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The formation of the European Union (EU) paved the way for a unified, multi-country financial system under a single currency: the euro. Most EU member nations agreed to adopt the euro but a few have decided to stick with their legacy currencies.
Key Takeaways
- There are 27 member countries in the European Union but six of them are not in the Eurozone and therefore don’t use the euro.
- Denmark is a member country but has negotiated an opt-out with the Union and it has kept its own currency.
- The six countries that are not in the Eurozone choose to use their own currencies as a way to maintain financial independence on certain key issues.
- These 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.
Understanding the European Union
There are 27 nations in the European Union as of 2024. Six of these countries are not in the Eurozone, the unified monetary system that uses the euro. Denmark is legally exempt from adopting the euro because it negotiated an opt-out with the European Union. All other EU countries must enter the Eurozone after meeting certain criteria but they do have the right to put off meeting the Eurozone criteria and 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 that’s applied uniformly. The problem is that what’s good for the economy of one EU nation may be terrible for another.
Most EU nations that have avoided the Eurozone do so to maintain economic independence.
Drafting Monetary Policies
The European Central Bank (ECB) sets the economic and monetary policies for all Eurozone nations. There’s no independence for an individual state to craft policies tailored to its own conditions.
The UK used to be an EU member. It may have managed to recover from the 2007-2008 financial crisis by cutting domestic interest rates beginning in October of 2008 and by initiating a quantitative easing program in March of 2009.
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 has a high sensitivity to interest rate changes because a lot of its mortgages have historically applied a variable interest rate rather than a fixed interest rate. The country doesn’t have sufficient independence to manage interest rates to most benefit its people and economy because it’s bound by European Central Bank regulations.
The UK economy is also very sensitive to interest rate changes but it was able to keep interest rates low through its central bank, the Bank of England, because it’s a non-Eurozone country.
Seven
The number of member countries that don’t use the euro as their currency; Bulgaria, Czechia, Denmark, Hungary, Poland, Romania, and Sweden.
Lender of Last Resort
A country’s economy is highly sensitive to Treasury bond yields. Non-euro countries have the advantage here. They have their independent central banks which can act as the lender of last resort for the country’s debt. These central banks start buying bonds in the case of rising bond yields and increase liquidity in the markets.
Eurozone countries have the ECB as their central bank but the ECB doesn’t buy member-nation-specific bonds in such situations. Countries like Italy have faced major challenges due to increased bond yields as a result.
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’s great for one country but not as helpful for others.
Inflation-Controlling Measures
Increasing interest rates is an effective response to rising inflation. Non-euro countries can do this through the monetary policies of their independent regulators. Eurozone countries don’t always have this option.
The European Central Bank raised interest rates fearing high inflation in Germany following the economic crisis. The move helped Germany but other Eurozone nations such as Italy and Greece suffered under the high-interest rates.
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. This makes exports cheaper and more competitive and it encourages foreign investments.
Non-euro countries can devalue their respective currencies as necessary but the Eurozone can’t independently change euro valuation. It affects 19 other countries and is controlled by the European Central Bank.
Why Do Some EU Countries Choose Not to Utilize EU Policies?
Some EU countries choose not to fully utilize EU policies for a variety of reasons. Sovereignty concerns often play a significant role. Some nations prefer to maintain greater control over their decision-making processes. Some countries may also have different national interests, economic considerations, and cultural elements that may not align with EU priorities or preferences.
What Alternatives Exist for Countries Opting Out of Full EU Membership?
Countries that opt out of full EU membership can pursue alternative relationships such as association agreements. They also have the option to participate in specific EU programs.
How Can Countries Participate in EU Decision-Making Without Full Membership?
Countries can participate in EU decision-making without full membership through mechanisms like observer status, consultation processes, or strategic partnerships. The country might seek some level of collaboration while still maintaining a specific legal level of autonomy.
What Economic Advantages Do Countries See in Maintaining National Currencies Over Adopting the Euro?
Countries maintaining national currencies rather than adopting the euro cite advantages such as control over monetary policy, the ability to respond to economic shocks independently, and flexibility in managing currency valuations. Countries may prefer having more control over their responses to macroeconomic events.
The Bottom Line
Eurozone nations thrived under the euro at first. 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.
But the financial crisis of 2007-2008 exposed some euro pitfalls. Some Eurozone economies suffered more than others. These countries could not set monetary policies to best foster their recoveries due to their lack of economic independence. 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.
Correction–May 7, 2024: This article has been updated to state that six EU member countries don’t use the euro and that Denmark has negotiated an opt-out with the EU.