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The Euro’s First 20 Years

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According to public opinion polls, 20 years after its introduction, the euro is highly popular, with 64% of eurozone citizens supporting the common currency. This offers hope that, if the eurozone’s leaders can learn from past mistakes, the monetary union will survive and even thrive in the future. CAMBRIDGE – Since its introduction two decades ago, the euro has faced serious challenges. So far, it has survived intact. Yet, on the common currency’s 20th anniversary, it is worth identifying problems that have been encountered and, one hopes, to learn from past mistakes. Fred Dufour - Pool/Getty Images Previous Next A first critical problem was inherent in the

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According to public opinion polls, 20 years after its introduction, the euro is highly popular, with 64% of eurozone citizens supporting the common currency. This offers hope that, if the eurozone’s leaders can learn from past mistakes, the monetary union will survive and even thrive in the future.

CAMBRIDGE – Since its introduction two decades ago, the euro has faced serious challenges. So far, it has survived intact. Yet, on the common currency’s 20th anniversary, it is worth identifying problems that have been encountered and, one hopes, to learn from past mistakes.

A first critical problem was inherent in the application of a common currency to a large and varied set of countries: They did not meet the criteria for an “optimum currency area,” as American economists pointed out. In particular, the members lacked cyclical synchronization. It is much harder to go without monetary independence if your economy’s needs are not aligned with those of the other countries in the union.

In 2004-2006, for example, Ireland needed a tighter monetary policy than the European Central Bank was prepared to set, given a housing bubble and economic overheating; but it had ceded the authority to revalue its currency or raise interest rates. Likewise, in 2009-2013, when Ireland needed an easier monetary policy than the ECB’s, given a steep recession, it was unable to devalue its currency, print money, or lower its interest rate.

A second mistake was that some peripheral eurozone countries maintained large current-account deficits during the euro’s first decade. At the time, these countries’ large net capital inflows were viewed as a sign of efficiency-improving financial integration. In retrospect, the imbalances, attributable in part to a rise in the periphery’s unit labor costs relative to Germany’s, were less benign.

Many countries – most notably, Greece – also maintained large budget deficits and high debt levels. They confirmed longstanding fears among wealthier members – especially Germany – that they would end up being forced to bail out their profligate partners, for which the expectation of being rescued amounted to a perverse incentive. To their credit, the architects of Europe’s monetary union recognized moral hazard as a central vulnerability, and tried to address it by requiring that countries cap their budget deficits at 3% of GDP, and including a “no bail-out” clause in the Maastricht Treaty.

But the fiscal rules proved un-enforceable. Virtually all eurozone members (including Germany) soon breached the 3% deficit ceiling. And though governments repeatedly claimed that fiscal targets would be achieved in the future, those expectations were based on overly optimistic growth forecasts.

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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