From Adoption to Integration: The Eurozone's Influence on European Markets
No matter if you want to grab some ice cream on a sunny day, run to the supermarket to grab a drink, or have lunch with your friends, chances are you use the Euro. This is, of course, if you are within the European Union, more specifically, the Eurozone. This “zone” spans 20 EU countries and forms the EU’s monetary union. Often overlooked by many, it allows you to enjoy life without much hassle and the need to convert to any other currency if you are traveling. Your day-to-day tasks, services, food and drinks, and more are all paid for in euros within the Eurozone.
The Eurozone celebrates its 25th anniversary this year, and the euro is continually developing as one of the largest currencies in the world. Originally, even before the effective circulation of the Euro as a currency, it was legally set in stone within the Treaty of Maastricht in 1992 whereby all EU countries were obliged to adopt the Euro as their universal currency in due time, once compliant with all fiscal and monetary benchmarks set out in the Convergence Criteria. Fast forward some 25 years, the Eurozone seems to hold the confidence of its users and the foreign exchange market. Even IMF data shows that of the global currency reserves held cumulatively by all countries, the Euro holds a 20% stake, putting it in second place right behind the US Dollar. However, not all EU states have adopted the Euro yet. Most recently, Croatia joined the Eurozone in 2023, marking the 20th EU Member State to have joined. This implies that 7 of them have not yet adopted the Euro. The reasons vary, from political unwillingness to fiscal criteria remaining unfulfilled. With global geopolitics becoming unstable and other threats like pandemics on the horizon, the stability of currencies is put into question. Whether or not it is economically viable for potential Eurozone members to join remains up for debate. This leads to several key questions, mainly: how can EU members ensure their participation leads to a bright future with higher welfare for all citizens of the European Union?
The Euro has been widely successful in its growth and circulation for several key monetary reasons. Consisting of members including Austria, Belgium, Croatia, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain, it has managed to attain the wide use of the populations of those countries making the effective daily user figure an astounding 341 million. This daily use inspires further confidence in the currency and its potential, as people and companies can maintain their connection and minimize foreign exchange fees, ultimately presenting a positive effect on the volume and flow of economic transactions taking place within the EU. Petroulas (2007) finds that there was an increase in inward foreign direct investment (FDI) of 16% in the Eurozone area following the introduction of the Euro. One added benefit of joining the Eurozone is the Euro Privilege. This refers to the statistically significant tendency of credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch which would upgrade the country’s rating in the range of 0.3 to 0.6 notches before the financial crisis of 2008 and even 1 to 1.5 after it. This points to a significant positive credit rating as a result of joining the Eurozone. It is visible that Euro adoption was a common strategy and a very beneficial one for all involved.
Despite the mass success the Eurozone has had, several EU states remain outside the Eurozone. These states include Romania, Bulgaria, the Czech Republic, Poland, Hungary, and Sweden. One additional state not yet in the monetary union is Denmark whose membership in the Eurozone is not obligatory due to them negotiating an opt-out. What most of these states have in common is their political unwillingness to adopt the currency, mainly due to the issue of losing the monetary policy and control mechanisms usually at the disposal of every individual state’s government. This theoretically allows them to adapt to crises and state-specific fiscal issues such as inflation. Furthermore, it allows for a stable and planned approach of governments in line with their specific national strategies for growth and development. De Grauwe (2011) argues that the danger comes from the inability of countries to issue sovereign bonds to guarantee they will have the necessary liquidity to pay off the bonds at maturity, as this is outside their scope of control. This, indeed, pushes towards a self-fulfilling liquidity crisis, potentially forcing the state to default. Under the monetary system of states with their national currencies, investors need not worry as the central banks are always there to introduce a monetary inflow in times of need.
The peculiar thing, according to De Grauwe and Ji (2022), is that in the years leading to the financial crisis of 2008, the bond yields of Eurozone countries all had a near-perfect strong positive correlation with each other. This meant investors’ perception of the riskiness of bonds was equal for all Eurozone members despite the intricacies of each country's fiscal policies and state of affairs. It seemed as if the Euro by its existence and implementation, created unprecedented confidence. However, leading up to the financial crisis, a sudden change was to be noticed where investors questioned their risk exposure, thus opting to funnel their capital from weaker economies, such as Greece’s, to more stable ones, such as the Netherlands’ and Germany’s perceived as safer. This meant the bond yields of developed Eurozone members decreased while Greece’s sharply increased, to account for more risk exposure (See Figure 1). This led to their financial instability ultimately warranting the involvement of the International Monetary Fund and foundational capital restructuring to sustain the operation of the country. One of the positives of this unfortunate turn of events was a shift in European Central Bank governance principles. The ECB continuously introduced bailout fail-safes which further strengthened the Eurozone members. Furthermore, it reassured investors their capital was reasonably safe and promoted further investments. Confidence in the stability and relative lower riskiness of bonds was gradually restored.
