Euro @ 25 – Opinion News

By Amol Agrawal,

The euro marks its 25th anniversary in 2024 but its history goes beyond that. 

After centuries of wars culminating in two World Wars, it was decided that Europe would be unified. There were two pillars of unification: politics and economics. For economics, the focus was on building a common European market. The European Economic Community expanded both number of markets and number of countries. In 1992, 27 of 50 European countries formed the European Union (EU). EU proposed strengthening unification by building a shared citizenship and common currency, security, and foreign policies. 

Common currency was not really a new idea for Europe. In the mid-19th century, select European countries formed two common currency unions: the Latin Monetary Union (LMU) and the Scandinavian Monetary Union (SMU). These were abandoned around the WWI.  However, these unions were based on politics and lacked economic reasoning.

In 1961, economist Robert Mundell laid the economic principles for a currency union. He said there is a case for separate currencies in economies having different business cycles and asymmetric shocks. If one economy is facing a recession and another a boom, the currencies will adjust differently and would need different stabilisation policies. However, if the regions have similar business cycles and face similar shocks, then they can shift to a common currency. But then we see several countries which have states/provinces that don’t have common business cycles but still have common currency, such as US, India etc. How do we reconcile theory with facts? Mundell said such countries have high labour mobility and wage flexibility. In case of a shock, people can move from slowing regions to growing regions. 

The Europeans adopted Mundell’s ideas but made their adaptations. They reversed the sequence of integration by first introducing the common currency and improving labour and sectoral mobility overtime. Doing so would require a political union and will, which was difficult to achieve given the timeline. Instead, they introduced a convergence criteria. The members wishing to adopt the euro had to converge their inflation, debt, and deficit levels to certain threshold levels. Eleven members qualified, though some members used accounting tricks to do so. They surrendered the monetary policy function to the newly-established European Central Bank and introduced the euro in 1991 as an invisible currency for electronic payments. In 2002, the physical notes and coins were circulated.

Given the weak foundations, it was not if but when the union would be shaken. The moment came during the 2008 crisis which started in the US but quickly spread to Europe. Pre-crisis,  members ignored their macroeconomic criterion and binged on credit. The crisis created an economic slowdown, turning credit binge into a high debt cycle. Member economies suffered asymmetric shocks, but due to weak labour mobility and ineffective policy support, the economic fortunes nosedived. The financial crisis was followed by the pandemic and two wars, completely crippling the European economies. The United Kingdom, which did not adopt the euro, left the EU in 2016, jolting the European integration project. 

One objective of the euro was to counter the growing hegemony of the US dollar (USD). The share of the euro in foreign exchange reserves rose from 18% in 1999 to 27% in 2009. Since then, the share has declined to 19-20%. The share of USD in the same period has declined from 70% to a still dominant 58%. Further, its share in export invoicing and international banking is upwards of 70%. Even in case of new age stablecoins, 99% of them are linked to USD! 

Despite these adversities, 20 members have adopted the euro up from 11, and the currency is circulated among 350 million people. Most of the new members are small Eastern-European economies which have traditionally had stronger economic ties with the larger European countries. Their currencies were anyways pegged to the euro and seek gains by being associated the common currency. Having said that, core European economies such as Czech Republic, Denmark, Sweden, and Norway continue to eschew the euro. 

Are there lessons for Indian rupee (INR) from the euro story? Here, the positions could be reversed. We have maps which show how several European countries fit as Indian states in terms of area and population. INR is a common currency used by states that have different business cycles and face asymmetric shocks. The British unified the currency in 1861 and post-Independence, we only strengthened it by allowing Indians to live and move freely across the country. The European currency needs both—a centralised fiscal policy and a centralised monetary policy, the latter alone will not help. Having said that, the euro does have lessons for internationalising INR. Despite a multipolar world, the USD has maintained a strong presence in world currency and financial markets. INR will not just need consistent macroeconomic policies over a long period, but also loads of patience to become a preferred currency in global finance.

The author teaches at Ahmedabad University. Views expressed are personal.