The euro at 20: Responsible adult or wayward youth?
Twenty years have elapsed since the euro came into being, when the European Central Bank (ECB) assumed responsibility for the monetary policy of 11 founding members on Jan. 1, 1999.
By 2002, the national currencies of the (by then) 12 participating countries had been replaced by euro notes and coins and the infant currency enjoyed a carefree childhood up to the years of crisis starting in 2007.
Its 10th birthday was marked by much self-congratulation, with more than a hint that prudent ECB policies had enabled Europe to avoid the worst of the financial crisis that had afflicted the so called “Anglo-Saxon” countries.
By contrast, the euro’s teenage years were bleak. Starting with the need to bail out Greece in 2010, the euro crisis saw further bailouts for Ireland, Portugal and Cyprus, plus two more for Greece, alongside severe market pressures on Italy and Spain. Many wondered whether the euro could survive and the crisis exposed deep fault lines in its construction.
One long-standing critic, eminent Harvard economist Martin Feldstein, took the view in 2012 that “the euro should now be recognized as an experiment that failed,” building on strongly worded objections penned 15 years earlier, before the single currency was launched.
Among many others, Paul Krugman, was strongly critical of how the crisis was handled and, in 2015, labelled the euro a “monstrous self-indulgence” while also advocating Greece’s exit from it. His fellow Nobel prize winner, Joe Stiglitz, wrote a book claiming the euro threatens the future of Europe.
Yet here we are, several years on, with the euro intact and its membership having grown to 19 countries, no more talk of its demise, and Greece and all the other “problem” members still participating.
Moreover, polls consistently find strong support from citizens for the euro, attaining an all-time high late in 2018 according to a Eurobarometer poll, which found that 64 percent of respondents agree the euro “is a good thing for your country.”
Even in Greece and Italy, two countries arguably with most to complain about, the extent of support is striking at around 60 percent of respondents.
What the years of crisis brutally exposed was a variety of flaws in the design and governance of the euro, many of them masked by the benign economic environment of the previous decade.
Price stability, the primary goal of the ECB’s monetary policy, had been achieved, with inflation at around the 2-percent mark targeted and economic growth had been respectable.
Imbalances between parts of the eurozone had, however, been widening. Much of Southern Europe was overheating, partly because of cheap money drawn in from Northern Europe, leading to a division between creditor and debtor countries.
When — to revive the aphorism coined by Herb Stein, Richard Nixon’s economic adviser — it reached the point where “If something can’t go on forever, it will stop,” it became clear that the euro lacked the adjustment mechanisms to allow it to deal with the sovereign debt crisis.
There was no funding stream to bail out countries in trouble, little experience in managing a crisis and, more generally, a reluctance on the part of the major creditor nations (above all Germany) to accept responsibility for resolving the problems in partner countries.
Put another way, the euro was a monetary union, a fiscal union to only a very limited extent and not at all a political union, making it a currency without a country. A key explanation is that, from the outset, there had to be compromises, above all between the French and German visions for the single currency.
France prefers great central power in setting macroeconomic policy but also a system of governance in which the political level can exercise discretion. Germany emphasises the need for national politicians to take responsibility and for rule-based governance.
These incompatible stances were most visible during the crisis years, with the German position uppermost. Nevertheless, several significant reforms have taken place since 2010. They include:
- the centralisation of banking supervision and a common approach to the resolution of failing banks;
- the establishment of a permanent fund (the European Stability Mechanism) to assist governments facing financing crises; and
- extensive changes to the rules around fiscal policy and the coordination of macroeconomic policies.
The euro still lacks a single debt instrument equivalent to the U.S. Treasury Bond and common fiscal instruments capable of stabilising the economy in the event of an economic shock. Nor has there yet been agreement on common deposit insurance, similar to the U.S. Federal Deposit Insurance Corporation, or on the establishment of a single eurozone Treasury and Finance minister.
As a result there are still vulnerabilities, despite a series of political initiatives intended to bolster the resilience of the eurozone. Many more are on the agenda and are likely to be given fresh momentum in the revised Elysée Treaty due to be signed by the French and German leaders on Jan. 22in Aachen.
This will build on the Meseberg declaration in which French President Macron and German Chancellor Merkel committed themselves “to strengthen and deepen the Euro area further, and make it a genuine economic union.”
The euro weathered the severe storms it faced earlier in this decade and has made considerable progress toward great stability, but it plainly cannot stand still and needs further reform.
As Jean Pisani-Ferry, one of the most insightful French commentators on Europe put it, the eurozone needs “politically balanced and economically wise” solutions.
There can now, however, be little doubt that it is here to stay.
Iain Begg is a professorial research fellow and co-director of the Dahrendorf Forum at the European Institute of the London School of Economics and Political Science.