Euro Zone

Introduction

The euro zone formally referred as the euro area as a common fiscal and monetary union of 17 European Union (EU) member states that have accepted euro as common and lone legal tender. The euro zone is also called as the monetary union and currency bloc.

The euro zone at present includes: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Italy, Ireland, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain. Nearly all EU states are free to join the currency bloc once they meet certain specified conditions also known as convergence criteria. No member states have exited the euro zone so far nor are there any clauses to do so or to be debarred.

The monetary policy of the euro zone is formulated by the European Central Bank (ECB), which is headquartered in Frankfurt, Germany. The European Central Bank is administered by a President and a board which comprises of heads of national central banks.

Although there is no common representation, or standard fiscal policy for the euro zone, joint collaborations on important matters are handled by the Euro Group, which is in-charge of making political decisions concerning the euro zone and euro.

The Euro Group includes finance ministers of monetary union states; nevertheless, during the time of any crisis and urgency national leaders of the euro zone countries can also join this group.

Since the onset of debt and financial crisis from late 2000s, the euro zone has set up  and used provisions for providing emergency loans to several member states in return of a ratification which requires  strict  fiscal reforms.

Occasionally, the euro zone also includes some non-EU nations who accept euro as local currency. For example, San Marino has entered into an official agreement with the EU to use the monetary union’s common currency alongside minting its own coins.   Some other countries like Kosovo and Montenegro also officially accept the euro- although unilaterally.

Nevertheless these three countries are neither part of the euro zone nor do have any sort of representation in the ECB or the Euro Union.

Member Nations

When euro zone came into existence in 1998, only 11 European member states based on convergence criteria qualified to enter the economic bloc. The euro was officially launched on January 1, 1999 although local currencies and coins were also used. Later in 2000, Greece qualified to enter the euro zone but it officially joined in January 1 2001.

By January 1, 2002, physical notes and coins circulated throughout the euro zone, replacing local currencies.  Later, between 2007 and 2012 five more EU member states entered the euro zone.

The Euro Zone Enlargement

Ten EU member states do not use the euro. These countries are: Bulgaria, the Czech Republic, Denmark, Hungary, Latvia, Lithuania, Poland, Romania, Sweden and the United Kingdom. When an EU member state wants to join the euro zone then it should spend two years in the European Exchange Rate Mechanism (ERM II). By 2011, central banks of Denmark, Latvia and Lithuania have take part in (ERM II).

As per the original Maastricht Treaty, both Denmark and United Kingdom got special opt-outs from euro zone.  Even though both these countries are not legally obliged to join the currency union, respective governments can still decide otherwise through a referendum or a parliamentary vote. Sweden also obtained an opt-out by making use of   a legal loophole. Sweden is obliged to join the euro zone as soon as it fulfills the specified criteria, which includes spending two years in European Exchange Rate Mechanism (ERM II) while joining ERM 1 is not mandatory.  As of 2012 Sweden hasn’t decided to participate in the (ERM II).

Following 2008 global financial crisis and subsequent economic slowdown, both Denmark and Poland became increasingly interested in joining the currency bloc. This is because, economic weakness in the euro zone, weighed heavily on the euro, which in result pushed up the local currencies of Denmark and Poland against the euro, hurting its exports. Iceland also looked keen to join the monetary union for the same reasons, but to join the euro zone; the country will have to first become a member of European Union.

Although Latvia was suppose to join the euro zone by 2013, looking at its current economic situation, it does seem that it will take some time for the ex-USSR nation to be a part the bloc. Latvia had to seek financial assistance from the International Monetary Fund (IMF) as country reeled under severe economic slowdown from 2008 due to global credit and financial crisis.

However, amid increasing debt crisis, both Poland and Czech Republic looked reluctant to join the currency bloc in 2010.

Non EU states and Euro

Some Non-EU countries also accept euro as a legal tender. Three sovereign states, Vatican City, San Marino and Monaco have entered a treaty with the EU to use euro as local currency in their states and mint their own coins. Andorra has also signed a monetary agreement with the EU in June 2011 which will permit it use the euro as official state currency.  Under this treaty, Andorra will get the right to mint its own euro coins provided that state will implement pertinent EU legislations.

Some states like Kosovo and Montenegro have formerly adopted euro as the sole currency without entering into any agreement with the EU. Accordingly, both these states have no issuing rights. ECB does not consider these countries as a part of the euro zone. Nonetheless, sometimes the scope of euro zone territory widens when all those countries that have adopted euro either officially or unilaterally are also included in the monetary union.

However, any further unilateral adoption of euro both by non-euro EU and non-EU countries is disallowed by the EU and ECB.

