THE ECONOMIC RATIONALE
A BRIEF HISTORY OF THE ROAD
TO THE EURO
THE LAST STEPS: FROM THE ECU
TO THE EURO
The euro became the single currency of the European Union (EU)—for exchange and financial markets—on 1 January 1999, the starting date for the third and final stage of the Economic and Monetary Union (EMU), one of the key components of the ongoing integration of Europe. The euro replaced the European Currency Unit (ECU), created in 1979, against which it was exchanged at the rate of 1 to 1. All obligations and contracts in ECUs were pursued in euros in a seamless transition. The euro is used in all operations (revenue and expenditure) linked to the EU's 110 billion euro budget and to EU financial activities (such as loans and bonds). A further evolution of the currency came on 1 January 2002 when the euro became the national currency for twelve of the fifteen EU member states: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.
In order to qualify to have the euro as the national currency, an EU member must fulfill three economic criteria linked to areas of sound management of public finance (public deficit and public debt, stability of exchange rates, and low inflation and interest rates). Failure to meet these criteria is the reason why the ten nations that entered the EU on 1 May 2004 could not, as of 2005, use the euro as their national currency, although they are aiming to meet the criteria by 2014. Thus, although by EU treaty all member states have the obligation to participate in the EMU, they may not be permitted to participate in all of its provisions. Moreover, three states, Denmark, Great Britain, and Sweden, although fully part of the EMU, negotiated to postpone their adoption of the euro until a later stage, when the nation's government and citizenry decide that the time is ripe.
As the EU is not yet a federal state, management of the Economic and Monetary Union is based on functioning rules, on strong interstate cooperation and policy coordination, and on a division of tasks between member states' economic policy ministers and the European Central Bank (ECB). Monetary and economic management rules are defined by treaty and specified by EU regulations. The main economic policy element is the Growth and Stability Pact, which obliges member states to pursue sound budgetary policy aimed at economic growth. The European Commission continuously monitors member states' economic situations and reports to the Council of Economic and Finance Ministers (ECOFIN). Breaches to the pact may lead to sanctions, if the ECOFIN decides so on the basis of the commission's recommendations. Although less strict for the countries that have not adopted the euro, treaty obligations and potential sanctions do apply to all EU members. The European Court of Justice is charged with dealing with disputes that arise concerning these matters. Monetary policy is the domain of the fully independent ECB. It defines objectives (such as inflation rates and growth of the money supply) and fixes reference interest rates accordingly as well as the amount of coins and notes in euro to be issued. Its treaty obligation is to ensure the stability of the euro both internally (inside the EU) and externally (outside the EU). The role of the European Parliament (EP) is very limited. The institutions in charge have an obligation to inform the EP of their actions, and it may issue nonbinding recommendations.
During Europe's nearly 2,500-year history as a politically organized but divided continent, Europeans had many occasions to use common monetary instruments and monies. The euro, however, is the first currency in world history willingly accepted by citizens from nation-states who used to fight one another, in a move toward building a commonwealth and political unity.
The story certainly starts with the development of economics as a science during the eighteenth century. Economists such as David Hume (1711–1776) and Anne-Robert-Jacques Turgot (1727–1781) demonstrated the interdependence of national economies and policies and developed the theories now called the "monetary approach of the balance of payment" and the "optimal currency area." From these derive liberal and monetarist economic policies, and the economic rationale for creating the euro. Briefly, the theory stipulates that when two (or several) rather small countries widely open their borders to mutual trade, they have no more control over their individual monetary policies and by consequence over their economic cycles. Therefore it is beneficial for the countries to create a monetary union, with a single currency. And this is the case with the EU members. Obviously, in an increasingly globalized world, there are many other economic reasons to create a single currency, including the reduction of transaction costs, economies of scale, productivity gains, and the creation of a large economic space that permits greater consolidation. Nevertheless, these economic rationales, if necessary, are not sufficient to explain why EU members made such an extraordinary decision—through a treaty signed in Maastricht, Netherlands, on 7 February 1992—to abandon one of the main hallmarks of national sovereignty. Politics and geopolitics certainly also played a major role.
The process has been long and difficult, even bloody. It necessitated the failure of the gold standard and of the limited monetary unions of the nineteenth century, the latter failures resulting mainly from the incapacity of European nations to cooperate and from their rivalry for dominance of the world—based on excessive nationalism and dictatorial ideologies—culminating in two world wars that killed millions and destroyed economies. Lessons were drawn during the last years of World War II. Some European federalists, such as Luigi Einaudi (1874–1961), argued in favor of a European political and monetary union, whereas others, such as John Maynard Keynes (1883–1946), wanted, along with some Americans, to establish an international monetary order. The latter succeeded with the creation, via the Bretton Woods Conference (1944), of the international monetary system monitored by the International Monetary Fund (IMF). The United States led the negotiations. It was by then the largest and strongest economy in the world and possessed 90 percent of the world's gold reserves. Therefore, the U.S. dollar was chosen as the reference currency against which all others had to define their value. To work smoothly, such a system needed the U.S. government to adopt a multilateral and cooperative approach to its economic policy that could lead the world economic cycle. Starting in the late 1950s, this was not the case. By the late 1960s, the United States' "benign neglect" approach, its growing indebtedness and money supply to finance its economic growth, and its wars made the dollar—which, up to then, had been considered "as good as gold"—an inconvertible currency (the crises of 1968 and 1971–1973) and led to the collapse of the Bretton Woods system in 1976.
