The euro is the single currency shared by 19 of the European Union’s Member States, which together make up the euro area. The introduction of the euro in 1999 was a major step in European integration. It has also been one of its major successes: more than 337.5 million EU citizens in 19 countries now use it as their currency and enjoy its benefits.
When the euro was launched on 1 January 1999, it became the new official currency of 11 Member States, replacing the old national currencies – such as the Deutschmark and the French franc – in two stages. First the euro was introduced as an accounting currency for cash-less payments and accounting purposes, while the old currencies continued to be used for cash payments. Since 1 January 2002 the euro has been circulating in physical form, as banknotes and coins.
The euro is not the currency of all EU Member States. Two countries (Denmark and the United Kingdom) have ‘opt-out’ clauses in the Treaty exempting them from participation, while the remainder (several of the more recently acceded EU members plus Sweden) have yet to meet the conditions for adopting the single currency.
Andorra, Monaco, San Marino and the Vatican City have adopted the euro as their national currency by virtue of specific monetary agreements with the EU, and may issue their own euro coins within certain limits. However, as they are not EU Member States, they are not part of the euro area.
THE EURO AND ECONOMIC AND MONETARY UNION:
All EU Member States form part of EMU, which can be described as an advanced stage of economic integration based on a single market. It involves close co-ordination of economic and fiscal policies and, for those countries fulfilling certain conditions, a single monetary policy and a single currency – the euro. The process of economic and monetary integration in the EU parallels the history of the Union itself.
When the EU was founded in 1957, the Member States concentrated on building a 'common market'. However, over time it became clear that closer economic and monetary co-operation was necessary for the internal market to develop and flourish further. The goal of achieving the EMU, including a single currency, was not enshrined until the 1992 Maastricht Treaty (Treaty on European Union), which set out the ground rules for its introduction.
The Treaty states what the objectives of EMU are, who is responsible for what, and what conditions Member States must meet in order to adopt the euro. These conditions are known as the 'convergence criteria' (or 'Maastricht criteria'). These criteria include low and stable inflation, exchange rate stability and sound public finances.
WHICH COUNTRIES USE THE EURO?
The euro (€) is the official currency of 19 out of 28 EU member countries. These countries, known collectively as the Eurozone are:
- THE NETHERLANDS
WHY THE EURO?
The euro was created because a single currency offers many advantages and benefits over the previous situation where each Member State had its own currency. Not only are fluctuation risks and exchange costs eliminated and the single market strengthened, but the euro also mean closer co-operation among Member States for a stable currency and economy to the benefit of us all.
When the EU was founded in 1957, the Member States concentrated on building a 'common market' for trade. However, over time it became clear that closer economic and monetary co-operation was needed for the internal market to develop and flourish further, and for the whole European economy to perform better, bringing more jobs and greater prosperity for Europeans. In 1991, the Member States approved the Treaty on European Union (the Maastricht Treaty), deciding that Europe would have a strong and stable currency for the 21st century.
The benefits of the euro are diverse and are felt on different scales, from individuals and businesses to whole economies. They include:
- More choice and stable prices for consumers and citizens
- Greater security and more opportunities for businesses and markets
- Improved economic stability and growth
- More integrated financial markets
- A stronger presence for the EU in the global economy
- A tangible sign of a European identity
Many of these benefits are interconnected. For example, economic stability is good for a Member State’s economy as it allows the government to plan for the future. But economic stability also benefits businesses because it reduces uncertainty and encourages companies to invest. This, in turn, benefits citizens who see more employment and better-quality jobs.
HOW DO THESE BENEFITS OF THE EURO ARISE?
The single currency brings new strengths and opportunities arising from the integration and scale of the euro-area economy, making the single market more efficient.
Before the euro, the need to exchange currencies meant extra costs, risks and a lack of transparency in cross-border transactions. With the single currency, doing business in the euro area is more cost-effective and less risky.
Meanwhile, being able to compare prices easily encourages cross-border trade and investment of all types, from individual consumers searching for the lowest cost product, through businesses purchasing the best value service, to large institutional investors who can invest more efficiently throughout the euro area without the risks of fluctuating exchange rates. Within the euro area, there is now one large integrated market using the same currency.
The scale of the single currency and the euro area also brings new opportunities in the global economy. A single currency makes the euro area an attractive region for third countries to do business, thus promoting trade and investment. Prudent economic management makes the euro an attractive reserve currency for third countries, and gives the euro area a more powerful voice in the global economy.