European Central Bank

The European Central Bank (ECB) is an organization of the European Union. The main task of the ECB is to govern the monetary policy of 17 member states of the euro zone. The ECB is one of the world’s most influential central banks. The bank came into existence from 1998, following the ratification of the “Treaty of Amsterdam”. Headquartered in Frankfurt, Germany, the central bank is currently headed by Mario Dragi, former governor of Central Bank of Italy.

The fundamental responsibility of the ECB is to keep the inflation under check within the monetary union.

Some of the key duties of the ECB include: mapping out and implementation of the monetary policy for the euro zone, to oversee foreign exchange operations, to ensure foreign exchange reserves are adequately maintained by European System of Central Banks and to facilitate smooth functioning of the financial market infrastructure under the TARGET2 payments system and the technical platform for settlement of securities in Europe (Target 2 Securities).

The ECB also provides advisory role to various national authorities on issues which come under its field of expertise, especially where Community or national legislation is needed.

Finally, to ensure smooth functioning of the tasks related to the ESCB, the ECB, supported by the NCBs, collects the essential statistical information either from the competent national authorities or directly from external agencies that can provide comprehensive data on economic indicators.

EuroSystem

No Expulsion and Secession Clauses

Even though any EU member state can join the euro zone following the fulfillment of converging criteria, the EU treaty is silent on matters like state exiting or being forced to leave the euro zone.  There is no clause as such- where ECB or EU can permit or prohibit a member nation to leave the currency bloc. However, some countries like Netherlands are in favor of adding a clause which would allow the EU to disqualify a nation in an event where deeply indebted state fails to implement the fiscal reforms, outlined by the EU.

While there several benefits of staying within the euro zone, states can also gain by exiting the currency bloc.  For an example, if a country leaves the bloc and its replacement currency devalues against major currencies, then the state will be able export more. On the other hand, if the currency appreciates after a country leaves the bloc, then imports will become much cheaper.

Governance and Representation of ECB and Eurosystem

The ECB along with the European System of Central banks (ESCB) are primarily responsible for the drafting the monetary policy of the euro zone.  ESCB consists of heads of all the central banks in the EU states.

However, since not all the EU states have adopted the euro zone, the ESCB could not be considered as the monetary authority of the euro zone.

This was the reason why the “Euro system” -which does not include all national central banks (NCBs) that have not joined the euro- turned into the institution in- charge of those responsibilities which in theory had to be governed by the ESCB.

In line with the agreement ratifying the European Community and the Statute of the European System of Central Banks and of the European Central Bank, the most important purpose of the Eurosystem is to maintain price stability (which can be also said as controlling the inflation).

Without showing any discrimination against any member state, the Eurosystem is expected to provide support on general economic policies in the Community and act in accordance with the principles of an open market economy.

The basic responsibilities of the Eurosystem are same as the ECB’s, which are:

• to define and execute the monetary policy of the euro-zone;
• to carry out foreign exchange operations;
• to astutely maintain the official foreign reserves of the Member States; and
• To facilitate operations related to payment systems.

Additionally, the Eurosystem ensures that policies followed by competent authorities are smoothly implemented by member nations and various financial institutions.

The Eurosytem continuously supervises credit institutions to ensure the stability of the financial system.

While all EU member states have their say on European System of Central Banks (ESCB), no non-EU state is allowed to participate in these three establishments: ECB, EU and ESCB even if they have monetary agreements with the euro zone, for example, Monaco.

Only the ECB has right to print bank notes, authorize design on notes and mint coins. Currently, Mario Dragi is the president of ECB.

The euro zone is officially represented its finance ministers, jointly called as the Euro Group. The head in charge of this group is Jen Claude Juncker.

The finance ministers of the EU member states that have adopted the euro assemble a day before a meeting of the Economic and Financial Affairs Council (Ecofin) of the Council of the European Union. The Group is not considered as the official ruling body; however, when the full EcoFin council votes on issues concerning only the euro zone, merely Euro Group members are allowed to vote on it

Since the beginning of global financial crisis in 2008, the Euro Group meetings also known as Euro Summit have been marred by irregularities. While the finance ministers of member states have been meeting regularly, the head of states and sovereign governments in general have been inconsistent.  It was in the Euro Summit where most of the reforms have been agreed or/and calibrated.  Erstwhile French President, Nicolas Sarkozy ardently tried to push other member nations to at least hold two formal meetings annually so that Euro Group could become a “True Economic Government”.

Earlier on April 15, 2008, Junker proposed that the euro zone should be represented as a bloc in International Monetary Fund meetings rather than every member nation of the monetary union taking a   unilateral stance. Junker called it as “absurd” and “absolutely ridiculous” as 17 member states failed to reach an agreement on single representation at the IMF. Junker also hit out at member nations by saying that they are regarded as buffoons on the international scene due to their unilateral stands.

On the other hand, European Commissioner for Competition, Joaquin Almunia believes that before agreeing on common representation, member states showed form a consensus on political agenda.

