Europe in the 21st Century

38.1: Europe in the 21st Century

38.1.1: Move to the Euro

The eurozone is a monetary union of 19 of the 28 European Union member states that have adopted the euro as their common currency and sole legal tender to coordinate their economic policies and cooperation.

Learning Objective

Explain why the euro was established and which countries currently use it

Key Points

  • A first attempt to create an economic and monetary union between the members of the European Economic Community (EEC) goes back to the 1960s, when the need for “greater co-ordination of economic policies and monetary cooperation” was defined. However, following the Bretton Woods system collapse, the aspirations for European monetary union were set back. Then in 1979, the European Monetary System (EMS) was created, fixing exchange rates onto the European Currency Unit (ECU), an accounting currency introduced to stabilize exchange rates and counter inflation.
  • In 1989, European leaders reached agreement on a currency union with the 1992 Maastricht Treaty. The treaty included the goal of creating a single currency by 1999, although without the participation of the United Kingdom. In 1995, the name euro was adopted for the new currency and it was agreed that it would be launched on January 1, 1999. In 1998, 11 initial countries were selected to participate in the launch. To adopt the new currency, member states had to meet strict criteria.
  • Greece failed to meet the criteria and was excluded from joining the monetary union in 1999. The UK and Denmark received the opt-outs while Sweden joined the EU in 1995 after the Maastricht Treaty, which was too late to join the initial group of member-states. In 1998, the European Central Bank succeeded the European Monetary Institute. The conversion rates between the 11 participating national currencies and the euro were then established.
  • The currency was introduced in non-physical form on January 1, 1999. The notes and coins for the old currencies continued to be used as legal tender until new notes and coins were introduced on January 1, 2002. The enlargement of the eurozone is an ongoing process. All member states, except Denmark and the United Kingdom, are obliged to adopt the euro. Currently 19 states are members of the eurozone and seven additional states are on the enlargement agenda. Several non-EU European states and some overseas territories also use the euro, but each case is regulated differently.
  • Following the U.S. financial crisis in 2008, fears of a sovereign debt crisis developed in 2009 among fiscally conservative investors. Several eurozone member states (Greece, Portugal, Ireland, Spain, and Cyprus) were unable to repay or refinance their government debt or bail out over-indebted banks under their national supervision without the assistance of third parties like other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).
  • The detailed causes of the debt crisis varied. In several countries, private debts arising from a property bubble were transferred to sovereign debt as a result of banking system bailouts and government responses to slowing economies post-bubble. The structure of the eurozone as a currency union (i.e., one currency) without fiscal union (e.g., different tax and public pension rules) contributed to the crisis and limited the ability of European leaders to respond. As concerns intensified, leading European nations implemented a series of financial support measures, but the crisis had far-reaching effects across the EU.

Key Terms

European Economic Community
A regional organization that aimed to bring about economic integration among its member states. It was created by the Treaty of Rome of 1957. Upon the formation of the European Union (EU) in 1993, it was incorporated and renamed as the European Community (EC). In 2009, the EC’s institutions were absorbed into the EU’s wider framework and the community ceased to exist.
European Council
The institution of the European Union (EU) that comprises the heads of state or government of the member states, along with the President of the European Council and the President of the European Commission, charged with defining the EU’s overall political direction and priorities.
Maastricht Treaty
A treaty undertaken to integrate Europe and signed in 1992 by the members of the European Community. Upon its entry into force in 1993, it created the European Union and led to the creation of the single European currency, the euro. The treaty has been amended by the treaties of Amsterdam, Nice, and Lisbon.
European Central Bank
The central bank for the euro that administers monetary policy of the eurozone. Consisting of 19 EU member states, it is one of the largest currency areas in the world, one of the world’s most important central banks, and one of the seven institutions of the European Union (EU) listed in the Treaty on European Union (TEU). The capital stock of the bank is owned by the central banks of all 28 EU member states.
Bretton Woods system
A monetary management system that established the rules for commercial and financial relations among the United States, Canada, Western Europe, Australia, and Japan in the mid-20th century. It was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states. Its chief features were an obligation for each country to adopt a monetary policy that maintained the exchange rate (± 1 percent) by tying its currency to gold and the ability of the IMF to bridge temporary payment imbalances.
European Commission
An institution of the European Union responsible for proposing legislation, implementing decisions, upholding the EU treaties, and managing the day-to-day business of the EU. Commissioners swear an oath at the European Court of Justice in Luxembourg, pledging to respect the treaties and be completely independent in carrying out their duties during their mandate.

