Should the EU Abandon the Euro?

Economics, Medium Reads
Reading Time: 4 minutes

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 create 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). All EU members still do not 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. The first reason is that 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 (at future prices), 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. When price equalization across borders, businesses are no longer competing against 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 countries can rely upon each other for different products. They spend less on being self-sufficient. Given that the majority of EU countries are export economies, encouraging specialisation maximises output and is a better allocation of resources.

However, despite this supposed economic development, many argue that this economic development only helps the major EU countries: France and Germany. Currency is controlled by European parliament (which elects the head of the ECB), Germany and France have large majorities and stronger economic contributions to the EU, which means that they are able to dictate monetary and fiscal policy concerning the Euro. This is bad for smaller countries because they have disproportionately less control over monetary policy which means Germany and France can hijack the euro and micromanage inflation and interest rates to serve their own interests. This looks like swathes of quantitative easing and reducing interest rates, but countries like Greece who have hyperinflation have very little power to stop this. When Germany as a stronger economy has the same currency as smaller countries, it increases Germany’s export machine and hurts other countries’ export competitiveness. 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 uncompetitive. 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, a fall in exports and low growth. This has particularly been a problem for countries like Portugal, Italy 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 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 coordinate 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. Interest rates not suitable for whole Eurozone. 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 a 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. Countries try to get revenge by blocking foreign policy initiatives such as sanctions or sabotaging the EU budget. 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 has left 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.

Leave a Reply