To what extent does the euro crisis reflect fundamental flaws in the

euro area’s design?

The Euro and European Monetary Integration

ECON340
The Euro and European Monetary Integration | ECON340 200772881

To appropriately answer the question it is imperative to outline the pretext and make certain

clarifications. The euro zone crisis was triggered, and exacerbated by the 2008 global financial crisis and

its aftermath. The financial crisis was largely caused by the moral hazard of the self-regulating private

banking sector. Which led to an economic shock that sternly tested the economic stability of all the

major western economies. The crisis undoubtedly identified flaws in the Euro area’s design, and the

apparent damaging practises of varying national governments. However, the design of the euro area

cannot be attributed as the sole cause to the Euro crisis itself. The resulting assault on the euro area

and its design stems from the fact the ‘one size fits all’ scheme, combined with the negligence of the

national governments, has limited national government autonomy, and policy prescription to the crisis.

Leading to the belief it has further antagonised and prolonged the initial financial crisis.

The thesis will argue the rules set for the Euro have deepened the current crisis by ruling out

conventional solutions, and by imposing a financial doctrine that may now be self-defeating. The essay

will explain how the inadequacies in the euro design can be attributed to political as well as economic

problems.

Before the Euro’s inception many economist were cynical about the extent of the success the Euro

would bring. The economic theory behind the Euro design was to strengthen economic cooperation

and monetary policy cooperation between national central banks. The Maastricht Treaty signed in 1992

was to become a formal realisation of monetary union as an EU Objective. By establishing the

convergence criteria, the treaty was meant to identify the economic conditions deemed ‘necessary’ for

the adoption of a single currency, reflecting the requirement for members to synchronise crucial

aspects of economic performance. As Mulhearn and Vane write the treaty was intended to, ‘separate

the good candidates from the bad.’1 The criteria set were as followed: The inflation rate could not

exceed 1.5% above the average of the three lowest inflation rate countries in the EU; government debt

1
C. Mulhearn & H. Vane, The Euro: Its origin, Development and Prospects, (Cheltenham: Elgar Publishing
Limited, 2008) P. 59

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The Euro and European Monetary Integration | ECON340 200772881

and deficit was to be no more than 60% AND 3% of its GDP respectively; long term interest rates were

to be no higher than 2% above the 3 best performers; finally members were to have maintained a

normal exchange rate fluctuation margins for 2 years without severe tension.. However, the rules were

not followed, in 2003 Germany became the first nation to break the 3% budget deficit rule and France

followed suit shortly afterwards. The commission which had the power to fine the two nations for their

indiscretions, was forced to back down as the then 15 Eurozone member countries voted against the

fine.2 This set a precedent and when the time came to decide Greece’s entry into the Euro, it had

almost become a tacit agreement amongst the members that the rules weren’t to be strictly followed.

Peter Doukas, the former Deputy Minister for Greece recalls, ‘the view was that, ok if the big boys won’t

adhere and impose discipline on themselves, they’re going to be more relaxed in enforcing the treaty

on us.’ Yet Greece took the insubordination, a step further having never stuck to the 3% target it

doctored its statistics to look adequate for entry in the first place. Leading to catastrophic

consequences for the southern European nation.

The ultimate failure of the Maastricht treaty is that it failed to provide adequate enforcement

mechanisms, should a member state fail to meet the convergence criteria. From the offset the

commission that was to ensure compliance had been permanently undermined. As Voss explains, ‘the

coupling of tremendous economic rewards for admittance to the Eurozone with no enforcement

mechanism for nations failing to meet convergence criteria created an incentive-rich environment for

nations to overburden themselves with debt, without much fear of reprisal.’3

Robert Mundell considered the father of the Euro4 and the architect of the Optimum Currency Area

theory posited an Optimum Currency Area was a region where it was beneficial to have one single

2
A. Little, ‘Did Germany sow the seeds of the Eurozone debt crisis?’, BBC News (2012)
<http://www.bbc.co.uk/news/world-europe-16761087> [Accessed 22nd April 2013]
3
J. Voss, ‘Key Players in the European Sovereign Debt Crisis’, CFA Institute (2011)
<http://blogs.cfainstitute.org/investor/2011/11/21/european-sovereign-debt-crisis-overview-analysis-and-
timeline-of-major-events/> [Accessed 22nd April 2013]
4
C. Baum, ‘What’s so special about the Euro Currency Area?’ Bloomberg (2012)
<http://www.bloomberg.com/news/2012-06-20/what-s-so-special-about-the-euro-currency-area-.html>
[Accessed 22nd April 2013]

