The Euro €

The euro was created because a single currency offers many advantages and benefits over the previous situation where each Member State had its own currency. Not only are fluctuation risks and exchange costs eliminated and the single market strengthened, but the euro also means closer co-operation among Member States for a stable currency and economy to the benefit of us all.

When the EU was founded (1957), the Member States centred on building a 'common market' for trade. However, over time it became clear that closer economic and monetary co-operation was needed for the internal market to develop and flourish further, and for the whole European economy to perform better, bringing more jobs and greater prosperity for Europeans.

In 1991, the Member States approved the Treaty on European Union (the Maastricht Treaty), deciding that Europe would have a strong and stable currency for the 21st century. The benefits of the euro are diverse and are felt on different scales, from individuals and businesses to whole economies.

They include:

• More choice and stable prices for consumers and citizens
• Greater security and more opportunities for businesses and markets
• Improved economic stability and growth
• More integrated financial markets
• A stronger presence for the EU in the global economy
• A tangible sign of a European identity

Many of these benefits are interconnected. For example, economic stability is good for a Member State’s economy as it allows the government to plan for the future » economic stability also benefits businesses because it reduces uncertainty and encourages companies to invest » benefits citizens who see more employment and better-quality jobs.

How do these benefits of the euro arise?

The single currency brings new strengths and opportunities arising from the integration and scale of the euroarea economy, making the single market more efficient. Before the euro, the need to exchange currencies meant extra costs, risks and a lack of transparency in cross-border transactions. With the single currency, doing business in the euro area is more cost-effective and less risky. Meanwhile, being able to compare prices easily encourages cross-border trade and investment of all types, from individual consumers searching for the lowest cost product, through businesses purchasing the best value service, to large institutional investors who can invest more efficiently throughout the euro area without the risks of fluctuating exchange rates.

Benefits worldwide

The scale of the single currency and the euro area also brings new opportunities in the global economy. A single currency makes the euro area an attractive region for third countries to do business, thus promoting trade and investment. Prudent economic management makes the euro an attractive reserve currency for third countries, and gives the euro area a more powerful voice in the global economy. Scale and careful management also bring economic stability to the euro area, making it more resilient to socalled external economic 'shocks', i.e. sudden economic changes that may arise outside the euro area and disrupt national economies, such as worldwide oil price rises or turbulence on global currency markets. The size and strength of the euro area make it better able to absorb such external shocks without job losses and lower growth.

Realising the benefits

The euro does not bring economic stability and growth on its own. This is achieved first through the sound management of the euro-area economy under the rules of the Treaty and the Stability and Growth Pact (SGP), a central element of Economic and Monetary Union (EMU). Second, as the key mechanism for enhancing the benefits of the single market, trade policy and political co-operation, the euro is an integral part of the economic, social and political structures of today’s European Union.

There are multiple opportunities for EU citizens and consumers to benefit from the euro. These arise because the euro and its political framework, the Economic and Monetary Union, offer lower costs, stable prices, more transparency and economic stability. Some of these consumer benefits are direct, such as easier-tocompare prices while shopping; others are indirect, such as the long-term benefits economic stability brings to interest repayments on a bank loan for a new car. In both cases, the opportunities the single currency offers are wide ranging, covering not only everyday transactions, but also employment opportunities and European citizens’ quality of life.

The following are examples of these opportunities:

A more competitive market

The euro brings price transparency to the single market. Consumers can easily compare prices across borders and find the most advantageous price for a product or service – especially in the internet era – whether it is a pair of trousers or a high-end home cinema system. This is because increased price transparency has the effect of increasing competition between shops and suppliers, keeping downward pressure on prices in the euro area.

Stable prices

The euro has brought inflation down to a low and stable level. In the 1970s and ‘80s many EU countries had very high inflation rates, some of 20% and more. Inflation fell as they started preparing for € and, since introduction, has remained around 2% in the €-area. Price stability means that ordinary citizens’ purchasing power and the value of their savings are better protected, which helps make the future more certain.

Easier, safer, and cheaper borrowing

Low inflation and stable prices are a key aim of the management of the euro-area economy. Because the European Central Bank acts to keep inflation low, interest rates are also lower. This means consumer loans are cheaper and future repayments are more predictable, so ordinary citizens can borrow more easily and cheaply, for example to pay for holidays or to buy a house.

Mortgage rates have fallen from around 8%-14% in the early 1980s to an average of 5% now in the euro area, saving a borrower with a €100 000 outstanding loan between €170 and €750 a month on interest payments.

