What does the future success of the common currency depend on?
The first euro banknotes and coins entered circulation 20 years ago. Although the exchange rates of almost all participating countries had already been fixed two years earlier, only the introduction of the euro marked the irreversible economic integration of Europe. Because after the creation of the single monetary policy and the introduction of hundreds of tons of euros in cash, a return to national currencies would have ended in disaster for the European Union and its Member States.
The global financial crisis and the euro crisis have shown that the single market would not work without the common currency, the euro, one of the reasons being exchange rate differences. Even if the euro has not supplanted the dollar at the forefront of the world monetary system, it protects the European economies from external shocks, that is to say from the negative impacts of the world economy.
Are you ready for the collapse?
Moreover, monetary integration has shown its benefits during the COVID-19 pandemic. Without the euro, some Member States would not only face a supply and demand crisis, but also a strong weakening of their currency, which could even lead to a currency crisis. It would then be extremely difficult to fight the pandemic and support jobs with public money.
EU citizens seem to appreciate the stabilizing effect of the common currency. According to the May 2021 Eurobarometer survey, 80% of respondents think the euro is good for the EU; 70% think the euro is good for their own country.
Moreover, eurozone membership is seen as attractive: Croatia will most likely join the eurozone in 2023. Bulgaria also aspires to join. Due to the loss of confidence in the currencies of Poland and Hungary, the introduction of the euro could become a realistic scenario in the event of a change of government in these countries.
A long list of reforms
Despite these developments, many euro area problems remain unresolved 20 years after the currency shift. The fundamental dilemma is between risk sharing and risk elimination. The question is how much more structural reform individual member states need to undertake before deeper euro area integration, which involves greater risk sharing between member states, can take place. In the banking sector, for example, the aim is to improve the financial health of banks, that is to say, among other measures, to increase their capitalization and reduce the level of non-performing loans before a common deposit insurance scheme can be created.
A second problem is the relationship between monetary policy and fiscal policy. Currently, the European Central Bank is the main stabilizer of the euro zone‘s public debt, which has increased considerably due to the pandemic, and it will remain so by reinvesting its holdings in government bonds at least until 2024. However , an alternative solution is needed to stabilize the eurozone debt market.
The joint debt guarantees, recently proposed by France and Italy, must be combined with incentives for the modernization of the economies, in particular of the countries south of the euro. In this context, it is important to keep in mind the limits of fiscal policy, which is currently too often seen as the magic bullet for all economic policy problems. Related to fiscal policy are the questions of the number of rules and the degree of flexibility needed in the euro area.
Lively discussions are to be expected this year on the corresponding changes to the fiscal rules. Indeed, there is great distrust between the countries of the northern and southern euro zone, which is mainly explained by the different levels of performance of the economies and the divergences of views on economic policy. Persistent inflation and problems with the implementation of the NextGenerationEU stimulus package, which is supposed to cushion the damage caused by the coronavirus to the economy and society, could exacerbate disparities in economic performance and therefore also disagreements within the euro area.
The euro crisis has shown that turbulence in one Member State can have fatal consequences for the entire monetary area. In the years to come, however, the biggest challenge for the euro area will not be the situation in the smaller member states like Greece, but in the larger ones. The economies of Italy, France and Germany, which account for nearly 65% of euro area gross domestic product, are difficult to reform with their complex territorial structures and growing political fragmentation. At the same time, these economies lack real convergence.
A decisive factor for the future development of the euro project will be whether the transformation of their economic models will succeed under the influence of the digital revolution, the climate crisis and demographic change.
*[This article was originally published by the German Institute for International and Security Affairs (SWP), which advises the German government and Bundestag on all questions relating to foreign and security policy.]
The opinions expressed in this article are those of the author and do not necessarily reflect the editorial policy of Fair Observer.