The euro

A Handbook on the European Union - Book index

In this second part of the handbook we turn our attention to the euro, examining its framework of economic governance, its paradoxical statelessness, and the institutional independence of the European Central Bank.

The euro is the official currency of the European Union. While there still are Member States who use their national currency, all are obliged to eventually adopt the euro. Exceptions to this rule are the United Kingdom and Denmark, which have negotiated opt-outs from the monetary union.

From the perspective of European integration, the euro is not just an international reserve currency. The creation of the euro coincided with the transformation of the European Economic Community into the European Union. This was set in place with the Treaty of Maastricht, signed in 1992. What the European leaders sought to initiate after the end of the Cold War was a new stage in the integration process that would see the European Community move beyond trade liberalisation and the establishment of the common market toward political unification. The euro with the concomitant monetary union was conceived as the best starting point for bringing about the eventuality of political union.

The idea was that the material changes brought about by the introduction of a single currency would eventually point to the need for harmonising areas of policy that were traditionally kept at the national level, such as economic and fiscal policy, and bank supervision. The euro would broaden the scope of—as well as accelerate—the integration process, while the uniform monetary policy would have positive spillover effects on all other areas of economic activity and planning. Once a higher degree of legitimacy and accountability would be needed, political union would come as a necessary and desirable extension of changes on the ground. It would be the last part of the puzzle.

This approach has had its shortcomings, already prior to the post-2008 financial crisis. The original design of the monetary union was predicated on some brave and ultimately erroneous assumptions about economic realities. One was that largely diverse national economic structures could organically converge without any close coordination or active involvement from policy-makers at the supranational level. A second wishful thought was that cross-border capital markets would emerge in spite of the compartmentalisation of banking policy along national lines. A third misguided belief was that a central bank can indeed be the sole institution in charge of the monetary union, without any need for a system-wide fiscal backstop, and a counter-party treasury capable of adapting fiscal policy to area-wide fluctuations along the business cycle.

From a purely economic standpoint, the euro should not have been introduced under the conditions it did. Though one can argue that the original euro was “minimal” that would not capture its actuality, for minimalism entails sufficiency. Europe’s monetary union was not viable in its original form. It was incomplete and insufficient for pursuing its stated objectives. The erratic capital flows in its first years already indicated the inability of the system to correct its own self-destructive propensities. Yet it was the economic shock following the collapse of Lehman Brothers that exposed all of the monetary union’s inadequacies, forcing policy-makers to actually focus on addressing the errors of the euro’s architects.

Nonetheless, it has to be noted that there is nothing about the European integration process which could reduce it to a “purely economic” project. Even when trade liberalisation was its primary objective, integration was profoundly political. The transition from the European Economic Community to the European Union, coupled with the introduction of the single currency, has only made the political nature of the project more apparent. Couched in those terms, one ought not underestimate the political capital invested in the euro. While the concurrent financial and debt crises have mired the European economy in near-stagnation and disinflation, and though the entire system was subject to duress and could have collapsed under the pressure, the euro remains, despite its persistent design flaws, the main driver for the realisation of the ultimate objective of the European Union: the formation of a transnational republic.

For the purposes of European integration the euro is much more than just fiat money. It is the catalyst in the efforts to deepen and broaden cross-border harmonisation. The very evolution of Europe’s Economic and Monetary Union provides such an insight. The original design of the euro was predicated on a monetarist conception of a single currency area. A fully independent central bank, the European Central Bank, was provided with a rather narrow mandate for targeting inflation. Fiscal policy remained primarily national, though a limited set of supranational rules were established for standardising the procedures and relevant targets. There were no instruments for carrying out area-wide stress tests for private banks, while the European Central Bank did not have the necessary tools for conducting micro- and macro- prudential policy. The currency area was left largely unfinished. An incorrectly decentralised monetary union, one without a fiscal, banking, and political capacity, was prone to abuses of its own rules by Member States that realised they could rig the rules with impunity. Meanwhile, the entire edifice remained exposed to external shocks as well as internal asymmetries. The Great Recession exposed the weaknesses of that model, with Europeans having to pay a very high cost for their leaders’ lack of foresight when deciding on the specifics of the euro.

The policy response to the financial shock, notwithstanding some of the ad hoc mechanisms that were introduced for bailing out individual states that had lost access to international money markets, was a means of retroactively correcting the frailties of the monetary union. Provisions for concerted economic governance were introduced with the intention to centralise fiscal policy at the supranational level. In such a legal order, the fiscal sovereignty of Member States has already been deprived of most of its substance, since every national government has to comply with an extensive set of common rules.

What currently is in place falls short of delivering a credible solution to the inadequacies of the Economic and Monetary Union. The next steps in the European integration process are meant to further strengthen the EMU by providing it with an embryonic capacity for autonomous fiscal policy as well as creating a basis for a unified banking sector. Perhaps changes will be made that will enable the supranational level to act as an economic government, though it is too early in the process to accurately estimate the immediate steps forward. Much of what we will witness in the foreseeable future depends on the presidential elections in France, as well as the outcome of the United Kingdom’s attempts at renegotiating its place in the European Union. The year 2017 will likely be the starting point of a new phase in the integration process, one whose qualitative features are contingent on a series of events over the coming months.