Scale and careful management also bring economic stability to the euro area, making it more resilient to so-called external economic 'shocks', i.e. sudden economic changes that may arise outside the euro area and disrupt national economies, such as worldwide oil price rises or turbulence on global currency markets. The size and strength of the euro area make it better able to absorb such external shocks without job losses and lower growth.
REALISING THE BENEFITS
The euro does not bring economic stability and growth on its own. This is achieved first through the sound management of the euro-area economy under the rules of the Treaty and the Stability and Growth Pact (SGP), a central element of Economic and Monetary Union (EMU). Second, as the key mechanism for enhancing the benefits of the single market, trade policy and political co-operation, the euro is an integral part of the economic, social and political structures of today’s European Union.
THE STABILITY AND GROWTH PACT
The Stability and Growth Pact (SGP) is a set of rules designed to ensure that countries in the European Union pursue sound public finances and coordinate their fiscal policies.
Some of the SGP’s rules aim to prevent fiscal policies from heading in potentially problematic directions, while others are there to correct excessive budget deficits or excessive public debt burdens.
The rules of the SGP’s ‘preventive arm’ bind EU governments to their commitments towards sound fiscal policies and coordination by setting each one a budgetary target, known as a Medium Term Budgetary Objective(MTO) .
These budget deficit (or surplus) targets are defined in structural terms, which means that they take into consideration business cycle swings and filter out the effects of one-off and other temporary measures.
Member States that share the euro as their currency outline how they intend to reach their MTOs in ‘Stability Programmes’, while other EU Member States do so in ‘Convergence Programmes’ . These are assessed by the European Commission and EU governments during the European Semester.
In the ‘corrective arm’ of the SGP, the Excessive Deficit Procedure (EDP) ensures the correction of excessive budget deficits or excessive public debt levels. It is a step-by-step approach for reining in excessive deficits and reducing excessive debts.
The EU Treaty defines an excessive budget deficit as one greater than 3 % of GDP. Public debt is considered excessive under the Treaty if it exceeds 60 % of GDP without diminishing at an adequate rate (defined as a decrease of the excess debt by 5 % per year on average over three years).
Countries that fail to respect the SGP’s preventive or corrective rules may ultimately face sanctions.
For Member States sharing the euro currency, this could take the form of warnings and ultimately financial sanctions including fines of up to:
HISTORY OF THE STABILITY AND GROWTH PACT
The Stability and Growth Pact has evolved significantly along with the EU’s economic governance rules.
- 1992: EU Member States sign the Maastricht Treaty, paving the way for the creation of the euro as the common currency of the EU. The treaty limits government deficits to 3 % of GDP and public debt levels to 60 %, so as to enable countries to share a single currency.
- 1997: EU Member States agree to strengthen the monitoring and coordination of national fiscal and economic policies to enforce the deficit and debt limits established by the Maastricht Treaty. The Stability and Growth Pact is born.
- 1998: The SGP’s preventive rules enter into force.
- 1999: The SGP’s corrective rules enter into force.
- 2005: EU lawmakers amend the SGP to allow it to better consider individual national circumstances and to add more economic rationale to the rules to be complied with.
- 2011: The SGP is made more comprehensive and predictable with a major enhancement of the EU’s economic governance rules through a collection of new laws, known as ‘the Six Pack.’ The monitoring of both budgetary and economic policies is organised under the European Semester and further details on the implementation of the SGP’s rules are laid down in a ‘Code of Conduct’ (last revised in September 2012).
- 2013: Adherence to the SGP is further strengthened by new laws, known as the ‘Two Pack,’ which reinforces economic coordination between Member States and introduces new monitoring tools. Further details on the implementation of the ‘Two Pack’ provisions are laid down in ‘Code of Conduct’ (last revised in November 2014).
- 2013: The importance of the budgetary targets set by the SGP’s preventive arm (the Medium-Term Objectives), are strengthened by a law known as the ‘Fiscal Compact,’ which is part of an inter-governmental treaty known as the Treaty on Stability, Coordination and Governance (TSCG).
- 2014: A review of the ‘Six Pack’ and ‘Two Pack’ rules , which was called for in the legislation, determined that the legislation had contributed to the progress of fiscal consolidation in the EU. The review highlighted some strengths as well as possible areas for improvement, which will be discussed with the European Parliament and Member States.
WHO MANAGES IT?
Themonetary policyof the eurozone is the responsibility of the European Central Bank (ECB), which was created for that purpose, and the national central banks of the euro area countries. Together they compose the Eurosystem.
Fiscal and structural policiesremain in the hands of individual national authorities. However, they must coordinate these policies in order to attain the common objectives of stability, growth and employment. A major coordination structure is the Stability and Growth pact , which contains agreed rules on fiscal discipline.
