Analysing European Monetary Integration: How exactly has the Euro impacted the European Union?
The monetary integration of the European Union formally began on January 1st 1999 with eleven member states meeting convergence criteria. Although the initial steps towards a monetary union were taken in 1969, it took thirty years to develop the framework, build cooperation, and launch the euro. This new European Economic and Monetary Union (EMU) consisted of Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands and Portugal, with Greece joining after the turn of the century. Each subsequent enlargement of the EU brought new member states to the eurozone. Cyprus, Estonia, Latvia, Lithuania, Malta, Slovakia and Slovenia have all adopted the euro within the last two decades, and the newest addition to the EU – Croatia – has a set target of joining the Euro Area by 2023. Maastricht Treaty opt-outs such as Denmark and the pre-Brexit United Kingdom maintain their own currencies, as do the EU member states of Poland and Sweden, who simply choose not to fulfil EMU accession criteria. With the departure of the UK from the European Union, however, it seems unviable that these and new EU member countries will be able to remain outside the eurozone indefinitely.
As plans for further eurozone enlargement progress and new countries join the European Exchange Rate Mechanism, it is important to consider the impact the euro has had on the European Union. Monetary integration has its proponents and its critics, but after twenty years of euro circulation, the debate continues – has the euro strengthened the EU or further exacerbated existing divergences? To best understand the question, it is important to assess both sides of the argument before deciding the impact of the euro on the European Union.
Strengthening the EU
The continued improvement of the Euro Area through the implementation of new stability mechanisms is the first argument for strengthening. An initial problem with the monetary union was the lack of oversight, with each member’s central bank retaining control over monetary policy. The European Central Bank (ECB)’s 2009 internal reforms addressed this issue following the global financial crisis, which exposed the vulnerabilities of the monetary union. The ECB now has a supervisory system and common monetary policy for the eurozone and can take concrete actions, such as open market operations, towards stabilising the economies of each member country. This ability to respond in a cohesive manner was also useful against the covid-19 pandemic with the Pandemic Emergency Purchase Programme (PEPP), which has helped the eurozone recover from an unprecedented crisis. Without the Euro Area’s implementation of new stabilising mechanisms and policies, such a unified response would have been impossible. This ongoing improvement has strengthened the European Union, especially in terms of keeping smaller economies afloat during recent financial and global health crises.
The euro’s status as a global currency is the second argument. While achieving this status was an aspiration for the new currency, policymakers were cautious about setting a possibly unattainable bar. Over time, however, the euro has come to be seen as a strong and stable currency and has naturally become an alternative to the US dollar. In a system where many global economies such as Japan and China have different monetary priorities, the euro is slowly growing as a leader in international currency markets and reserves. The strength of the euro creates a positive perception of the health of the EU’s economies and common market. This becomes a self-fulfilling prophecy, as the EU’s perceived health heightens economic attractiveness and draws increased trade and investment flows, strengthening the European Union as a whole.
Economic convergence between eurozone members is the final argument for strengthening. Business and financial cycles across EMU countries have increasingly synchronised, with nine out of eleven eurozone member states seeing concordance between their financial cycles post-2009 crisis. The business cycles of these countries also increasingly converged after eurozone accession, although the amplitude of their cycles remains variable. While the synchronisation of GDP growth rates between member states fluctuates, this is attributable to varied productivity rates across the Euro Area and not the euro itself. Other macroeconomic indicators, such as financial development and employment rates, reflect the same growing convergence seen with business cycles. The euro’s effects on strengthening and synchronising business cycles is statistically and economically significant, and this observed effect is far stronger between eurozone members than with other EU countries. Synchronisation of these cycles and indicators are empirically considered a sign of effective monetary policy in a union such as the EU, and can therefore be seen as an indication of the strength of the union as a whole.
