The Eurozone

How the Euro Works

The euro is the common currency of 20 EU member states (as of 2024). Monetary policy for the eurozone is set by the European Central Bank (ECB) in Frankfurt, which controls interest rates and money supply for all euro countries.

The eurozone was established by the Maastricht Treaty's convergence criteria, which require countries to meet targets on inflation, government debt, budget deficits, and exchange rate stability before adopting the euro. Not all EU members use the euro — Denmark has a permanent opt-out, and newer members like Poland, Hungary, and Sweden have not yet adopted it (or have chosen not to).

Benefits include eliminating exchange rate risk for cross-border trade, lower transaction costs, and price transparency across countries. The euro is the world's second most traded currency after the US dollar.

The Maastricht Convergence Criteria

A country cannot simply decide to adopt the euro; it must first prove economic stability by meeting the Maastricht convergence criteria, agreed in 1992. Croatia's successful entry on 1 January 2023 — the most recent — required clearing exactly these hurdles.

Worked example: why the criteria matter

Imagine two countries want to join. Country A has 2% inflation and a 2%-of-GDP deficit; Country B has 8% inflation and a 6% deficit. If both joined immediately, the ECB would have to set a single interest rate for both — but Country B needs high rates to curb inflation while Country A does not. The convergence criteria exist precisely to prevent this mismatch by ensuring members' economies are broadly aligned before they give up their national monetary policy. As the next section shows, the eurozone crisis revealed how dangerous that mismatch becomes once countries are already inside.

Case Study: 'Whatever It Takes'

By mid-2012 the eurozone was close to breaking apart. Borrowing costs for Spain and Italy had spiked to unsustainable levels, and markets were betting that some countries would be forced out of the euro. Because members share a currency, none could devalue or print money to ease their own debt — that power sits solely with the ECB in Frankfurt.

On 26 July 2012, ECB President Mario Draghi declared that the ECB was 'ready to do whatever it takes to preserve the euro — and believe me, it will be enough.' The ECB then announced its Outright Monetary Transactions programme, a commitment to buy the bonds of struggling members if needed. Remarkably, the mere credible threat calmed markets: borrowing costs fell sharply and the programme never had to be used at scale.

The episode is a classic lesson in central-bank credibility — words backed by capability can move markets more than actions. But it also underlined the core design flaw: the eurozone survived because an unelected central bank stepped in, not because members had built the shared fiscal tools a currency union normally needs.