Lower travel costs

The costs of exchanging money at borders have disappeared in the euro area. This makes it cheaper to travel, whether on vacation, studying, or on business. In the 1990s, a person travelling through all the EU countries and exchanging money at every border would lose half their money in exchange costs – without making a single purchase.

Now, a traveller starting out with €1 000 would return home with the same amount in his or her pocket having travelled through the €-area. € is readily exchanged in many countries outside the euro area as well – it is estimated that up to 20% of euro banknotes are circulated outside €-area.

More growth and jobs

Doing business across borders is cheaper for companies as they no longer need to include the risk of currency fluctuations into their prices nor to pay exchange costs. Previously, these costs amounted to around €20 to 25 billion annually within the European Union. Today, they have disappeared in the euro area.

This helps release capital to invest in expanding and growing business and employing more workers, thereby benefiting job seekers and their families. Since € was introduced in 1999, more than 10 million new jobs have been created in the euro area, compared with only 1.5 million in the previous 7 years.

More public investment

It is not only citizens and business which benefit from cheaper loans: government borrowing is also less expensive, as interest payments on national debt are lower. The money saved can therefore either be used for investment in new infrastructure, or to boost research spending for jobs and growth, or for improving welfare and pension systems, or to reduce the tax burden – depending on a Member State’s priorities.

Economic and Monetary Union (EMU) represents a major step in the integration of EU economies. It involves the coordination of economic and fiscal policies, a common monetary policy, and a common currency, €. Whilst all 27 EU Member States take part in the economic union, some countries have taken integration further and adopted the euro. These countries make up the euro area.

The decision to form an Economic and Monetary Union was taken by the European Council in the Dutch city of Maastricht in December 1991, and was later enshrined in the Treaty on European Union (the Maastricht Treaty). Economic and Monetary Union takes the EU one step further in its process of economic integration, which started in 1957 when it was founded.

Economic integration brings the benefits of greater size, internal efficiency and robustness to the EU economy as a whole and to the economies of the individual Member States. This, in turn, offers opportunities for economic stability, higher growth and more employment – outcomes of direct benefit to EU citizens.

In practical terms, EMU means:

•   Coordination of economic policy-making between Member States
•   Coordination of fiscal policies, notably through limits on government debt and deficit
•   An independent monetary policy run by the European Central Bank (ECB)
•   The single currency and the euro area

Economic governance under EMU

Within EMU there is no single institution responsible for economic policy. Instead, the responsibility is divided between Member States and the EU institutions.

The main actors in EMU are:

• The European Council – sets the main policy orientations 
• The Council of the EU (the 'Council') – coordinates EU economic policy-making and decides whether a Member State may adopt the euro
• The 'Eurogroup' – coordinates policies of common interest for the euro-area Member States
• The Member States – set their national budgets within agreed limits for deficit and debt, and determine their own structural policies involving labour, pensions and capital markets
• The European Commission – monitors performance and compliance
• The European Central Bank (ECB) – sets monetary policy, with price stability as the primary objective

What is meant by ‘economic integration’?

Generally, economic and monetary union is an advanced step in the process of economic integration. The degrees of economic integration can be divided into six steps:

1. Preferential trading area (with reduced customs tariffs between certain countries)
2. Free trade area (with no internal tariffs on some or all goods between the participating countries)
3. Customs union (with the same external customs tariffs for third countries and a common trade
policy)
4. Single market (with common product regulations and free movement of goods, capital, labour and
services)
5. Economic and monetary union (a single market with a common currency and monetary policy)
6. Complete economic integration (all the above plus harmonised fiscal and other economic policies)

When the European Union was founded in 1958 as the European Economic Community, the aim was to build a customs union and a common market for agriculture. The limited common market was extended to cover also goods and services in the single market, which was largely completed by 1993. Today, the European Union is on the fifth step of this model.

Progressive economic integration did not start with the decision to create the euro: it is a long process, part of the history of the EU, and one of its major achievements. The European Union grows as candidate countries meet the conditions for entry and accede to the Union – this process is known as enlargement. Similarly, the euro area is enlarging as non-euro-area EU Member States meet the conditions for entry and adopt the euro.

The euro area includes those EU Member States that have adopted the single currency. But the euro area is not static – under the Treaty, all EU Member States have to join the euro area once the necessary conditions are fulfilled, except Denmark and the United Kingdom which have negotiated an 'opt-out' clause that allows them to remain outside the euro area.

