The euro at 25

Greetings. This month, it is 25 years since 12 EU countries merged their currencies and the euro was born. It took another three years for euro banknotes and coins to replace the francs and marks, pesetas and lire that preceded them, their exchange rates had been irrevocably fixed and the monetary system was running on euros everywhere but in the shops. Below are some reflections on how it has turned out differently from what might have been expected. But first, don’t forget that the FT’s charity auction is still running — and there are some bargain deals (lunch with me!) to be snapped up!

At an event this week, I and the other participants were set the following “essay” question: “The euro is not what we expected it to be. Discuss.” The answers, of course, must depend on who you take “we” to be.

I start by assessing the expectations of the critics of monetary union. They predicted that merging the currencies of such different economies would make it much harder to protect against asymmetric shocks. The harshest of them concluded that the euro would surely disintegrate, unless it was complemented by a great leap of fiscal integration and transfers from creditor to debtor states — on which, see the next point.

They focused, however, on the wrong shocks. Few had thought through how balance of payments crises would work out, nor had many predicted that the euro would have the misfortune to be born into the biggest global credit bubble of all time, as I described in my book on the single currency.

As for conventional asymmetric shocks (changes in relative goods prices, say, or idiosyncratic downturns), the euro made little difference, and the balance of payments crises were, of course, managed (albeit badly) without setting up a fiscal union. So the most unexpected thing, from one starting point, is that the euro is still there, intact and, in fact, growing. I remember a colleague, who shall remain nameless, forecasting after Greece’s near-exit from the eurozone in 2015, that at least one country would leave the single currency within 10 years. But not a single member has left, despite the repeated Greek crises of 2010-15, and many new countries have joined, the last being Croatia a year ago.

The second point is that both the detractors and many supporters expected monetary unification to force the emergence of a fiscal and transfer union whose members put large budgets in common, the richer subsidising the poorer. Look to the US, the argument often went, whose federal budget leads to much more redistribution between states than takes place between EU members. The monetary union would be “incomplete” without such a system.

A leap of fiscal integration did take place in Europe in 2020. But it was for the EU as a whole, not for the eurozone: the establishment of an €800bn post-pandemic resilience and recovery fund, which would go on to make grants (and loans) to member states backed by previously unthinkable common bonds. And the political and economic motivations that made it happen related not to the single currency, but to the single market. The fear was that national budget support for companies and workers in the pandemic would be so uneven between countries that it would destroy the competitive “level playing field” and the single market itself. (This fear has returned in the case of national subsidies for green and chips infrastructure and energy subsidies.)

That the logic of the single market proved stronger than the logic of the single currency is no small thing. The euro itself was in part motivated by the need to make the single market work better: “One market, one money” the slogan went.

And note the parallels between today’s subsidy wars and the pre-euro competitive devaluations in how they are felt to undermine the level playing field in the single market. In the 1980s, the worry was that competitive devaluations — stealing your neighbour’s demand to boost your economy — would undermine the attempt at unifying the real economy. Monetary unification got rid of nominal exchange rate changes within the bloc. But the same beggar-thy-neighbour impulse has today returned in the race to subsidise green industry, with economic and political effects similar to the old competitive devaluation problem.

The threat posed by the subsidy race, however, is again to the single market as a whole, not to the monetary union. Hence the discussion on how the integrity of the single market requires either more discipline on subsidies or — more likely at a time when domestic cutting-edge green industry is a political imperative — more common spending on subsidies at the EU level.

Remembering the single market helps us realise that some of the policies and reforms without which monetary union supposedly cannot function, are really policies and reforms required for an integrated economic bloc — regardless of currency arrangements — to perform well. Take banking union (unification of banking regulations, a harmonised approach to resolution and deposit insurance, and removal of barriers to cross-border banking). The project is now seen in the context of making the monetary union work well, but the EU contemplated it in its own right long before the euro. It could well have been put in place sooner — and the eurozone crisis may have played out differently if it had.

Or, take the case for transfers between richer and poorer states — that, too, may be necessary to equalise the gains of economic integration and to maintain public support for it, even between countries that do not join a common currency. Again, then, this is a motivation for fiscal integration that is more strongly mobilised by the single market than the euro.

This is not to say that there aren’t some policy or institutional imperatives that are unique to the euro. One is the need to achieve the correct aggregate fiscal stance of the eurozone countries put together, which becomes challenging once monetary policy is unified but fiscal policy remains national. The reform of the EU’s fiscal rules (which I am generally modestly optimistic about) missed an opportunity to put in place a robust mechanism to ensure that the eurozone countries collectively determine the fiscal stance they think appropriate. But even if it is not ensured, it is possible, and it is to be hoped that the opportunity to do so will be seized in the eurozone’s budgetary politics going forward.

Another is the forthcoming digital euro — the retail central bank digital currency that I am confident the European Central Bank will start issuing within a few years (in fact I’m on the record predicting it by the end of 2025, which may be a little ambitious but perhaps not so much). Over at FT Alphaville, Bryce Elder has a nice piece on how the digital euro project is, however, stymied by the ECB’s keenness not to disrupt legacy banks even one little bit. As he puts it: “If a European CBDC doesn’t break a few [banks], what’s the point?” In any case, I think the digital euro will, in time, have a greater impact than many seem to believe now — mostly positive even if, or even because, it is disruptive — if it is allowed to do so.

Most discussions of what the euro “needs”, however, are really about the demands flowing from economic integration generally, which is to say, the single market. Being lucid about that could make those discussions more constructive.

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