WHY DID THE CRISIS HAPPEN?
Europe’s debt crisis was initially triggered by events in the American banking sector.
When a slowdown in the US economy caused over-extended American homeowners to default on their mortgages, banks all over the world with investments linked to those mortgages started losing money.
America’s fourth largest investment bank, Lehman brothers, collapsed under the weight of its bad investments, scaring other banks and investors with which it did business.
The fear that more banks could fail caused investors and banks to take extreme precautions. Banks stopped lending to each other, pushing those reliant on such loans close to the edge.
European banks that had invested heavily in the American mortgage market were hit hard. In an attempt to stop some banks from failing, governments came to the rescue in many EU countries like Germany, France, the UK, Ireland, Denmark, the Netherlands and Belgium. But the cost of bailing out the banks proved very high. In Ireland, it almost bankrupted the government until fellow EU countries stepped in with financial assistance.
As Europe slipped into recession in 2009, a problem that started in the banks began to affect governments more and more, as markets worried that some countries could not afford to rescue banks in trouble.
Investors began to look more closely at the finances of governments. Greece came under particular scrutiny because its economy was in very bad shape and successive governments had racked up debts nearly twice the size of the economy.
The threat of bank failures meant that the health of government finances became more important than ever.
Governments that had grown accustomed to borrowing large amounts each year to finance their budgets and that had accumulated massive debts in the process, suddenly found markets less willing to keep lending to them.
What started as a banking crisis became a sovereign debt crisis.
WHY DID THE CRISIS SPREAD?
In several countries, governments became ensnared by the problems of the banking sector when troubled banks started turning to them for help. The high cost of bank rescues led financial markets to question whether governments could really afford to support the banking sector. And as recession began to bite across Europe, the focus on the health of government finances threw a spotlight on the fact that a number of governments in the euro area had for some years been borrowing heavily to finance their budgets, accumulating huge debts in the process. Easy money was available because investors had turned a blind eye to warning signs about the health of the economy and were not paying enough attention to the risks involved in lending more and more.
Part of the reason some governments had become dependent on debt was that their economies had been losing competitiveness for a long time, as they failed to keep up with economic reforms in other countries.
In some countries, governments had allowed property bubbles and other unhealthy economic imbalances to develop. Finally, some governments had ignored the rules designed to make the euro work and had not done more to coordinate their economic policies since agreeing to share a common currency with a single monetary policy.
In an increasing number of countries a vicious cycle developed. Financial instability stifled economic growth, which in turn lowered tax revenues and increased governments’ debts. Higher debts then raised the cost of borrowing for governments, feeding financial instability. All of this prompted questions as to whether the institutional set-up of the Economic and Monetary Union and the euro was adequate in times of crisis.
The crisis exposed several shortcomings in the EU’s system of economic governance:
- Too much focus on deficits: monitoring of countries’ public finances had focused on annual budget deficits and not sufficiently on the level of government debt. Yet a number of countries that had kept to EU rules by running low annual deficits or even surpluses nevertheless found themselves in financial difficulties during the global financial crisis because of high levels of debt. Therefore, stricter monitoring of this indicator was needed.
- Lack of surveillance of competitiveness and macroeconomic imbalances: surveillance of EU economies failed to pay enough attention to unsustainable developments in competitiveness and credit growth leading to accumulated private sector debt, weakened financial institutions, and inflated housing markets.
- Weak enforcement: for euro area countries that did not play by the rules, enforcement was not strong enough; a firmer, more credible mechanism of sanctions was needed.
- Slow decision-making capacity: too often, institutional weaknesses meant that tough decisions on worrying macroeconomic developments were postponed. This also meant that insufficient account was taken of the economic situation from the perspective of the euro area as a whole.
- Emergency financing: when the crisis struck there was no mechanism to provide financial support to euro area countries that suddenly found themselves in financial difficulties. Financial support was needed not only to address country-specific problems but also to provide a ‘firewall’ to prevent problems spreading to other countries that were at risk.
As a consequence, Greece, and subsequently Ireland, Portugal, Spain and Cyprus, were eventually unable to borrow on financial markets at reasonable interest rates. The EU was requested to step in, which resulted in the creation of a crisis resolution mechanism and financial backstops i.e. large funds on stand-by to be used in an emergency by euro area countries in financial difficulty.
RESPONDING TO THE FINANCIAL CRISIS
To prevent a complete collapse of the banking system, European governments came to the rescue of their banks with urgent support of an unprecedented scale. 1.6 trillion euros, the equivalent of 13 % of the EU’s annual GDP were committed between 2008 and 2011.
