What Is the European Economic and Monetary Union (EMU)?

What Is the European Economic and Monetary Union (EMU)?

Let me explain the European Economic and Monetary Union (EMU) directly: it's a system that brings together several European Union (EU) member states into a unified economic framework. This setup replaced the earlier European Monetary System (EMS). Remember, the EMU has 19 members, while the full EU has 27 as of 2022—there's a clear distinction there.

You might hear it called the Eurozone, and it's a broad structure covering policies for economic convergence and free trade among EU states. The EMU developed in three phases, with the final one introducing the euro to replace national currencies. All original EU members adopted it except the UK and Denmark, who opted out. The UK left entirely in 2020 after Brexit.

Key Takeaways

Here's what you need to know: The EMU coordinates economic and fiscal policies, maintains a common monetary policy, and uses the euro across 19 Eurozone countries. The decision to create it came from the 1992 Maastricht Treaty signed in the Netherlands. In 2002, the euro officially replaced most national currencies in the EU.

History of the European Monetary Union (EMU)

Efforts to form something like the EMU started right after World War I. On September 9, 1929, Gustav Stresemann spoke at the League of Nations, asking where the European currency was that they needed. But that idea crashed with the Wall Street collapse a month later, sparking the Great Depression, dividing Europe, and leading to World War II.

The modern push began with Robert Schuman's speech on May 9, 1950—the Schuman Declaration. He argued that pooling resources like coal and steel would bind Europe economically and prevent more wars, given the devastation of the previous thirty years. This led to the 1951 Treaty of Paris, creating the European Coal and Steel Community (ECSC) among Belgium, France, Germany, Italy, Luxembourg, and the Netherlands.

The ECSC evolved into the European Economic Community (EEC) under the Treaties of Rome. The Paris Treaty was temporary, set to end in 2002, so politicians in the 1960s and 1970s proposed plans like the Werner Plan for permanence. But global events—the end of Bretton Woods, oil shocks, and inflation in the 1970s—delayed real progress.

In 1988, European Commission President Jacques Delors formed a committee of central bank governors to plan further integration. Their report paved the way for the 1992 Maastricht Treaty, which established the European Union. A key focus was economic convergence, setting a timeline for the EMU with a common economy, central banking, and currency.

By 1998, the European Central Bank (ECB) was up and running, and conversion rates between currencies were fixed. The euro started circulating in 2002.

Important Convergence Criteria

If a country wants to join the EMU, it must meet specific criteria: reasonable price stability, sustainable public finances, responsible interest rates, and stable exchange rates. These ensure the union's overall stability.

European Monetary Union and the European Sovereign Debt Crisis

Adopting the euro means giving up monetary flexibility—no country can print money to cover debts or deficits, or devalue against other European currencies. But the EMU isn't a fiscal union, so countries have varying taxes and spending. Before the global financial crisis, all borrowed cheaply in euros, but yields didn't match credit risks.

This led to stress in countries like the PIIGS: Portugal, Ireland, Italy, Greece, and Spain, threatening the euro's stability.

Greece as an Example of the Challenges in the EMU

Greece stands out as a prime case. In 2009, it admitted understating its deficits since joining the euro in 2001, triggering a severe crisis. It took two EU bailouts in five years, and without leaving the EMU, more would be needed.

The deficit stemmed from poor tax collection, high unemployment, and unchecked spending. In July 2015, Greece imposed capital controls, a bank holiday, and limited euro withdrawals.

The EU demanded strict austerity or exit. On July 5, 2015, Greeks voted against austerity, fueling exit talks. Leaving could mean economic collapse, returning to the drachma, capital flight, and distrust in the new currency. Imports would cost more as the drachma weakened, possibly leading to inflation or hyperinflation. Black markets might emerge, but contagion risk was low since Greece is only 2% of the Eurozone economy.

Ultimately, Greece stayed, received more bailouts, and exited its third program in 2018, achieving some stability and growth.

Do All European Countries Use the Euro?

No, not all do. Countries like the UK, Switzerland, Sweden, Norway, Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, and Romania keep their own currencies. Some non-EU places like Vatican City, Andorra, Monaco, and San Marino have agreements to issue euros with limits.

What Is the Difference Between the European Union (EU) and the Eurozone?

The EU is a group of 27 countries sharing democratic values and economic ties. The Eurozone is the 19 within it that use the euro; eight EU members don't.

When Did the European Monetary Union Begin?

It officially started on February 7, 1992, with the Maastricht Treaty. The euro launched as an accounting unit on January 1, 1999, and physical currency circulated from January 1, 2002.