The formation of the European Union (EU) paved the way for a unified, multicountry financial system under a single currency—the euro. While most EU member nations agreed to adopt the euro, a few, like the United Kingdom, Denmark, and Sweden (among others), have decided to stick with their own legacy currencies. This article discusses the reasons why some EU nations have shied away from the euro and what advantages this may confer on their economies.
There are currently 28 nations in the European Union and of these, nine countries are not in the eurozone—the unified monetary system using the euro. Two of these countries, the United Kingdom and Denmark, are legally exempt from ever adopting the euro (the UK has voted to leave the EU, see Brexit). All other EU countries must enter the eurozone after meeting certain criteria. Countries, however, do have the right to put off meeting the eurozone criteria and thereby postpone their adoption of the euro.
EU nations are diverse in culture, climate, population, and economy. Nations have different financial needs and challenges to address. The common currency imposes a system of central monetary policy applied uniformly. The problem, however, is what’s good for the economy of one eurozone nation may be terrible for another. Most EU nations that have avoided the eurozone do so to maintain economic independence. Here are a few reasons why many EU nations don’t use the euro.
- Independence in Drafting Monetary Policies: Since the European Central Bank (ECB) sets the economic and monetary policies for all eurozone nations, there is no independence for an individual state to craft policies tailored for its own conditions. The UK, a non-euro county, may have managed to recover from the 2007-2008 financial crisis by quickly cutting domestic interest rates in October of 2008 and initiating a quantitative easing program in March of 2009. In contrast, the European Central Bank waited until 2015 to start its quantitative easing program (creating money to buy government bonds in order to spur the economy).
- Independence in Handling Country-Specific Challenges: Every economy has its own challenges. Greece, for example, has high sensitivity to interest rate changes, as most of its mortgages are on variable interest rate rather than fixed. However, being bound by European Central Bank regulations, Greece does not have independence to manage interest rates to most benefit its people and economy. Meanwhile, the UK economy is also very sensitive to interest rate changes. But as a non-eurozone country, it was able to keep interest rates low through its central bank, the Bank of England.
- Independent Lender of Last Resort: A country’s economy is highly sensitive to the Treasury bond yields. Again, non-euro countries have the advantage here. They have their own independent central banks which are able to act as the lender of last resort for the country’s debt. In case of rising bond yields, these central banks start buying the bonds and in that way increase liquidity in the markets. Eurozone countries have the ECB as their central bank, but the ECB does not buy member-nation specific bonds in such situations. The result is that countries like Italy have faced major challenges due to increased bond yields.
- Independence in Inflation-Controlling Measures: When inflation rises in an economy, an effective response is to increase interest rates. Non-euro countries can do this through the monetary policy of their independent regulators. Eurozone countries don’t always have that option. For example, following the economic crisis, the European Central Bank raised interest rates fearing high inflation in Germany. The move helped Germany, but other eurozone nations like Italy and Portugal suffered under the high interest rates. (See related: Financial Regulators: Who They Are And What They Do)
- Independence for Currency Devaluation: Nations can face economic challenges due to periodic cycles of high inflation, high wages, reduced exports, or reduced industrial production. Such situations can be efficiently handled by devaluing the nation’s currency, which makes exports cheaper and more competitive and encourages foreign investments. Non-euro countries can devalue their respective currencies as needed. However, eurozone cannot independently change euro valuation—it affects 19 other countries and is controlled by the European Central Bank.
The Bottom Line
Eurozone nations first thrived under the euro. The common currency brought with it the elimination of exchange rate volatility (and associated costs), easy access to a large and monetarily unified European market, and price transparency. However, the financial crisis of 2007-2008 revealed some pitfalls of the euro. Some eurozone economies suffered more than others (examples are Greece, Spain, Italy and Portugal). Due to the lack of economic independence, these countries could not set monetary policy to best foster their own recoveries. The future of the euro will depend on how EU policies evolve to address the monetary challenges of individual nations under a single monetary policy.