 

Origin of Common Currency in Europe

A first attempt to create an economic and monetary union between the members of the European Economic Community (EEC) goes back to an initiative by the European Commission in 1969. The initiative proclaimed the need for “greater coordination of economic policies and monetary cooperation” and was introduced at a meeting of the European Council. The European Council tasked Pierre Werner, Prime Minister of Luxembourg, with finding a way to reduce currency exchange rate volatility. His report was published in 1970 and recommended centralization of the national macroeconomic policies, but he did not propose a single currency or central bank.

In 1971, U.S. President Richard Nixon removed the gold backing from the U.S. dollar, causing a collapse in the Bretton Woods system that affected all the world’s major currencies. The widespread currency floats and devaluations set back aspirations for European monetary union. However, in 1979, the European Monetary System (EMS) was created, fixing exchange rates onto the European Currency Unit (ECU), an accounting currency introduced to stabilize exchange rates and counter inflation. In 1989, European leaders reached agreement on a currency union with the 1992 Maastricht Treaty. The treaty included the goal of creating a single currency by 1999, although without the participation of the United Kingdom. However, gaining approval for the treaty was a challenge. Germany was cautious about giving up its stable currency, France approved the treaty by a narrow margin, and Denmark refused to ratify until they got an opt-out from the planned monetary union (similar to that of the United Kingdom’s).

In 1994, the European Monetary Institute, the forerunner to the European Central Bank, was created. After much disagreement, in 1995 the name euro was adopted for the new currency (replacing the name ecu used for the previous accounting currency) and it was agreed that it would be launched on January 1, 1999. In 1998, 11 initial countries were selected to participate in the initial launch. To adopt the new currency, member states had to meet strict criteria, including a budget deficit of less than 3% of their GDP, a debt ratio of less than 60% of GDP, low inflation, and interest rates close to the EU average. Greece failed to meet the criteria and was excluded from joining the monetary union in 1999. The UK and Denmark received the opt-outs while Sweden joined the EU in 1995 after the Maastricht Treaty, which was too late to join the initial group of member-states. In 1998, the European Central Bank succeeded the European Monetary Institute. The conversion rates between the 11 participating national currencies and the euro were then established.

Launch of Eurozone

The currency was introduced in non-physical form (traveler’s checks, electronic transfers, banking, etc.) at midnight on January 1, 1999, when the national currencies of participating countries (the eurozone) ceased to exist independently in that their exchange rates were locked at fixed rates against each other, effectively making them mere non-decimal subdivisions of the euro. The notes and coins for the old currencies continued to be used as legal tender until new notes and coins were introduced on January 1, 2002. Beginning January 1, 1999, all bonds and other forms of government debt by eurozone states were denominated in euros.

Euro coins and banknotes

Euro coins and banknotes: The designs for the new coins and notes were announced between 1996 and 1998 and production began at the various mints and printers in 1998. The task was large: 7.4 billion notes and 38.2 billion coins would be available for issuance to consumers and businesses in 2002. Despite the fears of chaos, the eventual switch to the euro was smooth, with very few problems.

In 2000, Denmark held a referendum on whether to abandon their opt-out from the euro. The referendum resulted in a decision to retain the Danish krone and also set back plans for a referendum in the UK as a result. Greece joined the eurozone on January 1, 2001, one year before the physical euro coins and notes replaced the old national currencies in the eurozone.

