When Should We Introduce the Euro?

The experiences gleaned from Greece, Spain and Portugal serve as a clear warning about what happens when a country adopts the common currency ill-prepared.

Photo: ANP via AFP

The subject of introducing the euro in Hungary arises from time to time, usually when the Hungarian National Bank organizes an annual Lamfalussy Lectures conference in honor of Sandor Lamfalussy, the "father of the euro." This was the case again now, which is why we are exploring the topic.

Establishing the precursor to the European Union, indeed the idea of European integration originally stemmed from the goal of preventing future wars and ensuring peace. Western European nations pursued ever closer cooperation, leading to the creation of the European Coal and Steel Community in 1951. Further dismantling of barriers and restrictions to trade led to the establishment of a single market and the formation of the Schengen Zone in 1990 to also allow the free movement of people across borders. Finally, in 1999, the euro was introduced as the common currency.

The main objectives of the euro were to support trade and prevent competitive devaluations and destabilizing, speculative capital flows. However, the eurozone was established without a fiscal union, meaning countries could only join if they adhered to strict financial regulations. The convergence criteria set limits on: budget deficit at max 3% of GDP, inflation rate at max 2-3%, public debt at max 60% of GDP, interest rates at no more than 2% above the averages of the three best-performing EU countries, and exchange rate stability meaning the national currency conversion rate had to be established and remain stable for two years before convergence.
While economic development is not among the criteria, it proved to be a crucial factor. The cases of Greece, Spain, and Portugal show that rushing into the eurozone ill-prepared can backfire. These Mediterranean economies lost competitiveness, saw budget deficits soar, and experienced capital flight—leading to rising costs and economic stagnation.

Countries can pursue both good and bad economic policies regardless of being inside or outside the eurozone. If a country’s per capita GDP is close to the eurozone average and its economy is highly integrated into the single market, adopting the euro makes sense. This is the position of the Orban government.

Should we introduce the euro? For Hungary, the key requirement is to continue structural reforms to enhance competitiveness. Once inside the eurozone, currency devaluation is no longer an option to boost competitiveness. While short-term devaluation can help, sustained devaluation leads to inflation. Therefore, the euro should only be adopted when Hungary’s GDP per capita (adjusted for purchasing power) approximates the eurozone average. Currently, Hungary stands at about 75%.

At the recent Lamfalussy Lectures Conference, Prime Minister Viktor Orban acknowledged that Hungary had considered adopting the euro but deliberately held off for 20 years. In its current form, the euro benefits strong and competitive economies but does not necessarily help emerging economies catch up. Even Sandor Lamfalussy, the "father of the euro," warned that "joining the monetary union prematurely could be lethal".

Over the past decade, central bank analyses have consistently found that in and of itself adopting the euro is not a panacea. Only in few, exceptional sectors did the performance of value added production improve after euro introduction. Germany's processing industry is a case in point. As for sectors in other countries, technological advancements, institutional structures, and country-specific factors played a larger role in economic growth than the euro itself.

The sector results clearly show that the biggest winners of euro adoption were Germany and the Netherlands, thanks to their strong manufacturing sectors. Surprisingly, the expected boost for tourism on the continent, especially in southern Europe, did not materialize—instead, Belgium, Austria, and Lithuania saw faster economic growth.

In conclusion, a comment on the convergence criteria: macroeconomic indicators serve "only" as a general guideline. The most important conditions for euro adoption are: commitment to boosting competitiveness and an adherence to strict budgetary discipline spanning across political cycles. And most crucially the public readiness for a new currency. 
 

The author is a senior analyst at Vilaggazdasag.