Introduction of the Euro (1999)

Introduction of the Euro

The introduction of the euro was a monumental achievement, marking the largest monetary changeover ever. The euro was officially launched as an electronic trading currency on January 1, 1999. Euro notes and coins were put into circulation in 2002.

The 11 initial member states were: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland. As of 2015, there are 17 countries in the Eurozone.

Each country fixed its currency to a specific conversion rate against the euro, and a common monetary policy governed by the European Central Bank (ECB) was adopted.

To many economists, the system would ideally include all of the original 15 EU nations, but the United Kingdom, Sweden, and Denmark decided to keep their own currencies. In deciding whether to adopt the euro, EU members have many important factors to consider.

The 1993 Maastricht Treaty sets out five main convergence criteria for member states to participate in the European Monetary Union (EMU):

Maastricht Treaty: Convergence Criteria

  • The country’s government budget deficit could not be greater than 3% of GDP.
  • The country’s government debt could not be larger than 60% of GDP.
  • The country’s exchange rate had to be maintained within ERM bands without any realignment for two years prior to joining.
  • The country’s inflation rate could not be higher than 1.5% above the average inflation rate of the three EU countries with the lowest inflation rates.
  • The country’s long-term interest rate on government bonds could not be higher than 2% above the average of the comparable rates in the three countries with the lowest inflation.
    Although the ease of traveling is one of the most attractive reasons to join the euro, being part of the monetary union provides other benefits:
  • It eliminates exchange rate fluctuations, providing a more stable environment to trade within the euro area.
  • The purging of all exchange rate risk within the zone allows businesses to plan investment decisions with greater certainty.
  • Transaction costs also diminish, mainly those relating to foreign exchange operations, hedging operations, cross-border payments, and the management of several currency accounts.
  • Prices become more transparent as consumers and businesses can compare prices across countries more easily, which, in turn, increases competition.
  • A huge single currency market becomes more attractive for foreign investors.
  • The economy’s magnitude and stability allow the ECB to control inflation with lower interest rates, thanks to increased credibility.

Yet the euro is not without its limitations. Leaving aside political sovereignty issues, the main problem is that, by adopting the euro, a nation essentially forfeits any independent monetary policy.

Since each country’s economy is not perfectly correlated to the EMU’s economy, a nation might find the ECB hiking interest rates during a domestic recession.

This can be particularly true for many of the smaller nations. As a result, countries try to rely more heavily on fiscal policy, but the efficiency of fiscal policy is limited when it is not effectively combined with monetary policy. This inefficiency is further exacerbated by the 3% of GDP limit on budget deficits, as stipulated by the Stability and Growth Pact.

Some concerns also subsist regarding the ECB’s effectiveness as a central bank. The central bank strives for a 2% inflation target, but in the past 15 years, it strayed away from this level often.

Also, from 1999 to late 2002, a lack of confidence in the union’s currency (and in the union itself) led to a 24% depreciation, from approximately $1.15 to the euro in January 1999 to $0.88 in May 2000, forcing the ECB to intervene in foreign exchange markets in the last few months of 2000.

This chart shows a daily chart of the euro since it was launched in 1999.

EUR/USD Price Since Launch
EUR/USD Price Since Launch

Since 2000, things have greatly changed, with the euro trading at a premium to the dollar, but quantitative easing in 2014 put the currency back in a downtrend versus the dollar.

Some analysts claim that the euro will one day replace the dollar as the world’s dominant international currency, and while we believe it will have a greater share in reserve portfolios, we doubt that this will be likely.

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