Amol Agrawal
On 1 January 1999, 11 European countries gave up their currency and adopted a single currency, the euro. The short 20-year history of the euro resembles the plot of a potboiler movie; there are elements of drama, suspense and even comedy. The very idea of asking member countries to give up their currencies was no mean achievement.
Consider where it all began. After centuries of hatred and wars, European countries decided to push peace after World War II. They realised that the only way to institutionalise peace was to push for common European values. This gave way to a grand European integration project which started small by sharing common resources such as coal and steel, building common markets and custom borders.
The adoption of the euro is part of this very project where countries gave up control of their monetary policy to the European Central Bank. Apart from monetary policy, the ECB is also responsible for printing and circulation of Euros across member countries.
It was not easy becoming a member of this select club. Stringent conditions convergence criteria were imposed. This required members to have low inflation, government deficit below 3 percent of GDP, and public debt at 60 percent of GDP. Members were also bound by a Stability and Growth Pact (SGP) to ensure they do not abuse macroeconomic variables especially fiscal ones after joining the club. This led to 11 nations becoming initial members with England, Sweden and Denmark staying away from the Monetary Union but still remaining part of the European Union.
The journey was hardly smooth. Members did not stick to the SGP and the first violators were the big economies of Germany and France which allowed debt levels to rise following a slowdown. The SGP failed to penalise the errant economies leading to a weakening of first principles. This set an early precedent that violators would not be punished, building in a moral hazard which proved costly in later years. Despite these early errors of omission (along with dotcom crisis and 9/11 attack), the euro project managed to chug ahead. After depreciating to about 0.85 to a Dollar in 2002, euro appreciated to touch 1.6 levels by 2008. The share of the euro in global forex assets ranged from 14-18 percent between 1999 and 2008, next to the US dollar whose share hovered between 35 and 56 percent.
The major challenge came from the 2008 crisis which saw the euro depreciating to near parity against US dollar by 2014. The highly complex and inter-connected crisis which started in the US, engulfed Europe as well. European banks had taken wide exposures to toxic assets in the US which were funded by short-term liabilities, leading to wide mismatches in the balance sheets.
This was though just the tip of an iceberg. The older problems of ignoring errant countries began to bite severely. It started with Greece which was found to have much higher deficit and debt levels than were reported by authorities. Italy, Spain, Portugal and Ireland were next.
Germany, which was earlier seen as a weak link in the chain, was now the strongest member, leading to partition of Euro economies into a strong core and weak periphery economies. Discussions started on whether the core should separate itself from the periphery or whether the periphery should be asked to leave the Union. ECB being the sole central bank for the union was divided over its policy, with core countries saying no to any stimulus but periphery ones demanding a stimulus. Gradually, ECB had to shift from its price stability mandate to saving the periphery economies by buying their government bonds inviting both criticism and admiration.
The economics community is divided between Eurosceptics and Europhiles. The former mainly belong to US and argue that a monetary union can never be successful without a fiscal union. They cite the case of US which first unified the fiscal policies of its states before unifying the currency. Europhiles are mainly European policymakers who say the currency has come a long way despite these limitations. They cite rising Euro membership from the original 11 members to 19 members today as a signal of its success. There are quite a few others who are making economic adjustments to become part of the currency.
Mario Draghi, president of the ECB, said that it is this “togetherness” which has helped the euro in the past and will ensure its future as well. He also said that Euro has produced price stability that too in countries which always had instability and intra-EU exports have risen from 13 percent of EU trade in 1992 to 20 percent today.
Further, policymakers are making even more investments in cementing the Union by pushing for more unions. The banking union is aimed to build a common banking market allowing to regulate and govern banks at a pan European level. The capital market union will allow firms to raise resources from a pan European capital market. The fiscal union which is still being discussed would build a common finance ministry/ treasury amidst the member countries. ECB has also moved beyond its price stability mandate to financial stability and banking supervision.
Thus, the Euro is a classic case of the glass being half-full or half -empty. One cannot deny that the project has come a long way from when it started. But the currency has also been unsettled and destabilised by multiple shocks. If there is one thing which is certain in the 20 years of the euro’s, it is uncertainty! This is likely to be its future as well at least in near term.
(The author teaches Economics at Ahmedabad University. Views are personal)
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