05 February 2024

Report to ECON: The euro at 25 and what’s next for the ECB? Whelan

The euro has proved to be remarkably resilient and is popular with the EU’s citizens. This paper reviews the reasons for this and argues that the euro project is more resilient now due to several institutional changes.

EXECUTIVE SUMMARY
• The euro has proved to be remarkably resilient and is popular with the EU’s citizens. This paper reviews the reasons for this and argue that the euro project is more resilient now due to several institutional changes.
• It also reviews how the European Central Bank (ECB)’s monetary policy has evolved over time. It discusses the ECB’s policy stance in recent years and some of the ways in which it may need to change in the future.
• Prior to its existence, many economists had doubts about the euro project. US-based economists, in particular, tended to be more sceptical about the economic case for a single currency across many different European countries.
• Many of the weaknesses in the euro project that were claimed by its critics turned out have some truth to them. The euro crisis exposed the limits of a common monetary policy and the absence of a shared fiscal policy. In addition, some other largely unpredicted crises also occurred during the 2010-13 period.
• Despite many thinking the euro could end during the early 2010s, it has survived. Indeed, surveys show the euro is now more popular than ever with the EU’s citizens.
• Having survived the crisis, there are various reasons why the euro is more resilient than ever. These include enhanced macroeconomic monitoring and macro-prudential policies, improved banking regulation and supervision and the introduction of the Bank Recovery and Resolution Directive (BRRD).
• The ECB’s monetary policy strategy has been transformed over the past 25 years. Its definition of price stability has been improved and new programmes have given the ECB a much larger toolkit of policies to deal with negative shocks than it had in 1999.
• There has been some criticism of the ECB because of the recent high inflation. This criticism is largely unfair with the principal impetus to inflation being supply shocks that were out of the ECB’s control. The ECB’s strong response to the COVID-19 pandemic was required and their short delay in raising interest rates in 2022 relative to the Federal Reserve and other central banks was understandable and had little impact on inflation.
• The ECB will have to consider a number of operational issues in the future. This paper recommends substantially reducing the Eurosystem’s sovereign bond holdings, while maintaining the fixed-rate full allotment approach to providing liquidity and introducing a tiering system for paying interest on deposits.
• The ECB is devoting a lot of resources to its plan to introduce a digital euro over the next few years. I am not convinced there is a need for this project.
• The ECB has become more active and vocal in relation to the issue of climate change. While these actions can be justified based on the secondary objectives of the Eurosystem to support the EU’s policies as set out Article 3 of the Treaty on the European Union, the ECB should be cautious when playing a role supporting these secondary objectives, only intervening when there are clear market failures that call for the specific use of its powers....

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