The euro 20 years on: Ireland’s long journey to currency union
The first part of a series examines the trade-offs made in joining the single currency
The euro is now the currency of 340 million people in 19 countries and internationally meets the key criteria of wide acceptability as a means of exchange and as a store of value. Photograph: iStock
Sometimes European politics has found a way to take a step forward. At a summit of European Union leaders in the Dutch town of Maastricht in December 1991, there was talk of whether an irreversible step could finally be taken towards the creation of a single European currency.
The politics was tricky. Germany had just reunified and had its historic attachment to a hard-currency policy. UK prime minister John Major was seeking opt-outs from moves on social policy and employment law.
After seemingly interminable hours of talking, the decisive compromise was struck. EU leaders were to assess in 1996 whether at least seven countries had met the criteria set down to form a single currency.
But the crucial decisions was the second deadline, which would kick in if the first one was not met. French president François Mitterand had, it is said, got it over the line with his old friend, German chancellor Helmut Kohl, in return for assurances about how the currency would be governed.
As the UK decided to stay out, this inevitably led to the breaking of the one-to-one link with sterling which had existed since independence
EU leaders would reassess the position in 1998 and, so long as at least two countries met the criteria, the single currency would come into being the following January. And so a near-irreversible course was set to the creation of what was to become the euro, 20 years ago, on January 1st,1999.
At the time, Kohl, Mitterand and those driving the project in the European Commission saw the single currency as a move towards a single European economy and some kind of federal Europe. In the event, Maastricht was one of the last big steps forward in European economic integration. The euro remains, in some ways, an unfinished project.
A single currency would normally exist in an area exhibiting similar economic characteristics and with a single government budget to transfer wealth from richer to poorer and – crucially – to ensure protection for any area hit by an economic shock. It would normally have an entirely integrated financial system. The euro zone does not fully meet these criteria, contributing to the fears for its future during the economic and financial crash which started in 2008.
But the euro survived the crisis – with European Central Bank president Mario Draghi famously saying in 2012 that he would do “whatever it takes” to preserve the single currency. It is now the currency of 340 million people in 19 countries and internationally meets the key criteria of wide acceptability as a means of exchange and as a store of value – a currency in which to invest. More tests may lie ahead, but the betting must be that the euro is here to stay.
Ireland’s momentous decision to join the euro came in two stages. First, in 1979 we aligned ourselves with what was then called the European exchange-rate mechanism (ERM), a system which limited the amount which currencies could vary in value against each other.
As the UK decided to stay out, this inevitably led to the breaking of the one-to-one link with sterling which had existed since independence. As Patrick Honohan and Gavin Murphy wrote in a Trinity College research paper which examined the decision: “While financial issues were to the fore in the discussions, the final decision to join was based on a strategic vision that Ireland’s economic and political future lay with Europe, rather than the former colonial power.”
The benefits in terms of continental-style inflation and interest rates did not initially emerge. Indeed, shortly after the decision was taken to create the euro, the ERM was hit with a major crisis – the 1992-1993 currency crisis which led to soaring interest rates here.
The inevitable devaluation of the pound against the deutschmark followed – a recognition that we were not yet a core EU economy – but a subsequent surge in Irish economic growth removed any doubt that Ireland would qualify for the single currency by meeting the required debt and deficit rules. But the question was should we join or, like the UK and Denmark, opt out?
There was intense debate among economists about the concept of the euro and Ireland’s potential membership through the 1990s. An ESRI paper in 1996 came down in favour of the official view that Ireland should go ahead, but pointed out the risks and said that the net gains would likely be modest. Our receipt of significant EU funding was also clearly a factor weighing on the decision.
The arguments against were based on our trading links with the UK and the fact that our economic cycle was not aligned with that of the other members dominated by the big continental economies – and thus interest rates and monetary policy might not suit us.
The impact of possible sterling weakness against the new currency was also widely debated. More widely, there was international economic criticism of the euro, notably from the United States. One survey summed up the US economic mood on the euro as: “It can’t happen, it’s a bad idea, it won’t last.”
As in 1979, politics and a desire to move away from the UK and towards the EU was an important driver for Ireland. By the mid-1990s economic growth was strong and, helped by EU funds, the long-discussed convergence with EU living standards had started.
The economic debate may have been finely balanced, but there was little political support for not going ahead. And so we were one of 11 countries which joined in 1999 and introduced the euro notes and coins three years later, in what was a near-seamless transition.