The new Member States, which joined the Union in 2004 and 2007, are expected to enter the euro area over several years, as they fulfil the necessary conditions.

Progressive enlargement, progressive integration

An accession country that plans to join the Union must align many aspects of its society – social, economic and political – with those of EU Member States. Much of this alignment is aimed at ensuring that an accession country can operate successfully within the Union’s single market for goods, services, capital and labour – accession is a process of integration.

Adopting the euro and joining the euro area takes integration a step further – it is a process of much closer economic integration with the other euro-area Member States. Adopting the euro also demands extensive preparations; in particular it requires economic and legal convergence.

Preparing for entry

Before a Member State can adopt the euro, it must fulfil certain economic and legal criteria. The economic ‘convergence criteria’ are designed to ensure that a Member State's economy is sufficiently prepared for adoption of the single currency and can integrate smoothly into the monetary regime of the euro area.

Legal convergence requires that national legislation, in particular the national central bank and monetary issues, is compatible with the Treaty.

Replacing a national currency with the euro is a major operation that demands many practical preparations, for instance ensuring that the national currency is withdrawn quickly, that prices of goods are properly converted and displayed, and that people are kept well informed. All these preparations rely on the particular ‘changeover scenario’ that a euro-area candidate country adopts.

Significant experience was gained when the euro was first launched, which benefits euro-area candidate countries today. The European Commission, in particular, offers much help and advice to euro-area candidate countries.

Exchange Rate Mechanism

Some non-euro-area countries are already members of the Exchange Rate Mechanism (ERM II). ERM II is a system designed to avoid excessive exchange-rate fluctuations between the participating currencies and the euro that might disrupt economic stability within the single market. Participation is voluntary, but it is also one of the 'convergence criteria' – euro-area candidate countries must participate, without severe tensions, for at least two years before they can qualify to adopt the euro.

As well as serving as the currency of the euro area, the euro has a strong international presence. Currencies are the means by which wealth is stored, protected and exchanged between countries, organisations and individuals. A global currency, such as the euro, does this on a global scale. Since its introduction in 1999, it has firmly established itself as a major international currency, second only to the US dollar.

Within the euro area, the single currency, the euro, is the means by which governments, companies and individuals make and receive payments for goods and services. It is also used to store and create wealth for the future as savings and investments. However, the size, stability and strength of the euro-area economy – the world's second largest after the United States – make the euro increasingly attractive beyond its borders, too. Public and private sectors in third countries acquire and use the euro for many purposes, including for trade or as currency reserves. For this reason, today, the euro is the second most important international currency behind the US dollar.

The widespread use of the euro in the international financial and monetary system demonstrates its global presence:

• The euro is increasingly used to issue government and corporate debt worldwide. At the end of 2006, the share of the euro in international debt markets was around one-third, while the US dollar accounted for 44%.
• Global banks make significant loans denominated in euro around the world.
• The euro is the second most actively traded currency in foreign exchange markets; it is a counterpart in around 40% of the daily transactions.
• The euro is extensively used for invoicing and paying in international trade, not only between the euro area and third countries but also, to a lesser extent, between third countries.
• The euro is widely used, alongside the US dollar, as an important reserve currency to hold for monetary emergencies. At the end of 2006, more than one-quarter of the global foreign exchange holdings were being held in euros, compared to 18% in 1999. Developing countries are among those which have increased their reserves in euro the most, from 18% in 1999 to around 30% in 2006.
• Several countries manage their currencies by linking them to the euro, which acts as an anchor or reference currency.

The status of the euro as a global currency, combined with the size and economic weight of the euro area, is leading international economic organisations, such as the IMF and the G8, increasingly to view the euroarea economy as one entity. This gives the European Union a stronger voice in the world.

To benefit from this stronger position, and to contribute effectively to international financial stability, the euro area is speaking with one voice more and more in important economic fora. This is done through close coordination between the euro-area Member States, as well as the European Central Bank and the  European Commission during international economic meetings.

European Commission during international economic meetings. A number of third countries and regions are even more closely linked to the euro. The stable monetary system behind the euro makes it an attractive 'anchor' currency for them, particularly for those that have special institutional arrangements with the EU, such as preferential trade agreements. By linking their currency to the euro they bring more certainty and stability to their national economies.

The euro is also widely used in third countries and regions neighbouring the euro area, for example in South-eastern Europe, while some other countries – Monaco, San Marino and the Vatican City – use the euro as their official currency by virtue of specific monetary agreements with the EU, and may issue their own euro coins within certain quantitative limits.