Economy: Interest Rates and Fiscal Policies

The Interest rates in the euro zone are set by the ECB. Amid June 2000 and October 2008, the main refinance operations were variable tenders instead of fixed rate tenders.

Fiscal Policies

“Broad Economic Policy guidelines” which is written for every member state of the EU with particular emphasis on 17 states of the euro zone, clearly lays the foundation of fiscal coordination among EU states.  Although these guidelines are not obligatory, it is expected that EU member states follow the coordination policy which will help taking account the linked structures of their financial system.

For overall economic stability and judicious management of the common currency, members of euro zone are expected to respect “The Stability and the Growth Pact”. This pact charts out the agreed limits on budgetary deficits, national debts. Should any country deviates from the stipulated limits then it might have to face sanctions. According to the original fiscal pact, the yearly deficit limit for euro zone countries was set at 3% of GDP, with fines for those states exceeding this limit.  Even though in 2005, Portugal, France, and Germany exceeded this limit, no fines were levied on erring states as council on ministers decided against imposing penalties.

Following this decision, some reforms were introduced in the euro zone aimed at providing more flexibility to member states. The reforms ensured that deficit criteria took into account the economic condition of each member nation along with some other factors.

On 20 March, 2008, the Organization of Economic Co-operation and Development lowered its economic forecasts for the euro zone for first six month of 2008. Just then, the 30 nation group cautioned that euro zone has no room to ease its fiscal and monetary policy. Again in 2011, the OECD painted a gloomy picture for the euro zone as it estimated the first quarter GDP growth at 0.5% even as no improvement was anticipated in the second quarter with GDP expected to grow at 0.4%.

Bailout Clauses

By the end of late 2000s, numbers of reforms have been enacted in the euro zone.  One of them was the complete reversal on its stance concerning the bailout policy. Under the new bailout provision, specific funds were created in order to assist the struggling economies of the euro zone.

Numbers of bailout schemes like “European Financial Stability Facility”(EFSF), “The European Financial Stability Mechanism” (EFSM) were launched in 2010 along with International Monetary Fund (IMF)assistance to help out euro zone economies.

Nonetheless, both EFSF and EFSM were limited in scope, too small and lacked basis in EU Treaties. As a result, in 2011, a more focused and improved scheme, European Stability Mechanism (ESM) was ratified.

Unlike EFSF and EFSM which were financed by the EU and temporary, the ESM was supported only by the euro zone states, was larger and had permanent basis in treaties.

The ratification of ESM resulted in an agreement over the amendment of TEFU Article 136 allowing ESM and ESM treaty to map out how the ESM will operate. If both ESM and ESM treaty are successfully enacted, then it is expected that ESM will be operational from mid 2013 while EFSF and EFSM expires.

Peer Appraisals

While the basic idea behind forming the EU and euro zone was fiscal consolidation and integration, several provisions enforced by the EU, which ranges from budgetary policy to deficits vis-à-vis GDP have forced many analysts to describe those as latent infringement on the sovereignty of euro zone states.

Subsequently, in June 2010, a comprehensive treaty was eventually reached on some controversial proposals for member nations of EU- one of them being regular appraisals of each other’s budgets, prior to their presentation to national parliaments.

The proposal met with strong resistance from Germany, Sweden and U.K since these countries were comfortable showing entire budget to member nations. Nevertheless, the member nations mutually agreed on sharing with peers and European commission their respective growth estimates, inflation levels, and revenue and expenditures for six month before they are presented in national parliaments.

According to the new agreement if a country was running a huge fiscal deficit then it will have to explain it to other EU member states regarding fiscal imbalances, while in case of states having debts more than 60% of GDP, called for closer scrutiny.

These plans will be applicable to all EU member states not just the euro zone countries. The plans will have to be approved by the EU together with proposal that EU member state can risk sanctions should it breach 3% deficit-to-GDP limit. However, Poland is opposed to the idea of holding back funding in case of country failing to keep deficit limit at 3% as it will hurt the poorer country the most.

Back in June 2010, France supported Germany’s stance -which was suspending the voting rights of those member states who break this rule.

In March 2011, the Stability and Growth Pact was amended by bringing new reforms. The changes  aimed  at simplifying the rules by adopting an automatic procedure for levying  penalties in case of fiscal imbalances.

Euro Summit

The Euro Summit is a formal gathering of all heads of states/ governments of the member states of the euro zone.  The Euro Summit and European council are two different events. While former only involves representatives of 17 states of the euro zone, the later includes all 27 EU states.

The Euro summit is the extension of the Euro Group- which is the official gathering of all finance ministers from the euro zone.

They first Euro summit was held on October 2008, at the height of global financial and debt crisis. Later, the summits were held on May 2010, July 2011 and October 2011.

In October 2011, it was mutually agreed among member states to hold Euro Summit at least twice a year, through enacting a change in the exiting treaty.