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The Euro and European Monetary Integration | ECON340 200772881

currency rather than multiple national currencies. The fundamental prerequisites for an optimum

currency area was the degree of symmetry in economic shocks and business cycles; high labour market

flexibility, and the degree of trade integration. The EU undoubtedly fits the latter criteria, as intra trade

has always been highest within the EU than any other region, since its inception. However the suitability

for the initial two criteria have to be questioned.

Mundell recognised high labour market flexibility was an imperative, particularly labour mobility. Yet

economists had always squabbled about whether Europe had the degree required. It was recognised

by encouraging monetary union, it limited the response available to asymmetric economic shocks, and

therefore the criteria mentioned above were vital to ensure a successful recovery. Krugman explains,

‘the disadvantage of single currency area is limited to a one-size-fits-all monetary policy; even more

important is the loss of a mechanism for adjustment.’5Usually asymmetric shocks can be absorbed by

a change in the exchange rate, however this is reliant on the affected regions within the OCA having

their own currencies.

It is still disputed amongst economists, as to what the adequate amount of labour market flexibility may

be as it cannot be easily quantified and definitions seem rather arbitrary. However, when assessing

Europe’s political climate the evidence suggests, it may fail to meet the criteria.

It is an indisputable fact that the plea for greater European integration at its earliest stages were

embarked upon to prevent World War III. Baum explains, ‘to a certain extent the economic justifications

were just that, nothing more.’6 It must be asserted that another failure of the Euro design is that it

didn’t consider Europe’s history and the high cultural independence of the different nations to be a

potential problem. The nations within the Euro all have strong individual national identities, as well as

5
P. Krugman, ‘Revenge of the Optimum Currency Area’ New York Times (2012)
<http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/> [Accessed 22nd April
2013]
6
C. Baum, ‘What’s so special about the Euro Currency Area?’ Bloomberg (2012)
<http://www.bloomberg.com/news/2012-06-20/what-s-so-special-about-the-euro-currency-area-.html>
[Accessed 22nd April 2013]

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The Euro and European Monetary Integration | ECON340 200772881

unique cultures and languages, all these factors make Europe ill-suited for monetary integration. For

the system to have worked the member states would have had to view themselves as one communal

economy and identity however this is not the case. The euro crisis has illustrated how divided Europe

really is, and clear examples can be seen all over the EU. In Greece the nation hit worst by the Euro

crisis, the far right, anti-european party ‘Golden Dawn’ has achieved a ‘meteoric rise’ and is Greece’s

fastest growing party.7 Anti-European, and particularly anti-German sentiment has been demonstrated

in the streets of Greece, culminating in riots on more than one occasion.8 Euro scepticism in England

continues to rise also. Demonstrated none more so by the challenge faced by the current Conservative

government from the UK Independence Party (UKIP), experts have predicted the Tories could lose a

third of their seats in the upcoming local elections9, as they are considered to be ‘weak in Europe’. The

Tory government were reportedly contemplating a negative ad campaign in a desperate attempt to

reduce the predicted influx of Romanian and Bulgarian immigrants.10 A poll ran in 2010 by the financial

times found varying reasons round Europe for the anti-immigration stance, 64% of Britons believed EU

immigration was making their country a worse place to live, and in Spain 67% thought EU immigration

was making it harder to find a job.11 The 2010 Eurobarameter, stated most Europeans do not intend to

move to another EU country any time in the future. The evidence above suggests the policy makers

underestimated the differences between the nations and the inevitable hostility that would transcend.

After all it was just over half-century since Europe had been devastated by the greatest war ever fought.

