Alka Bala

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By Alka Bala

25 Years of Euro: What lies ahead?
01 January 2024, marked the 25 years of the Euro, Europe’s common currency which stands as a symbol of European stability and unity. It was adopted on 01 January 1999 by 11 EU countries, who implemented a single monetary policy outlined by the European Central Bank (ECB). Celebrating 25 years of the Euro, Christine Lagarde, President of the ECB, stated the Euro's evolution has been “…from the dream of a few visionary founders to a currency used by 350 million people across 20 countries.” The European Central Bank, wielded the euro’s financial autonomy and general stability in the union, carrying responsibility for high risks and fruits of high rewards through greater economic integration. 

How has the euro performed in the 25 years?
Monetary unification through a common currency was adopted to allow easier cross-border trade avoiding the price shocks and fluctuations caused by the changing exchange rates.  In the first decade of the euro’s adoption, 16 million jobs were created in the eurozone, achieving the promise of greater employment. European Central Bank succeeded in managing the overall inflation performance maintaining it under 2.1 per cent since 1991. The transparency in price stability also brought greater economic growth, jobs and economic benefits. However, the increased flow of capital was still into mostly non-tradeable sectors. The flow of capital between the high-income core countries and the low-income periphery countries within the eurozone paused during the recession and debt crisis in 2009. 

Eurozone faced a sovereign debt crisis, financial sector crisis and an economic decline from 2009, as a consequence of the global financial crisis in 2008. Eurozone countries such as Portugal, Spain, Italy, Ireland, and Greece suffered the most while the collective GDP had declined by four per cent in 2009. EU’s efforts to overcome this included short-term measures such as bailouts for banks and engaging in long-term plans of initiating structural reforms, provision of safety nets and improving economic governance. However, these policy measures remained inadequate as they led to procyclical fiscal consolidation. The recession killed the incentive to expand for higher-income eurozone countries. The 2020 COVID-19 pandemic hit the eurozone economies during their slow recovery from the recession. This time, the response from the European Central Bank was prompt, through measures for fiscal relaxation and a balanced combination of national and regional initiatives. The pandemic also witnessed collective leadership, in contrast to the earlier fragmented response to the Great Recession. The increased policy response from national governments resulted in growing public debt, as seen in Italy and France, where the debt increased by 13 per cent and 15.5 per cent respectively. The rising inflation during the pandemic was also met with Europe’s energy crisis following Russia’s invasion of Ukraine, forcing the European governments to balance inflation through gas subsidies and provide income support, often carried out through deficit financing. 

Where does the euro stand currently as a global currency?
Internationally, the euro is considered to be the most important currency after the dollar. However, 2022 was highlighted as the “worst year in the euro’s history” as it lost 16 per cent of its value against the dollar, and was lowest at trade since December 2002. Europe’s macroeconomic challenges were faced because of its heavy energy dependency on Russia, the economic and production slowdown due to the Ukraine war, and increasing inflation and economic recession, ultimately leading to the euro’s decline against the dollar. The differences in policies between the US Federal Reserve and the European Central Bank (ECB) and the delay in hiking interests by the ECB led to the euro’s further decline. However, the euro’s devaluation has given it a competitive advantage o, as exports increase and become cheaper. ECB’s efforts to starkly increase interest have aided the euro's recovery and a three per cent gain against the US dollar in 2023. Europe’s political and economic climate in 2024 appears volatile, as countries gear for European Parliament elections and several countries equip for presidential or Parliamentary elections at the national level. The election results would determine new policies regarding the euro, the EU budget and the financing of the green transition.

What lies ahead for the euro in the next 25 years?
Firstly, in the short term, the euro will have to navigate the energy price fluctuations due to the ongoing Russia-Ukraine war. Europe needs to diversify its markets as sanctions on Russia are likely to continue. As the EU diverts increased funding to begin its reconstruction efforts in Ukraine from late 2024/early 2025, avenues for market expansion should not be overshadowed.  The disruptions in the global supply chain due to the spillover of the Israel- Palestine conflict in the Red Sea also has increased shipping costs for European firms. European firms are adjusting better with the delivery delays, to avoid supply shortages and production slowdowns witnessed during the pandemic.

Secondly, Structural and macroeconomic policy changes. The functioning of a stable single market requires the implementation of structural reforms. Policies should be implemented to achieve a banking and capital market union with strong market infrastructures. Europe can learn lessons from its past misallocation of capital into non-tradeable sectors and rather increase sectoral specialisation in its investments. The implementation of countercyclical macroeconomic policies and structural reforms would ensure the euro’s stability and growth, providing a long-term paradigm shift. These reforms must differ from the responses the ECB utilised to tackle unexpected financial shocks. 

Thirdly, greater integration of the European Monetary Union’s fiscal and monetary governance. The complete separation between national banks and the European Central Bank was earlier considered essential to maintain the independence of the ECB and ensure that it is not coerced into adopting popular policies to avoid public discontent. However, this approach can no longer be pursued as external shocks such as the pandemic demanded fiscal and monetary responses at national and bloc levels. The challenges of fragmented responses from different countries during the financial crisis call for better stabilising measures at the national and the bloc levels. The establishment of Central Fiscal Capacity is voiced that would function solely during crises and external shocks. This would entail a common framework coordinated with national fiscal authorities and the ECB.

Fourthly, increased focus on the digitalisation of payments.  The new EU industrial policy emphasizes the digitalisation of payment systems. The proposal for Central Bank Digital Currency, or a digital euro has been accelerated since the COVID-19 pandemic, as the digital euro would complement cash payments and allow avenues to pay securely and more quickly. The digital euro is also expected to make European payments more competitive and innovative. The retail digital euro project for the use of private citizens is currently in its preparation stage with the digital euro rulebook, platform and infrastructure for the digital euro yet to be finalised. The governing council of the ECB would decide by the end of 2024, if a wholesale digital euro project, accessible to only financial institutions and certain non-financial institutions can be implemented. However, the digital euro has received political scepticism as certain countries view it to be a measure that violates privacy and increases surveillance.

Euro’s experience as an international monetary experiment would need to undergo the mentioned policy reforms and structural changes to overcome the present challenges and future challenges of geopolitical tensions, digitalisation and green transition that await Europe in the 21st century.

About the Author

Alka Bala is an undergraduate scholar at the Department of International Relations, Peace and Public Policy at St Joseph’s University, Bangalore. Her areas of interest include Europe, maritime, climate change, and southeast Asia.
 

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