany and Italy). Even now, not all EU members universally adopt the euro as the main currency but many of the holdouts peg their currencies to it in some way. The European Central Bank (ECB) controls the euro, by setting a common interest rate along with other European monetary policy. Given that the euro has huge influence over the world economy, it is therefore important to assess whether or not it has been beneficial.
Supporters argue that the euro promotes better economic development across the Eurozone. The first reason is because the euro eliminates exchange-rate fluctuations: any time either a consumer or a business makes a commitment to buy something in an another EU country in the future, they stand the chance of paying much more (or less) than they had planned. The euro eliminates the fluctuations of currency values across certain borders, and therefore removes the uncertainty in the value of those transactions. The second reason is that the euro creates price transparency – being able to easily tell if a price in one country is better than the price in another is also a big benefit. With price equalization across borders, businesses are no longer competing with similar businesses in their country, but rather all similar ones in the EU. Pricing still varies, but consumers can more easily spot a good deal, or a bad one. Finally, the euro encourages specialisation, because a common currency reduces transaction costs (no bank commission charges and no need to hedge exchange rate risk) and reduces uncertainty. Encouraging specialisation maximises output and is a better allocation of resources.
However, despite this supposed economic development, many argue that this economic development has only helped the major EU countries: France and Germany. The reason is that in the run-up to the introduction of the euro, smaller countries like Portugal, Greece and Italy bid up the value of their individual national currencies such that they joined the euro at valuations far above those supported by their economic fundamentals. The overpricing gave these governments and their populations an inflated sense of their global economic purchasing power, encouraging spending and borrowing beyond their ability to support such behaviour. Meanwhile, the inflated currency values put their producers at a competitive disadvantage. On the other hand, Germany entered the euro still suffering from the difficulties with its reunification and the deutschemark was weaker than otherwise could have been. This had the exact opposite effect to the one in Greece. IMF data suggests that at the euro’s inception, this currency distortion gave German industry a 6% competitive advantage compared with the country’s economic fundamentals, and in 2017, updated data shows that Germany has a 12% advantage. There is no scope for devaluation and since the start of the euro, several countries have experienced rising labour costs. This has made their exports less competitive. Usually, their currency would devalue to restore competitiveness. However, in the euro, you cannot devalue and you are stuck with uncompetitive exports. This has led to record current account deficits (which is unsustainable in the long run), a fall in exports and low growth, which has particularly been a problem for countries like Portugal and Greece.
The EU responds by saying that smaller countries are better off within the Eurozone because the euro promotes stability. This is because during a crisis, there is a shared risk between all EU countries, because if one goes down, others have an incentive to bail them out because they want the whole Eurozone to be prosperous. This is important because even if countries act out of pure selfish interest, there still exists an incentive (or even an obligation) to help others in order to strengthen the currency, which in turns helps them. This incentive to resolve internal crises was illustrated when France and Germany supported a recovery fund worth over 500 billion euros for the coronavirus pandemic. Moreover, the euro promotes co-ordination between countries because in order to deal with crises, countries need to co-ordinate policies with other countries; the euro makes that far more effective and countries are also quicker to respond during a crisis. Finally, the euro promotes financial market stability because the financial and stock exchanges can list every financial instrument in euros rather than in each nation’s denomination. This has further ramifications in that it promotes trade with less restriction internationally, as well as strengthens the European financial markets. Banks (such as the ECB) can offer financial products (loans, CDs, etc.) to countries throughout the Eurozone.
Despite this stability, many believe that a one-size fits all currency (and monetary policy) cannot work for a club of countries as diverse as the Eurozone. When countries have high unemployment, inflation and other specific local crises, countries need targeted monetary policy such as capital injections and adjustments of interest rates to counteract employment issues, inflation, etc. A common monetary policy involves a common interest rate for the whole Eurozone area. However, the interest rate set by the ECB may be inappropriate for regions, which are growing much faster or much slower than the Eurozone average. For example, in 2011, the ECB increased interest rates because of fears of inflation in Germany. However, in 2011, southern Eurozone members were heading for recession due to austerity packages. The higher interest rates set by the ECB were unsuitable for countries such as Portugal, Greece and Italy. It would be fair to say that the euro contributed to the government debt crisis in Greece in the aftermath of the 2008 financial crisis. Moreover, the process by which disputes occur over monetary policy set nations against each other. Even if in fact the policy impacts are overstated in terms of causing economic damage, the fact is Germans and Greeks blame each other for it. This in turn promotes nationalism and makes it harder to work together on other issues. In effect, other aspects of European policy are also damaged due to a lack of co-operation.
What is clear is that the euro is by no means a perfect solution to promote economic development in the EU. A universal currency is ideal in theory, but due to internal politics, tensions and varying conditions within the EU, the euro has caused conflict and may have left some smaller countries behind. The extent to which these countries would have been better off without the euro however, is uncertain, especially because redenomination (the process to convert back to old currencies) presents its own unique challenges and costs.