7
H. Smith, ‘Greece’s neo-Nazi Golden Dawn goes global with political ambitions’, The Guardian (2013)
<http://www.guardian.co.uk/world/2013/apr/01/greece-golden-dawn-global-ambitions> [Accessed 22nd April
2013]
8
R. Neate, ‘Growing anti-German feeling on streets of Greece’, The Guardian (2012)
<http://www.guardian.co.uk/business/2012/feb/27/growing-anti-german-feeling-streets-greece> [Accessed
22nd April 2013]
9
P. Hennessy, ‘Tories could lose 600 shire seats amid Ukip surge in local polls’ The Telegraph (2013)
<http://www.telegraph.co.uk/news/politics/ukip/10007830/Tories-could-lose-600-shire-seats-amid-Ukip-surge-
in-local-polls.html> [Accessed 22nd April 2013]
10
R. Syal, ‘Immigration: Romanian or Bulgarian? You won’t like it here’, The Guardian (2013)
<http://www.guardian.co.uk/uk/2013/jan/27/uk-immigration-romania-bulgaria-ministers> [Accessed 22nd April
2013]
11
J. Blitz, ‘Britons lead on hostility to Migrants’, Financial Times (2010) <http://www.ft.com/cms/s/0/231ffb5e-
b9fa-11df-8804-00144feabdc0.html#axzz2RWSOmCdt> [Accessed 22nd April 2013]

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The Euro and European Monetary Integration | ECON340 200772881

It seems over optimistic to believe citizens will be willing to move from one state to another in search

of work like they do in the US, with such differences within the EU.

The lack of political harmony is further demonstrated in fiscal matters. Peter Keenen had argued about

the co-ordination of national fiscal policies and the need for a common Eurozone budget, a mechanism

to transfer fiscal resources from booming to depressed regions.12 Krugman explains, ‘the lack of fiscal

integration has had an enormous impact,’13 on the Euro crisis. A comparison can be made to the US,

where should a state suffer from an asymmetric adverse shock it receives an automatic transfer from

the rest of the nation, however it has no impact on the welfare the state can receive. This has not been

the case in Europe where fiscal aid has come with strict austerity attachments, leading to an increase

in anti-European sentiment, and the vilification of Germany. Kenan correctly summariesed, ‘countries

must be asserted with a wide range of budgetary policies to deal with stubborn pockets of

unemployment that are certain to arise from export fluctuations combined with an imperfect mobility

of labour’14 Had fiscal integration been agreed prior to the shock, the Eurozone would have been much

better placed to deal with the crisis. Furthermore the European Central Bank (ECB) has been labelled

as a chamber of secrets.15 Although it has a leading role in fighting the Euro crisis, it shares less

information than its comparable counterparts in the US and UK for instance. The rules do not require

the ECB to state whether a vote was taken and how it came to its decision, additionally there is a 30

year wait before it will release minutes from its policy-making meetings. In fact deliberations from the

ECB’s first meeting won’t appear until 2028s. The lack of accountability and transparency has resulted

in Germany being pinpointed as the culprit behind the tough austerity measures forced upon struggling

12
B. Eichengreen & C. Wyplosz, ‘Kenen on the Euro’ Vox (2012) <http://www.voxeu.org/article/kenen-euro>
[Accessed 22nd April 2013]
13
P. Krugman, ‘Revenge of the Optimum Currency Area’ New York Times (2012)
<http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/> [Accessed 22nd April
2013]
14
P. Kenen, ‘The Theory of Optimum Currency Areas: An Eclectic View. Monetary Problems in the International
Economy’, in Exchange Rates and the Monetary System: Selected Essays of Peter B. Kenen (USA: Edward Elgar
Publishing, 1994) P.54
15
‘European Central Bank Should Open its Chamber of Secrets’ Bloomberg (2012) <
<http://www.bloomberg.com/news/2012-11-11/european-central-bank-should-open-its-chamber-of-
secrets.html> [Accessed 23rd April 2013]

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The Euro and European Monetary Integration | ECON340 200772881

nations. The belief amongst a number of citizens in the nations hit hardest by austerity is Germany has

seized its opportunity as the European powerhouse to control proceedings within the ECB and increase

its wider influence in Europe. Something deemed all too familiar in Germany’s relatively young history.

Others believe Germany have been indecisive and ineffectual in their involuntary role as the European

driving force, as they do not want to resonate with the historical view of the dominating Germany. The

polish foreign minister stated, ‘I fear German power less than I am beginning to fear German

inactivity.’16 Speculation by its very definition is, due to the absence of knowledge, and the lack of

transparency and accountability in the euro area’s design, particularly the ECB has allowed speculation

to triumph, creating the perfect breeding ground for anti-European/German sentiment.