Exacerbating Existing Divergences
On the other side of the argument, the euro is exacerbating pre-existing divergences within the European Union. Under the original EMU framework, intra-eurozone loans moved from core countries like Germany and France to periphery countries such as Ireland and Greece. When global financial systems collapsed in 2008, this lending suddenly stopped, leaving the periphery countries in the lurch. Their loans were largely invested in non-traded sectors such as housing and government services, leaving them without capital returns to fall back on when money stopped coming in. Without any sources of external funding or centralised monetary policy to rely on, Ireland and Greece were forced to pay back loans they could no longer service. The crises only worsened under increasing austerity measures, with no space for economic recovery. Greece especially was not even allowed time to petition for GDP-linked debt repayment and was eventually forced, at the risk of having loan eligibility frozen, to agree to the European Commission’s repayment plan. This push for debt-riddled eurozone members to apply for bailouts and adopt austerity measures during a financial crisis not only isolated the citizens of these countries at a time of desperation but created a negative perception towards them throughout the EU. The media fanned these flames and Greece was labelled a victim of its own poor decision-making, exacerbating the existing core-periphery divergences within the EU.
The eurozone’s core-periphery divide also demonstrates regional economic imbalances. A driving goal for the euro was to facilitate economic convergence across member states. However: intra-eurozone trade has only grown by 10% compared to a 30% growth in global trade; average incomes in Greece and Portugal have converged towards German income by 7% and 27%, while the Czech Republic has converged by more than 140%; and most of the investment spending from core eurozone members goes to non-euro countries. Economic convergence between EMU and non-EMU countries has increased since the adoption of the euro while a north-south divide persists within the eurozone. Euro Area adjustment mechanisms, such as cross-country flows across markets, were expected to increase convergence. Instead, due to a lack of structural reform and procyclical fiscal policies, many of these mechanisms have contributed to divergence. “Northern” countries experience export-driven growth while “Southern” members are characterised by debt-driven growth, fuelled by continuous borrowing. Educational and state institutions in the south are weak, which decreases productivity, dampens growth rates and contributes to cyclically increasing economic stress. These regional imbalances can be reduced but not corrected without a political and fiscal union, and the existence of a monetary union without this additional support exacerbates these existing divergences.
The Euro – Good or Bad?
When considering these two arguments, it is important to remember that the monetary union has been in place for more than two decades. Many arguments for weakening point to problems relating to the original EMU framework; after twenty years, however, these arguments have lost validity. Structural flaws may be a deterrent for countries who are working to meet convergence criteria, but for current member states who have deeply invested in the eurozone, leaving would be devastating not only for their own economies, but also to the unity and stability of the European Union. Should a country like Italy leave the Euro Area, it would regain monetary control and could depreciate the lira to increase competitiveness. Its twenty years-worth of ECB loans, however, would still be owed in euros, which would remain markedly stronger than the lira. This level of debt would be intolerable for the Italian economy, while simultaneously crippling the EU. If a founding and integral member of the European Union were to leave the Euro Area, the economic shocks to European markets would be catastrophic and the unity of the Union would come into question.
Overall, the euro has strengthened the European Union. It has improved European unity, made the EU a more competitive and reliable trading partner, and has boosted the Union’s status to that of a global superpower. With further enlargement plans, however, it is crucial to remember existing divergences and consider how the addition of new members may affect current instabilities. Expansions to Euro Area policies, such as allowing fiscal transfers, are necessary to maintaining the stability of the EU. These transfers are intended to strengthen weaker parts of the monetary union and are a possible next step for the eurozone. NextGenerationEU’s use of eurobonds, which are a useful policy instrument when designed well, and an expanded EU budget make this movement towards fiscal transfers a more viable outcome. The Covid Recovery Fund has already set an important precedent for the creation of a common fiscal policy, and its fiscal transfers have been more effective at a macroeconomic level than intra-eurozone loans. Intra-Euro Area lending contributed to Ireland and Greece’s financial crashes by allowing an incredibly high level of public debt buildup, whereas fiscal transfers allow for risk sharing and provide an insurance for the EU against spillover effects. The EU’s Sustainability and Growth Pact (SGP) reinforces procyclical policies, forcing Euro Area countries to maintain arbitrary limits regardless of economic differences. These limits continue to exacerbate divergences, and the SGP’s temporary suspension provides an important opportunity to reform and personalise these limits to individual member states. Although the euro has strengthened the EU, the monetary union has also exacerbated existing divergences by applying a common policy across eurozone countries without consideration for regional imbalances. New stabilising mechanisms have improved the EMU over the last two decades, but now the European Union must reassess the Euro Area in the wake of a global pandemic. It must take the opportunity not only to reform, but also to move towards deeper integration with fiscal and political unions to bolster the current Economic and Monetary Union.