Figure 1: Bond yields for EU states 1999 - 2021
Poland is one of the few relatively larger economies that still fails to adopt the Euro on account of its own currency’s flexibility. This means they consider their national currency, the Polish Złoty, to be a monetary tool open for use by their government. This can be used to curb inflation, adjust a budget deficit, or respond to a dire need. An overarching goal is to increase GDP, which is expected to be more easily achieved exactly by maintaining its national currency. In particular, Karnowski and Rzońca (2023) argue the adoption of the Euro may trigger a so-called boom-bust cycle, which is excessive borrowing due to lower interest rates. They further state that keeping the Polish Zloty maintains more robust control over economic policy alignment with more developed EU states instead of the pressure and strain that adoption would imply. Sweden also applies similar principles and considers data points suggesting a potential negative GDP per capita impact of 6.5% had it joined the Eurozone in the period 1999 to 2013. Furthermore, projections showed there would be limited economic benefits from joining the Eurozone, as Sweden already has well-established economic ties and trade. Similar principles apply to Denmark, which has negotiated an opt-out, meaning it is not legally obliged to join the Eurozone.
Figure 2: Central Bank Interest Rates PL, BG, RO, EU, SE
On the other hand, Hungary and the Czech Republic, while maintaining their position as key transit countries between EU states for trade and economic activities, still maintain a strong hold on their national currencies. Overall, the adoption of the Euro for these countries would have a comparatively greater positive effect than that of Sweden and Denmark. While whether they will join the Eurozone is not a question as it is a key step in EU integration, political willingness is necessary in the long term. The Euro is projected to have marginal effects on more developed countries and moderate to high effects on relatively less developed countries of Central Europe.
Figure 3: Eurostat GDP per capita for EU states
On the other hand, Bulgaria and Romania, as countries on the lower side of EU GDP rankings, are seeking to strengthen their position as well. This means they politically and operationally remain on track to join the Eurozone soon. While Bulgaria has already entered into the further stage of adoption, ERM II of the adoption process, Romania remains behind. It is predicted there will be an increase of 15% of GDP over a 20-year horizon once Bulgaria adopts the Euro. Reasons behind this include the increased influx of Foreign Direct Investment (FDI) and the reduced cost of capital that is likely to result from it (Ganev, 2009). For Romania, which has one of the largest seaports – Constanta – enabling large volumes of trade to the rest of Europe, will most certainly benefit from the decrease in the costs of currency conversions (deadweight loss) and a more direct effect on streamlining the further increase in transit and trade volume. Some of the added benefits that have the potential to accelerate Romania’s industrial development are the cheaper credit sources compared to those currently available in Romanian Leu and national commercial banking institutions. Romania has set 2024 as its goal to join the Eurozone; however, it seems this will be delayed as it has yet to progress to the second stage of Euro adoption, which involves foundational monetary changes. Moreover, it is recommended Romania strengthen its approach to economic reforms and a stronger judiciary to enforce those reforms (Spendzharova, 2003). Despite obstacles on their way, Romania and Bulgaria are well underway to join the Eurozone and this will ultimately have an expansionary effect on their economies.
While the Eurozone is conceptually and legally set to expand in the future, the economic effects of that process are uncertain. More developed EU Member States, such as Sweden and Denmark, do not seem to have much of a tangible need for such a step. On the other hand, developing countries such as Romania and Bulgaria and some moderately-developed countries such as Hungary, the Czech Republic, and Poland all have a foundational macroeconomic argumentation to continue with the process. This is particularly pronounced for the Balkan region, where GDP is generally the lowest in the EU. Losing sovereign monetary policy mechanisms makes more sense for those countries, namely Bulgaria and Romania, as the benefits seem to outweigh the drawbacks. However, it seems pertinent for the European Central Bank to impose stricter control mechanisms to ensure that crises such as that of Greece in 2010 can be assuredly avoided. With careful planning and governance systems, the ECB can ensure the Euro continues to grow and dominate the world as one of the most reliable and stable currencies.
Further reading:
Campos, N. F., F., Coricelli, F., Moretti, L., & Swedish Institute for European Policy Studies. (2016). Sweden and the Euro: The neglected role of EU membership. European Policy Analysis, https://www.sieps.se/publikationer/2016/sweden-and-the-euro-the-neglected-role-of-eu-membership-201615epa/sieps_2016_15epa.pdf
European Commission, Joint Research Centre, Erhart, S. (2021). The impact of euro adaption on sovereign credit ratings and long-term rates, Publications Office. https://data.europa.eu/doi/10.2760/59588
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