The formation of the European Union (EU) paved the way for a unified, multi-country financial system under a single currency—the euro. While most EU member nations agreed to adopt the euro, a few, such as 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 27 nations in the European Union and of these, eight countries are not in the eurozone—the unified monetary system using the euro. Denmark is legally exempt from ever adopting the euro. 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's a look at the issues that many EU nations want to address independently.
- There are 27 countries in the European Union, but 8 of them are not in the eurozone and therefore don't use the euro.
- The 8 countries choose to use their own currency as a way to maintain financial independence on certain key issues.
- Those issues include setting monetary policy, dealing with issues specific to each country, handling national debt, modulating inflation, and choosing to devalue the currency in certain circumstances.
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 prior EU member, 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 to spur the economy).
Handling Country-Specific Issues
Every economy has its own challenges. Greece, for example, has a high sensitivity to interest rate changes, as most of its mortgages are on a variable interest rate rather than fixed. However, being bound by European Central Bank regulations, Greece does not have the independence to manage interest rates to most benefit its people and economy.
The number of EU countries that do not use the euro as their currency; the countries are Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, and Sweden.
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 can act as the lender of last resort for the country’s debt. In the 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.
A common currency brings advantages to the eurozone member nations, but it also means that a system of central monetary policy is applied across the board; this unified policy means that an economic structure could be put in place that is great for one country, but not as helpful for another.
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.
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, the 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 policies 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.