The EU also launched a Europe-wide recovery programme to safeguard jobs and social protection levels and to support economic investment. In this way, bank runs were avoided and European savings were protected.
The euro broadly maintained its value and successfully shielded euro zone countries from the worst effect of the economic crisis by providing EU companies with a stable playing field for international trade and investment. But this effort took its toll, especially because most of this money had to be borrowed.
The economic and financial crisis has demonstrated that the EU’s banking system is vulnerable to shocks. A problem at one bank can spread quickly to others, affecting depositors, investment and the overall economy. In response, the EU and its member countries have been strengthening financial sector supervision.
As part of the reforms, 3 European supervisory bodies were set up to help coordinate the work of national regulators and ensure EU-level rules are applied consistently.
- The European Banking Authority (EBA), which deals with bank supervision, including the supervision of the recapitalisation of banks;
- the European Securities and Markets Authority (ESMA), which deals with the supervision of capital markets and carries out direct supervision with regard to credit rating agencies and trade repositories,
- and the European Insurance and Occupational Pensions Authority (EIOPA), which deals with insurance supervision.
European financial supervision is being stepped up to ensure that banks are better capitalised, behave responsibly and are able to lend money to households and businesses. This paves the ways for Banking Union to make sure that people’s deposits are protected and taxpayers are not forced to pay for the failure of banks.
The Banking Union is a natural complement to the Economic and Monetary Union. It addresses the weaknesses that were revealed by the crisis. Soon banks in every country that uses the euro will report to a common supervisor, the European Central Bank. Moreover, decisions on how to handle a failing bank will be taken centrally, according to a common set of rules that have been designed to minimize the cost to tax payers.
Depositors across Europe will also be better protected. Through these measures nearly 30 more, the EU is working to build a more effective financial sector based on stronger, more resilient banks and sounder regulation and supervision.
As the euro area’s independent monetary policy authority, the European Central Bank (ECB) played an important role in containing the crisis with innovative policies. The institution’s decision to lend banks as much as they needed at low rates and for as long as three years, helped to calm markets by ensuring that banks would be able to cover their short term needs.
When financial markets became so dysfunctional that they were demanding unreasonably high returns for lending to governments, the ECB devised the Outright Monetary Transactions (OMT) programme, under which it promised to buy the bonds of struggling government to ensure a reasonable rate, provided that they also commit to a programme of economic reforms with the euro area’s assistance fund, the European Stability Mechanism.
Although no country has ever requested the OMT programme to be used, its mere fact of its existence helped to calm financial markets.
RESPONDING TO THE DEPT CRISIS
From late 2009 and early 2010, certain euro area countries were beginning to have problems financing their debts. Market uncertainty led to normal government borrowing operations becoming costly and eventually impossible.
At the time, EU countries reacted quickly by putting in place so-called ‘firewall’ confidence-building measures to help to finance the debts of countries facing temporary difficulties in borrowing money from financial markets.
In parallel the EU also set to work on resolving the root causes of its weaknesses. A twin track approach was followed. Temporary assistance mechanisms were established to cope with the immediate crisis, and long-term measures to create permanent support facilities and to help prevent a reoccurrence of future crises were set in motion.
ASSISTING COUNTRIES IN TROUBLE
European countries have pulled together to create the world’s biggest financial assistance funds. By working together, the European Commission, the International Monetary Fund and the European Central Bank, help governments in need to devise assistance programmes to stabilize fragile economies and address deep-rooted economic problems.
When international investors stopped lending the Greek government the money on which it had grown dependent, euro area finance ministers and the International Monetary Fund (IMF) joined forces. On 2 May 2010 EUR 110 billion was set aside to support the Greek government in implementing reforms that would restore its economy. The money, of which EUR 80 billion came from Greece’s euro area partners, was disbursed by the European Commission in tranches between May 2010 and June 2013, following Greece’s successful implementation of promised reforms.
On 14 March 2012, euro area finance ministers and the IMF approved a second round of economic assistance for Greece, worth EUR 164.5 billion. This time, Greece’s fellow euro area countries stepped in with EUR 144.7 billion through the European Financial Stability Facility, a rescue fund that was launched in August 2010. A deal with financial investors to reduce Greece’s crushing debt burden by almost EUR 200 billion was also arranged.
Disbursement of the money was divided into tranches to be paid out between March 2012 and December 2014, in parallel with the completion of reforms that are crucial to the revival of Greece’s economy.
In November 2012, euro area finance ministers and the IMF agreed to further help Greece by cutting the cost of their loans and giving the country more time to repay them.