KEY POINTS

1. A currency union occurs when two or more sovereign nations share a common currency. Sometimes these arrangements are unilateral, such as when a country like Ecuador adopts the U.S. dollar. But some are multilateral, the most prominent example being the Eurozone.
2. The euro is (as of 2014) the currency of 18 European Union (EU) countries, and they manage it collectively by a common monetary authority, the European Central Bank (ECB). Most of the EU’s 28 countries are expected to join the euro eventually.
3. According to the theory of optimum currency areas (OCAs), regions should employ a common currency only if they are well integrated and face fairly similar (symmetric) economic shocks. If these criteria are met, efficiency gains from trade should be large, and the costs of forgone monetary autonomy small.
4. A currency union is usually a more irreversible and costly step than simply fixing the exchange rate. The OCA threshold is therefore higher than the threshold for a fixed exchange rate.
5. Additional economic factors can strengthen the case for an OCA. If regions have high labor mobility or large fiscal transfers, these mechanisms may make the costs of a currency union smaller for any given asymmetric shock. In addition, countries with a poor nominal anchor may be eager to join a currency union with a country with a better reputation for inflation performance.
6. Political considerations can drive monetary unions, as when countries feel they have a common destiny and wish to treat monetary union as part of a broader goal of political union.
7. The Eurozone has fairly high trade integration, although not quite as high as that of the United States. The Eurozone might or might not pass this OCA test.
8. The Eurozone has fairly symmetric shocks for most countries. The Eurozone probably does pass this OCA test.
9. The Eurozone has very low labor mobility between countries. The Eurozone almost certainly fails this OCA test.
10. The OCA criteria may fail ex ante, but they may be self-fulfilling: thanks to the common currency, after some years, trade and labor mobility may increase, tipping the balance in favor of an OCA ex post. But increasing specialization due to trade may cause more asymmetric shocks, which would push in the opposite direction.
11. The lack of compelling economic arguments for the euro leads us to study its historical and political origins. The EU must be understood as a political project, and the euro is an important part of the conception of the EU. Although many EU citizens have trust in this project, polls show that such a view is held by only a bare majority.
12. The ECB plays the pivotal role in securing the future of the euro. If it can deliver low inflation and economic stability comparable with the German central bank, after which it was designed, the euro is more likely to succeed as a currency in the EU and as a global currency.
13. Attempts to exert political influence on the ECB continue and the Council of Ministers has often proved weak at punishing countries that break the rules of the Eurozone (the Maastricht criteria and the Stability and Growth Pact).
14. The global financial crisis of 2008 and Great Recession were the first real test of the euro, and a stern test at that. Like other economies, the Eurozone suffered from excessive lending and financial bubbles in some countries, fiscal indiscipline in other countries, bailouts of banks, and (as a result) pressure on the central bank to deviate from established policies to support the real economy, banks, and governments. These problems were difficult to handle because they affected Eurozone countries in an asymmetric fashion. As a result, ECB and EU authorities struggled to devise effective policy responses based on broad cooperation except in the direst moments. The economic and political situation remains fragile, especially in the hard-hit peripheral economies of Greece, Ireland, Portugal, and Spain.
15. A double-dip recession began in 2011 making matters even worse: slow growth damaged fiscal positions, government ambitions were limited, the ECB was reluctant to try aggressive or unconventional tactics, and the European banking system remains fragile.