Eurozone

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Reviewed by :

The Eurozone or Euro area is the monetary region constituting countries that have replaced their national currencies with the Euro. They are a part of the Economic and Monetary Union (EMU) for coordinating the framing of economic policies to support the financial goals of the European Union.

The Euro is the primary currency that offers many advantages to this union. It has removed expenses incurred due to exchange rate fluctuations, protecting consumers and producers within the area from price oscillations. Also, it reduces risk, eliminates extra costs on exchanges, and makes it easier to conduct business and invest.

Eurozone is an economic region that consists of members of the EU that have adopted the Euro as their primary currency. It is a distinctive identity that is different from the European Union.
Adopting Euro as the primary currency has multiple advantages. It eliminates expenses incurred due to exchange rate fluctuations, reduces risk, and makes investments easier.
Austria, Belgium, Cyprus, Estonia, France, Finland, Germany, Greece, Italy, Ireland, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain make up the Eurozone's economy, which has a population of 341 million people.

Eurozone Explained

The Eurozone is officially known as the euro area. It consists of member states of the European Union who have exclusively opted for the Euro as their official currency. European Union member states such as Bulgaria, Croatia, Czechia (Czech Republic), Hungary, Poland, Romania, and Sweden have not adopted Euro as their primary currency. Therefore, they are not part of the Eurozone. Denmark, however, is a member state with an opt-out condition. The country has met all the convergence criteria but has not introduced the Euro and claimed to opt out under the Maastricht Treaty of 1992.

Adopting a single currency as the national currency has made these countries more unified and economically integrated. Therefore, economic management of the area is a thing of prior importance. An independent euro system comprising a European central bank (ECB) headquartered in Frankfurt, Germany, and the central banks of the Euro area members frame the monetary policies. The primary objective of formulating these policies is to maintain price stability. But the countries of Kosovo and Montenegro have no representation in the common banking system.

The national governments of the respective member states must coordinate with the framed monetary policies of the Eurozone. They can do this through various structures and instruments, notably through the "stability and growth pact." The pact contains rules for fiscal policies, such as limits on national debts and deficits. Only euro area countries are subject to financial and other sanctions in the event of non-compliance.

Eurozone Countries

EU member countries that desire to join EuroZone must realize the convergence criteria. The criteria require countries to frame their national legislations according to the relevant EU law. They also should meet conditions designed to ensure Euro and economic convergence preparedness. The countries must have price stability and secure public finances along with stable exchange rates. In addition, governments need to follow financial and legal requirements, as agreed in the Maastricht Treaty of 1992(Maastricht criteria). They also must not cause any economic risks to member countries while joining the Euro area.

The members of the European Union must adopt the Euro and join the Eurozone as soon as they are ready to oblige them. However, there is no specific date within which they have to enter. It leaves desecration to the countries to develop strategies to make them meet conditions for the adoption of the Euro. The European Commission and the European Central Bank jointly check the adoption legibility of the countries. They do this by evaluating progress made following the convergence criteria. They publish their findings in reports that the ECOFIN (Economic and financial affairs) Council. The council will use it then in consultation with the Parliament and Heads of State to check the favorability of starting the adoption process.

At present, the Eurozone is the third-largest economy in the world in terms of economic size. It revolves around 341 million people. There are 19 countries, namely, Austria, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Estonia Netherlands, Portugal, Slovakia, Slovenia, Belgium, Cyprus, Finland, France, Germany, and Spain.

Eurozone Crisis

The Eurozone crisis arose due to sovereign debt problems in the countries' economies. Sovereign debt or public debt is money borrowed by the country's government, usually in bonds and securities. The beginning of the crisis was on set off when Greece, Ireland, Portugal, Spain, and Italy saw a downgrade in the rating of their public debt. To give a backdrop, Euro came into existence in 1999 and into its physical form in 2002. As a result, financial markets witnessed rapid changes by introducing a new currency; bond markets were quickly integrated. Due to this, the years 1999-2002 saw convergence in government bond yields, reductions in short-term rates, and a decline in interest rate dispersion between rates offered by banks.

It saw increased competition, lower transaction costs, and the establishment of common benchmarks. Similar instruments traded in the national markets were perceived as close substitutes by the TARGET system (used to link large value national payments). This led to narrowing yields and spreads, and market liquidity. Convergence of interest rates resulted in lower nominal rates and lower long-term interest rates in Eurozone economies. Meanwhile, the currency risk premium decreased, and credit growth improved. Financial institutions could easily borrow money from abroad thereon. Financial services and construction grew rapidly, resulting in a rise in macroeconomic vulnerability as credit grew disproportionately in the housing sector. When home prices rose, credit expanded, resulting in debt accumulation.