In summary the failure of the Euro area design can be attributed to the undermining of the imperatives

outlined in the Maastricht treaty, which set an irrevocable and catastrophic precedent. Furthermore as

Krugman contends, ‘In summary, optimum currency area theory suggested two big things to look at –

labour mobility and fiscal integration. And on both counts it was obvious that Europe fell far short of

the U.S. example, with limited labour mobility and virtually no fiscal integration.’17 The limited role of

the ECB has also limited the Eurozone’s ability to deal with the crisis prolonging the crisis whilst further

dividing Europe. It seems rather obvious now, but European leaders should have given more thought

to the critics of the idea, before embarking on the adventure. Not just for economic reasons, but also

because of the strong cultural differences and identities within Europe.

16
A. Little, ‘Did Germany sow the seeds of the Eurozone debt crisis?’, BBC News (2012)
<http://www.bbc.co.uk/news/world-europe-16761087> [Accessed 22nd April 2013]
17
P. Krugman, ‘Revenge of the Optimum Currency Area’ New York Times (2012)
<http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/> [Accessed 22nd April
2013]

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The Euro and European Monetary Integration | ECON340 200772881

http://www.bbc.co.uk/news/business-16290598

http://www.bloomberg.com/news/2011-12-09/european-crisis-timeline-from-maastricht-treaty-to-

fiscal-union-agreement.html

http://www.social-europe.eu/2012/03/the-maastricht-roots-of-the-euro-crisis

http://www.imf.org/external/np/vc/1999/121399.HTM

http://www.bloomberg.com/news/2012-11-11/european-central-bank-should-open-its-chamber-of-

secrets.html

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The Euro and European Monetary Integration | ECON340 200772881

References

Books
Brown, B., Euro Crash: The Exit Route from Monetary Failure in Europe, (Basingstoke: Palgrave
Macmillan 2012)

Kenen, P., ‘The Theory of Optimum Currency Areas: An Eclectic View. Monetary Problems in the
International Economy’, in Exchange Rates and the Monetary System: Selected Essays of Peter B.
Kenen (USA: Edward Elgar Publishing, 1994)

Mulhearn, C., & H. Vane, The Euro: Its origin, Development and Prospects, (Cheltenham: Elgar
Publishing Limited, 2008)

Web Resources
Baum, C., ‘What’s so special about the Euro Currency Area?’ Bloomberg (2012)
<http://www.bloomberg.com/news/2012-06-20/what-s-so-special-about-the-euro-currency-area-
.html> [Accessed 22nd April 2013]

Blitz, J., ‘Britons lead on hostility to Migrants’, Financial Times (2010)

<http://www.ft.com/cms/s/0/231ffb5e-b9fa-11df-8804-00144feabdc0.html#axzz2RWSOmCdt>
[Accessed 22nd April 2013]

Eichengreen, B., & C. Wyplosz, ‘Kenen on the Euro’ Vox (2012) <http://www.voxeu.org/article/kenen-
euro> [Accessed 22nd April 2013]

Hennessy, P., ‘Tories could lose 600 shire seats amid Ukip surge in local polls’ The Telegraph (2013)
<http://www.telegraph.co.uk/news/politics/ukip/10007830/Tories-could-lose-600-shire-seats-amid-
Ukip-surge-in-local-polls.html> [Accessed 22nd April 2013]

Krugman, P., ‘Revenge of the Optimum Currency Area’ New York Times (2012)
<http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/> [Accessed
22nd April 2013]

Little, A., ‘Did Germany sow the seeds of the Eurozone debt crisis?’, BBC News (2012)
<http://www.bbc.co.uk/news/world-europe-16761087> [Accessed 22nd April 2013]

Neate, R., ‘Growing anti-German feeling on streets of Greece’, The Guardian (2012)
<http://www.guardian.co.uk/business/2012/feb/27/growing-anti-german-feeling-streets-greece>
[Accessed 22nd April 2013]

Smith, H., ‘Greece’s neo-Nazi Golden Dawn goes global with political ambitions’, The Guardian (2013)
<http://www.guardian.co.uk/world/2013/apr/01/greece-golden-dawn-global-ambitions> [Accessed
22nd April 2013]

Syal, R., ‘Immigration: Romanian or Bulgarian? You won’t like it here’, The Guardian (2013)
<http://www.guardian.co.uk/uk/2013/jan/27/uk-immigration-romania-bulgaria-ministers> [Accessed
22nd April 2013]

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