Eurozone

What Is the Eurozone?

The eurozone, officially known as the euro area, is a geographic and economic region that consists of all the European Union countries that have fully incorporated the euro as their national currency. As of Aug. 2020, the eurozone consists of 19 countries in the European Union (EU): Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain. Approximately 340 million people live in the eurozone area.

Understanding the Eurozone

The eurozone is one of the largest economic regions in the world and its currency, the euro, is considered one of the most liquid when compared to others. This region's currency continues to develop over time and is taking a more prominent position in the reserves of many central banks. It is often used as an example when studying trilemmas, an economic theory that postulates that nations have three options when making decisions regarding their international monetary policies.

History of the Eurozone

In 1992, the countries making up the European Community (EC) signed the Maastricht Treaty, thereby creating the EU. The creation of the EU had a few areas of major impact — it promoted greater coordination and cooperation in policy, broadly speaking, but it had specific effects on citizenship, security and defense policy, and economic policy. 

Regarding economic policy, the Maastricht Treaty aimed to create a common economic and monetary union, with a central banking system — the European Central Bank (ECB) — and a common currency (the euro).

In order to do this, the treaty called for the free movement of capital between the member states, which then graduated into increased cooperation between national central banks and the increased alignment of economic policy among member states. The final step was the introduction of the euro itself, along with the implementation of a singular monetary policy coming from the ECB.

Special Considerations

For various reasons, not all EU nations are members of the eurozone. Denmark has opted out from joining, although it can do so in the future. Some EU nations have not yet met the conditions needed to join the eurozone. Other countries choose to use their own currency as a way to maintain their financial independence regarding key economic and monetary issues.

Some countries that are not EU nations have adopted the euro as their national currency. The Vatican City, Andorra, Monaco, and San Marino have monetary agreements with the EU allowing them to issue their own euro currency under certain restrictions.

Requirements for Joining the Eurozone

In order to join the eurozone and use the euro as their currency, EU nations must meet certain convergence criteria or requirements. The criteria consist of four macroeconomic indicators that focus on price stability, sound and sustainable public finances, the durability of convergence, and exchange rate stability.

For an EU nation to demonstrate price stability, it must have a sustainable price performance and average inflation not more than 1.5 percentage points above the rate of the three best performing member states. To demonstrate sound public finances, the government's deficits and debts are reviewed and must show the government is not under excessive deficit pressure.

A nation's durability of convergence is assessed through its long-term interest rates, which should not be more than 2 percentage points above the rate of the three best performing member states in terms of price stability. Lastly, the nation must demonstrate exchange rate stability by participating in the Exchange Rate Mechanism (ERM) II for at least two years without severe tensions and without devaluing against the euro.