Growth of fiscal deficit

Faster growth masked the fiscal system's flaws, becoming apparent as the fiscal deficit and public debt grew. Growth was accompanied by an increase in import demand, resulting in a greater current account deficit than in 2003.

The rise in the twin deficits (current and fiscal deficits) was mostly financed by debt, particularly in the case of Greece. It was difficult to tell if the fundamentals had improved or if there had been a bubble waiting to burst. The general growth momentum was in place until 2005.

Economy declines further

The massive global financial crisis of 2007–08 acted as a catalyst for debt widening across Europe and the Eurozone while the economy slowed dramatically. Financial intermediation was disrupted as a result of the financial crisis. Falling interest rates aided the credit boom from 2003 until early 2007 period. However, starting in 2006, interest rates in the Eurozone began to vary, separating the weak from the strong countries. Excessive lending had left banks with bad debts and governments in the peripheral economies with substantial fiscal deficits and public debt in various magnitudes.

During the worldwide financial crisis of 2008-2009, many emergency measures proposed to combat the situation appeared to be successful in averting the adversity and supporting short-term domestic demand. They did, however, exacerbate the budget deficit and debt. Greece revealed in late 2009 that it underestimated its budget deficit (12.7 percent of GDP vs. 3.7 percent previously indicated). Moreover, its governmental debt was above 113 percent of GDP in late 2009, greatly exceeding the Eurozone ceiling of 60 percent. By early 2010, the Eurozone was amidst a sovereign debt crisis, with Greece at the center. Data also revealed Ireland's, Portugal's, and Spain's troubles. Members then financed rescue loans, and the IMF participated in bailouts and the additional help of voluntary contributions from the private sector, which brought in money. As a result, closing the financing gap helped the Eurozone crisis end.

Eurozone GDP / Inflation / Unemployment Rate

The war between Russia and Ukraine (2022) has left economies in uncertainty; the soaring energy prices, negative sentiments, and sanctions on Russia may significantly impact Euro area trade growth. However, the European central bank and the euro system opine it to be temporary and have predicted the Eurozone GDP growth rate to average 3.7% in 2022. In 2023, the rate expected is 2.8%, and in 2024 it will be 1.6%. Due to prevailing factors in the global economy, experts have revised the predictions of Eurozone GDP growth rates to 0.5% and 0.1% for 2022 and 2023, respectively.

According to the Eurozone inflation forecast, the headline inflation will remain at high levels and slowly ease into the levels of 5.1 %( 2022), 2.1 %( 2023), and 1.9 %( 2024) owing to energy shocks. Headline inflation had been revised upwards, especially in 2022, due to high energy commodity prices, supply disruptions, stronger wage growth, and especially the minimum wage growth in Germany. At the same time, the Eurozone inflation forecast of HICP excluding energy and food remains high at 2.6% in 2022. This is due to increasing energy prices and supply chain issues.

However, if the underlying inflation eases through demand increase, tightening of labor markets and wages, along with historical regularities, the rates can dip to 1.8% in 2023 and 1.9% in 2024. Employment grew by 0.5% in the last quarter of 2021, resulting in a decline in the unemployment rate. It may decline by 7% by 2024 due to the ongoing economic recovery and strong labor demands in the future. Overall, given the Eurozone economy size, economic growth may pick up from the second quarter of 2022.

Frequently Asked Questions (FAQs)

Why was the Eurozone created?

It was created to promote the idea of a single currency that can strengthen economic policies. As a result, Euro is the Eurozone currency, and countries that have adopted it only are part of this region. A single primary currency lowers risk, removes exchange expenses, and simplifies conducting business and investing in the area.

How does the Eurozone work?

Members who are abiding by the convergence criteria can come forward to adopt the Euro as their primary currency and become members of the Eurozone. After that, the individual member states' national governments must work in unison with the Eurozone's monetary policies.

What caused the Eurozone crisis, and how was it resolved?

The sovereign debt incurred by member countries in the Eurozone without effective control gave rise to the problem. It was resolved by financial guarantees from European governments concerned about the prevailing economic instability and the help of the UN's International Monetary Fund (IMF).

Is Eurozone the same as the EU?

No. Euro is the Eurozone currency, and member countries parts of the EU that have adopted it as their primary currency are only part of the region.