The Irish public welcomed the currency and the convenience it brought in travelling, even if the initial promises for consumers never entirely materialised. You can spend the same currency across the euro zone, but you still can’t get a mortgage in Germany, or insure your car in France.
Twenty years later Ireland is a richer, much more developed country and the process of convergence, as measured by the traditional economic indicators, is complete. Our trade with Europe has grown strongly and businesses have gained from the ease of trading in one currency.
But we have not got there in a straight line – rather the economy inflated into a massive bubble, then had a huge bust and a subsequent strong bounceback. The key question – and one which we can never answer – is how would our experience compare with what would have happened if we had not joined the euro.
The first question is whether the property and lending bubble would have been so damaging had we not been in the euro.
Economist Frank Barry has argued that the huge flood of international finance into the Irish banking system which fuelled property lending and inflated the bubble would not have been so extreme if we had stayed outside the euro. Others disagree – arguing that the globalisation of international finance would have led to an influx of cash into Ireland and a boom in property lending even if we hadn’t joined the euro.
Nobody disputes, however, that Irish domestic policy did not adjust to euro membership and was blind to the risks of the inflating bubble, while oversight from Europe was inadequate. Nor did anybody in officialdom in Dublin, Brussels or Frankfurt spot the associated risk in the Irish banking system.
The second key issue is whether Ireland was helped or hindered in its response to the crisis by being a euro member. There is no doubt that the EU and ECB’s response was deeply flawed, particularly early in the crisis.
The tools were not there to close down bust banks in an orderly fashion, or impose losses on bondholders and the ECB insisted that Ireland must not run the risk of doing so. On the flip side the liquidity support from the ECB for the Irish banking system, equivalent at one stage to Ireland’s entire GDP, kept the domestic banking system open.
Perhaps, had we not been in the euro we would have hit the buffers more quickly and dramatically, heading into the arms of the International Monetary Fund more quickly.
Since the crisis, Ireland has benefited from the rock-bottom interest rates set in Frankfurt and the massive programme of monetary expansion which has kept interest rates at rock-bottom levels. For a heavily indebted country this has been an invaluable spur to a recovery.
Since the crisis, the reform of the euro zone has been more reactionary than visionary. The priority, not surprisingly, has been to put in place measures to stop a similar crisis in future. Bank regulation has been strengthened, with key decisions now taken in Frankfurt. Regulators insist that bank finances are now more robust in relation to what they lend.
Procedures are in place to “burn” bondholders in bust banks. That said, the banking union is not complete and a bust banking system could still imperil a country. A common deposit-guarantee scheme for banks has still to be agreed – a key way to avoid bank runs.
Ireland took a conscious decision to break the link with sterling and then to join the euro, thus moving itself more into the EU economic sphere
Meanwhile, debate on a larger central euro-zone budget remain mired in difficulty, with the richer countries insisting that such funds could not be used to stabilise an economy hit by a particular shock – the absence of just such a mechanism was identified before the euro foundation as key risk.
The initial vision of the euro founders – to create a major currency – has been achieved, but the presumption that this would spur a move to a wider economic and political union has not, at least nowhere near fully. The post-crisis measures have done much to protect the euro economy and banking system, but some of the fundamental issues remain.
With populist politics in the ascendant in some countries, this could lead to future tensions and crisis, with a row between Brussels and Rome over Italian budget plans just the latest issue to rattle nerves.
Influential economists such as Americans Paul Krugman and Joe Stiglitz continue to insist that the euro is, by its nature, unstable. At its heart, however, the question remains a political one. Are Europe’s new generation of leaders willing, like Draghi, to do “whatever it takes” to protect the euro ?
Twenty years on, Irish budget policy is now much more closely controlled by EU rules, and banking regulation is directed from Frankfurt. The implications of euro membership for domestic policy are now better understood, even though there is a debate over current budget policy.
As interest rates are controlled from Frankfurt, this is the only lever we have to influence the overall level of economic activity. But whether Irish politics has fully come to terms with this trade-off is the question.
Meanwhile, the Brexit debate carries many echoes of the initial discussion about whether we should join the euro and the competing pulls of the EU and the UK. Ireland’s economic links to the EU are now more developed – and few suggest they should be cut – but sterling weakness is again real, this time along with the risk of real economic and political upheaval in the UK.
Ireland took a conscious decision to break the link with sterling and then to join the euro, thus moving itself more into the EU economic sphere.
Now the UK has decided to move in the other direction. Twenty years after the launch of the euro, Ireland’s unique position and deep ties with both the EU and the departing UK are again in focus.
Tomorrow: Conor Pope on the impact of the euro on Irish consumers