The euro has weathered the economic storm

The single currency has delivered very significant benefits for the euro area – that is the union of 20 member states ranging from giants like Germany and France to smaller nations like Latvia and Lithuania.

"About 70 per cent of European citizens think the euro is a good thing and brings positive benefits.”

But it has not been an easy ride. The European economy, particularly in the euro area, has been beset with many difficult challenges.

Over the short life of the currency its member states have had to contend with the Global Financial Crisis in 2007-2008, followed quickly by the debt crisis which ran from 2010-2012. Both events affected member states differently and threatened the viability of the nascent monetary union. Also, EU enlargement, which swiftly followed the demise of the Soviet Union, has not been free from political challenges and ultimately contributed to Brexit in the UK.

There has also been significant exogenous shocks including the pandemic and war in Ukraine. Yet the euro area has managed to survive and come closer together, even if growth has suffered.

Indeed, it is likely many euro member states would not have navigated these challenges as successfully as they have did had they not been part of the single currency. The irrevocable nature of the euro, the strength and size of the European Central Bank (ECB) and the political commitment to the single market have provided critical support during times of crisis.

New members

The fact Croatia joined the euro in January 2023 is a positive sign, indicating confidence in the currency across Europe remains high. About 70 per cent of European citizens think the euro is a good thing and brings positive benefits.

A recent example is the war in Ukraine which initially caused large spikes in energy prices and inflation. If smaller nations affected by these higher costs were not part of the euro, the associated inflation shock would have been worse. This would lead to sharper rises in interest rates to protect their economies from capital flight and currency depreciation.

During the pandemic, it's likely highly indebted countries would have struggled to provide the level of financing necessary to keep their economies afloat had they not been part of the euro.

Italy, for example, would have struggled to access capital markets more difficult and expensive, which could have led to long-lasting economic scarring and currency depreciation.

These two examples help illustrate the benefits of euro membership, both through the single currency’s size and the stability of its institutions.

But the history of the single currency is littered with positive examples of how euro membership has benefited economies in difficult times.

Fiscal policy

Fiscal policy remains a challenge for the euro area. Whilst there is monetary union, there isn’t a fiscal union. Debt levels across the euro area vary significantly and this contributes to a lack of political support for a federal fiscal authority.

Some countries have government debt-to-GDP (gross domestic product) ratios of 140 per cent to 160 per cent, while other countries have low levels of 20 per cent or below. There is no fiscal harmony across the single currency bloc.

Fiscal differences remain one of main the criticisms of the single currency. No common fiscal policy means the euro area can never match other federal unions like Australia or the United States.

This structure has led to speculative attacks against the currency in financial markets, criticism in the media and from market economists. The absence of fiscal union, it is argued, means monetary union is unstable in the long run and the currency will ultimately crack.

This has yet to be proven the case. Europe has worked hard to ensure debt sustainability over time and has delivered necessary financial support during crises.

The current debt problem in the euro area is a legacy issue. Since the last debt crisis countries are being more fiscally responsible than in previous years – thus bolstering the strength of the monetary union.

Bond yields

Another sign of euro cohesion is the euro area bond markets. Many currencies were under speculative pressure during the European debt crisis between 2010 and 2015. Now most of their bond yields are well below levels in the US and other federal unions.

In Ireland, whose bond market was under heavy selling pressure at facing financial meltdown, the 10-year yield is now only 40 basis points above Germany.

Whilst the euro area is not a fiscal union, the single currency bloc has been focused on fiscal sustainability. This has led to dramatic fiscal improvement for the euro area and underpinned investor confidence in European cohesion in recent years.

Spain was another economy under huge pressure during the debt crisis. It’s bond market had record issuance in January which was strongly supported by investors. Demand for European bonds is very high, which suggests market confidence in European fiscal sustainability.

If you compare aggregate debt levels in the euro area (90 per cent of GDP) and the euro area's budget deficit (3.5 per cent of GDP) with the United States, it is significantly better, despite the presences of some highly indebted countries.

All this tells a very interesting and positive story about the resilience and future of the euro as it enters its 25^th year.

Brian Martin is Head of G3 Economics at ANZ.

This story is based on comments Martin made to ANZ's 5in5 podcast on the 25th of January. Click here to listen to the episode.