Why the Euro Is Failing

By Vijay Narayanan

Why was the euro created in the first place?

During Europe's recovery from WW2, an important goal for the European Union was to establish an economic & monetary union (EMU). It was planned for the EMU to include coordinating economic and fiscal policies, a single common monetary policy and a currency: the euro.

The euro was created, not for commoners, but for the prosperity of the global trade network and multinational corporations. The euro offered many benefits to the aforementioned parties - easier for companies to continue cross-border trade, a stable economy (only for the richer nations of the EU) and more choice for the consumer.

Unfortunately, weak political commitment, divisions over economic priorities all marred the progress towards the EMU.

In 1991, the new Treaty on “European Union” which contained the provisions needed to implement the monetary union was agreed at the European Council. After nearly 10 years of preparation, the euro was launched on January 1st 1999, but only in staggered stages. For the first three years, it served as an ‘invisible’ currency, only used for accounting and electronic payments On the first day of 2002, coins and banknotes were launched, and in 12 EU countries, the biggest cash changeover in recorded history took place.

The Euro's tendency to serve richer Eurozone members

The euro’s most significant drawback is the rigid monetary policy. This unfairly serves richer countries and continues to exploit poorer nations particularly in the Balkans, which is a major impetus of the Greek debt crisis.

To understand how the Euro’s inflexible monetary policy affects poorer EU members, we must first explore the theory of monetary policy, and understand why different countries set different interest rates in accordance to their economic status. Richer countries like France and Germany should have high interest rates to prevent inflation. If interest rates were low, the population would have more spending power as people borrow more money, leading to inflation. If interest rates were high,the population would borrow and spend less money, lowering inflation

On the other hand, poorer countries, such as Greece and Latvia have to have lower interest rates to stimulate spending. These countries don’t have to worry about inflation because the unemployment rate would probably be high, so there is space to produce more goods.

This is how different countries increase and decrease their interest rates to manage their own economic stability.

Unfortunately, the same doesn’t work in the eurozone, as all countries use the same currency. This is because the euro defies conventional wisdom and upends traditional monetary theory, which assumes nation states can control their interest rates. Free trade is a very important element of the euro, as it does not deflate the currency of consumer markets. However, in a situation like this, interest rates cannot be simultaneously raised in richer countries and lowered in poorer countries, thereby reducing the wealth of people in poorer countries.

Without the euro, emerging and underdeveloped countries would have been able to recover from inflation and other economic evils much easier. That being said, let us now look at a case study of the Greek Debt Crisis.

The Greek Debt Crisis

When Greece became the 10th member of the EU on January 1st, 1981, the country and its finances were in good shape. By 1999, the country had a debt-to-GDP ratio of 60%, not fantastic, but not horrible either. 2 years later, the country joined the eurozone and adopted the common euro currency. It is important to note that the euro did not completely influence the debt crisis. In the 1980s, the Greek government pursued expansionary economic policies. Unfortunately, this backfired completely, as the country suffered soaring inflation rates, high fiscal and trade deficits, low growth rates and exchange rate crises.An environment like this prompted the Government to join the EMU, believing that the monetary union backed by the European Central Bank (EBC) would lower inflation and interest rates, increase private investment and economic growth. Furthermore, the single currency would allow for easier trade with the global and European economies and eliminate many transaction costs. As Greece explored its new eurozone membership, it found that this helped the nation to borrow at cheaper rates and finance government operations in absence of sufficient tax revenues. However, the single currency exacerbated the country’s fiscal problems. The euro also indicated the substantial differences in economic structures between Greece and other member states, notably Germany. Compared to Germany, the Greek productivity rate was much lower, making the state’s goods and services far less competitive. The adoption of the euro only highlighted the competitiveness gap, as it made German goods and services cheaper than in Greece. Having accepted the eurozone monetary policy, Greece could no longer devalue its currency, worsening its trade balance and increasing the current account deficit. In the case of the euro, countries cannot devalue, increase printing, or default. And so, they resort to the last method, which is economic austerity, raising taxes, and decreasing pensions.Austerity hurts the public and the economy, even worse than inflation. This led to shortage of medical supplies, massive layoffs in Greek companies and more. Austerity measures also hit Greece particularly hard during the coronavirus pandemic, as hospitals and medical facilities faced a shortage of test kits, vaccines and beds.

Bottom Line - How can the euro improve?

The euro is great in simplifying trade with the global community, supporting cross-border investments with the eurozone and mutual support between nations in times of crisis. However, examples like Greece and the 2007 financial crisis truly show us the major flaws behind the system and why it will ultimately fail. The rigid monetary policy and bias towards richer countries pulls down the euro and fails to benefit the common man. In order to improve the euro, there needs to be greater fiscal and financial integration with the euro area to match the degree of monetary integration. Additionally, there needs to be a single central fiscal authority with its own source of revenues, the ability to issue debt and to make fiscal transfers with the eurozone. This sets the overall fiscal stance for the eurozone and central debt would be joint liabilities. Finally, there needs to be a proper rulebook to resolve failing institutions and guaranteeing deposits. This better helps nations like Greece and Portugal to restart their economies.