The euro is the official currency of the 17 nations in the euro zone. It is the second most traded currency in the world after the US dollar. How and why did it come about?
1. Why was there a need for the euro?
When the European Economic Community (EEC) (the predecessor of the European Union) was first founded in 1957, the focus of the member states was to build a common market for trade. Over time, the member states began to realize the need to promote even closer economic and monetary cooperation so that the whole European economy can perform better. Hence, in February 1992, the member states concluded the Maastricht Treaty (or the Treaty on European Union) to create a single currency called the euro. The Treaty officially came into force on 1 November 1993.
2. When did the euro come into force?
On 1 January 1999, the euro was introduced in non-physical form, such as electronic transfer, traveler’s cheques and bank transactions. The old notes and coins of the member states’ national currencies remained in use as legal tender until 1 January 2002 when the new euro notes and coins were introduced. In each member state, the people were given an official grace period to exchange the old currency for the euro, after which the former would cease to be legal tender.
3. Are all the European Union members using the euro?
No. The euro is currently the sole currency of the euro zone, comprising of 17 member states such as Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain (326 million people in total).
Among the existing EU members, the United Kingdom, Denmark, Sweden, Poland, Czech Republic, Hungary, Romania, Bulgaria, Latvia and Lithuania have yet to adopt the euro.
Outside the EU, the euro is also the sole currency of Montenegro and Kosovo and several European microstates like Andorra, Monaco, San Marino and the Vatican City.
4. Who manages the euro?
The euro is collectively managed by the independent European Central Bank (ECB) and the respective central banks of the euro zone states. While the national governments will still control their own economic policies, they will also coordinate with one another to promote a common growth and stability.
5. What are the conditions for adopting the euro?
Before a EU member can adopt the euro, it must first fulfill certain economic and legal criteria. This is to ensure that its economy is sufficiently prepared for adoption of the euro and can integrate smoothly into the monetary regime of the euro zone. National legislation is also required to ensure monetary compliance with the Treaty’s requirements. If approval is given, the country has to make preparations for the replacement of the national currency and the conversion of financial transactions to the euro. A public education campaign is also required to inform the people of the implications of the currency change.
6. What are the benefits of having a single European currency, compared to each member state having its own national currency?
- It is a strong symbol of closer ties within the European community, further strengthening the European identity.
- It reduces the fluctuation risks in the currency value, eliminates exchange costs and improves the transparency of cross-border transactions.
- With a more stable currency, it gives consumers more stable prices. It also removes the inconvenience for consumers having to change currency when they travel within the European Union. Price comparison of products becomes easier too.
- With reduced currency risks, it gives a sense of stability to businesses, which are able to do better long-term planning and expand their investments. This will also help to improve the employment situation in the European Union.
- There is greater integration of the member states’ financial markets, leading to higher efficiency in the allocation of capital in member states.
- With a unified currency, the European Union also becomes a more attractive investment destination for foreign investors.
- With an enlarged euro zone economy, it lets the European Union command a stronger presence in the global financial community. The euro also becomes an alternative reserve currency, besides the US dollar, for other countries.
7. What are the drawbacks or disadvantages of the euro?
- Member states have fewer fiscal monetary tools to work with. For example, with their own national currencies, member states can adjust their own interest rates to encourage investment and domestic consumption. However, with the establishment of the euro, the interest rates for all member states are now under the control of the European Central Bank.
- Similarly, in an economic downturn, member states no longer have the option of devaluing their currency to boost their own exports.
- In the past, member states, if faced with high unemployment and low economic growth, could increase government spending (i.e. unemployment benefits and other welfare funding) to encourage domestic consumption so as to boost the economy. With the Stability and Growth Pact (an agreement signed in 1997 to maintain fiscal discipline among members of the euro zone), member states are now required to keep their budget deficits within a certain limit. This meant that they could no longer spend their way out of a recession like in the past.
- Within the euro zone, different members are at different stages of development and economic cycles. Given the diverse conditions and structural differences, it is difficult to set an appropriate level of interest rates to accommodate the needs of all members.
- A financial collapse by one member state can spark off a domino effect on others, adversely affecting the whole system. As seen in the recent euro zone debate over a possible Greek default, the member states were forced to work together to ensure the overall stability of the euro zone.
- There is a political agenda behind closer European integration. By removing national control of monetary policy (and some parts of fiscal policy), member states are, in a sense, relinquishing some form of their sovereignty. Some have said that the economic integration of the EU is a prelude to a possible political union in the future. This is one of the common reasons why some EU members like the United Kingdom are reluctant to adopt the euro.