In the meantime, the Europeans, thanks to the U.S. Marshall Plan (1948–1951) and the European Payments Union (1950–1958), reconstructed their economies. To suppress one cause of war, they decided to pool their coal and steel industry (European Coal and Steel Community, formed 1952), then to create, through the Rome Treaty of 1957, a broader economic and political community known initially as the European Economic Community (later simply the European Community). To succeed, an economic union needed internal and external monetary stability. The mismanagement of the dollar was putting the entire enterprise at risk. As early as 1960, a gold pool had to be created to maintain the value of the dollar against gold. The growing crisis of the dollar led to a formalized strengthening of the monetary cooperation of the European Community central banks in 1964, and the dissolution of the gold pool prompted the first project with a goal of creating a European common currency (Plan Barre, 1968). The Council of the European Union asked one of its members, Pierre Werner (1913–2002), the prime minister of Luxembourg, to prepare a road map. Adopted in 1971, the plan's policy tools and monetary practices were aimed at achieving a common currency by 1980.
The international monetary crisis precipitated by the crises of the dollar (1971, 1973, and 1976), reinforced by the first oil crisis (1973–1975), disrupted the European Community economies, placing their cooperation at stake, and leading to the partial failure of the agreement to maintain the fluctuations of the European currencies within a small band (a system known as the "European monetary snake"). But the negative consequences on growth and unemployment were such that the monetary unification process was reinitiated in 1978. In March 1979 the European Monetary System (EMS), based on the ECU, a weighted basket of the EC national currencies, was adopted, with the ECU becoming the monetary unit of account of the EC budget. The ECU was managed by the European Monetary Cooperation Fund, which later evolved into the European Central Bank, and the Committee of the Governors of the EC central banks. The second oil crisis (1979–1981), as well as the initial unbalanced practices of the monetary cooperation in favor of Germany, made its debut difficult. Two reforms (in 1985 and 1987) solved these problems, ensuring real cooperation in the definition of monetary policies and bringing about a better share of EMS management costs. In the meantime, the ECU developed as an international currency. By 1991 it was the third most used international currency on the financial markets.
The success of the EMS in stabilizing the national currencies internally and externally, the growing convergence of economic indicators, the interdependence and integration of the EC economies, the large swings in the value of the U.S. dollar, the collapse of the communist systems of central and eastern Europe and the end of the Cold War, and the vital necessity of Europe to contribute to world monetary stability were the main developments that enabled the adoption of a three-step plan toward the creation of the EC monetary union. The Maastricht Treaty that formalized it also contained elements to build a political union. The reluctance of Great Britain, Sweden, and Denmark to abandon their monetary sovereignty in order to slow down the process of political union did not compromise the monetary union of which they are part without using the single European currency. The transition to the full use of the euro (1999–2002) in the twelve other countries was an incredible challenge: all coins and notes had to be exchanged, the new euro had to be designed and produced, all systems—financial, banking, accounting—had to be modified, vending machines had to be changed, and so on. A changeover plan was adopted in December 1995. As planned, the euro was introduced as the international currency and the accounting currency of banks on 1 January 1999. At that point, the twelve national currencies of the union disappeared from exchange and financial markets. Only coins and notes continued to circulate internally. Their exchange for euro coins and notes started on 1 January 2002 and was achieved in two months, far quicker than expected.
Although there are some political tensions surrounding the application of the Growth and Stability Pact that could lead to some limited modifications, the whole system is functioning smoothly. Very quickly, the ECB was able to gain strong international credibility. In a few short years, the euro has become the second most used international currency in world trade—on all types of financial markets—standing just behind the U.S. dollar (at a ratio of 3 to 4). In some countries, complaints were raised from citizens contending that the changeover to the euro permitted professionals to increase their prices, but all are using the euro coins and notes without major problems and benefit from the low or nil electronic transaction costs for payments. The euro is generally considered to be a major European success.
See alsoEuropean Union.
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eu·ro1 / ˈyərō; ˈyoŏrō/ • n. (pl. eu·ros or eu·ro) (also Eu·ro) the single European currency adopted in 1999 by eleven countries in the European Union (Belgium, Austria, Finland, Spain, Ireland, Portugal, Germany, France, Netherlands, Italy, Luxembourg) as an alternative currency in noncash transactions. In 2002 it replaced the national currencies of twelve member countries (the original eleven, plus Greece). (Symbol: ₠)