Eurozone Today

The enlargement of the eurozone is an ongoing process within the EU. All member states, except Denmark and the United Kingdom which negotiated opt-outs from the provisions, are obliged to adopt the euro as their sole currency once they meet the criteria. Following the EU enlargement by 10 new members in 2004, seven countries joined the eurozone: Slovenia (2007), Cyprus (2008), Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014), and Lithuania (2015). Seven remaining states, Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, and Sweden, are on the enlargement agenda. Sweden, which joined the EU in 1995, turned down euro adoption in a 2003 referendum. Since then, the country has intentionally avoided fulfilling the adoption requirements.

Several European microstates outside the EU have adopted the euro as their currency. For the EU to sanction this adoption, a monetary agreement must be concluded. Prior to the launch of the euro, agreements were reached with Monaco, San Marino, and Vatican City by EU member states (Italy in the case of San Marino and Vatican City and France in the case of Monaco) allowing them to use the euro and mint a limited amount of euro coins (but not banknotes). All these states previously had monetary agreements to use yielded eurozone currencies. A similar agreement was negotiated with Andorra and came into force in 2012. Outside the EU, there are currently three French territories and a British territory that have agreements to use the euro as their currency. All other dependent territories of eurozone member states that have opted not to be a part of EU, usually with Overseas Country and Territory (OCT) status, use local currencies, often pegged to the euro or U.S. dollar.

Montenegro and Kosovo (non-EU members) have also used the euro since its launch, as they previously used the German mark rather than the Yugoslav dinar. Unlike the states above, however, they do not have a formal agreement with the EU to use the euro as their currency (unilateral use) and have never minted marks or euros. Instead, they depend on bills and coins already in circulation.

Euro Banknotes

Euro Banknotes: The euro banknotes have common designs on both sides created by the Austrian designer Robert Kalina. Each banknote has its own color and is dedicated to an artistic period of European architecture. The front of the note features windows or gateways while the back has bridges, symbolizing links between countries and with the future.

Eurozone Crisis

Following the U.S. financial crisis in 2008, fears of a sovereign debt crisis developed in 2009 among fiscally conservative investors concerning some European states. Several eurozone member states (Greece, Portugal, Ireland, Spain, and Cyprus) were unable to repay or refinance their government debt or bail out over-indebted banks under their national supervision without the assistance of third parties like other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).

The detailed causes of the debt crisis varied. In several countries, private debts arising from a property bubble were transferred to sovereign debt as a result of banking system bailouts and government responses to slowing economies post-bubble. The structure of the eurozone as a currency union (i.e., one currency) without fiscal union (e.g., different tax and public pension rules) contributed to the crisis and limited the ability of European leaders to respond. As concerns intensified in 2010 and thereafter, leading European nations implemented a series of financial support measures such as the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM). The ECB also contributed to solve the crisis by lowering interest rates and providing cheap loans of more than one trillion euro to maintain money flow between European banks. In 2012, the ECB calmed financial markets by announcing free unlimited support for all eurozone countries involved in a sovereign state bailout/precautionary program from EFSF/ESM through yield-lowering Outright Monetary Transactions (OMT).

Return to economic growth and improved structural deficits enabled Ireland and Portugal to exit their bailout programs in 2014. Greece and Cyprus both managed to partly regain market access in 2014. Spain never officially received a bailout program. Nonetheless, the crisis had significant adverse economic effects, with unemployment rates in Greece and Spain reaching 27%. It was also blamed for subdued economic growth, not only for the entire eurozone, but for the entire European Union. As such, it is thought to have had a major political impact on the ruling governments in 10 out of 19 eurozone countries, contributing to power shifts in Greece, Ireland, France, Italy, Portugal, Spain, Slovenia, Slovakia, Belgium, and the Netherlands, as well as outside of the eurozone in the United Kingdom.

Attributions