The euro was a political project from the start. German Chancellor Helmut Kohl saw the euro as a major peace project. At the birth of the euro in 1999, French President Jacques Chirac drew a vision of a pole of stability. In 2001, Chancellor Gerhard Schröder saw better times ahead than under the German mark.
Since its introduction, the euro has lost a good 40 percent of its value, but its popularity among the population is high. In spring 2026, 82 percent of people in the euro area supported the common currency. Even the AfD, which was founded as an anti-Euro party, no longer fundamentally rejects the euro. The current high inflation rate of 3.8 percent is not attributed to the ECB, but primarily to Donald Trump's Iran War.
But suddenly fears of a sovereign debt crisis in France are making the rounds. National debt stands at around 120 percent of gross domestic product. The budget deficit is more than five percent, while the government cannot find the strength to make sufficient spending cuts. On October 2nd, the yield on ten-year French government bonds touched the five percent mark. Is there a risk of a new euro crisis?
Science was more critical than politics. The star US economist Paul Krugman warned in 1990 of growing economic imbalances because the planned euro area was too heterogeneous. Milton Friedman feared that a unified monetary policy could trigger political tensions and even division. In Germany, a group of professors went to the Federal Constitutional Court. According to Robert Mundell's theory of optimal currency areas, a common currency is only stable if the economic cycles are the same. This was not the case for the Euro candidate countries in 1999.
If one part of the currency area is booming and the other is in crisis, a common monetary policy increases imbalances. A key interest rate that is based on the average of both parts will exacerbate the recession in the part that is in crisis because it is too high. In the part with a good economy, it drives inflation further up because it is too low. Flexible labor markets can balance out unequal economic cycles. In the crisis region, wages must fall and the unemployed must migrate to regions with better economic conditions.
But the labor markets in most euro countries are inflexible. Language barriers and highly developed social systems hinder labor mobility across borders. The European Commission therefore hoped that fixing exchange rates through more trade would lead to an equalization of economic cycles. The actually most effective instrument for aligning economic cycles – a common financial and social policy in a political union – was politically unrealistic at the time the euro was founded.
Instead, uncoordinated financial policies drove the economies of the young euro area apart. In Germany, Chancellor Gerhard Schröder pushed forward far-reaching reforms from 2003 onwards, which increased savings and slowed the economy. The German banks therefore granted more loans to the southern euro area and Ireland, where these fueled government consumption and/or speculation on the real estate markets.
As a result, the financial markets in the Euroland did not compensate for different economic cycles as hoped, but instead became the source of exaggerations that led to the European financial and debt crisis. The risk premiums on the government bonds of the highly indebted Euro countries rose, which initially triggered rescue packages legitimized by parliaments. Because that wasn't enough, in July 2012 ECB President Mario Draghi took responsibility for the continued existence of the euro with the statement "Whatever it takes."
The euro area has become even more heterogeneous over the years
This marked the starting point for a fundamental change in the architecture of the European Monetary Union. The ECB's implicit guarantee for the continued existence of the euro encouraged politicians to engage in high government spending and debt. The Stability and Growth Pact to control debt in the currency area was repeatedly ignored, not enforced, suspended and watered down. In addition to the ECB's price stability mandate, there were other goals such as banking supervision, indirect financing of government spending and climate policy.
The euro area has become even more heterogeneous - also, but not only, due to the expansion from the original eleven to today's 21 countries. Trade between euro countries and other EU and third countries has grown faster than trade with each other. The divergence in inflation rates is immense. Instead of nominal exchange rates, real exchange rates change, also because wage policies are still decided nationally. There were no sufficient labor market reforms, or, as in Germany, they were partially withdrawn.
Therefore, the ECB had to strengthen the euro through permanently low interest rates, the accumulation of huge government bond holdings and rescue mechanisms increasingly tailored to individual countries. The Euro governments were able to use the additional spending leeway created by the ECB to keep the population happy by expanding social spending and employment in the public sector. Since the steep rise in inflation forced the ECB to raise key interest rates from 2022, additional safety nets have been needed.
With the so-called transmission protection instrument, the ECB has allowed itself to specifically purchase bonds from individual euro countries under certain conditions. The aim: to curb “unjustified, disorderly market dynamics” that pose a serious threat to the transmission of monetary policy across the euro area. There should therefore be no new euro crisis.
Germany's spending obligations are no longer sustainable with higher interest rates
France's Finance Minister Roland Lescure has already stated that the ECB does not need to intervene yet. In addition, the EU program NextGenerationEU (809 billion euros), financed with EU bonds, is successfully supporting the heavily indebted euro problem children Italy and Spain. With a new edition, the EU could take care of France.
The problem: Germany is suffering under the burden. The persistently low interest rates and the depreciation of the euro against the dollar, which has continued the trend since 2008, have made companies sluggish, which is slowing growth. Between 2008 and 2020, the German governments, with the backing of the ECB, created large spending obligations that have no longer been sustainable given the higher key interest rates since 2022. The goals of generous social security, climate protection and the cohesion of the euro are increasingly coming into conflict.
The potential for tension predicted by Milton Friedman is gradually approaching over France. France has the incumbent ECB President, who, as a professional politician, has balanced the different interests of the euro countries well with the help of low interest rates.
But now inflationary pressure is back and the ECB would have to raise interest rates further. In the spring of 2027, the Rassemblement National could win the presidential election, calling for the ECB's mandate to be expanded to include boosting growth and production.
But that would increase the potential for conflict with Germany, where before the euro the hard German mark drove industry to ever new heights. The low growth and the negative distributional effects of the permanently expansionary monetary policy have created many losers who are pushed to the political fringes. It therefore remains exciting to see how Germany may soon position itself towards the euro in relation to a France led by Rassemblement National that is not willing to save money.
Gunther Schnabl is director of the Flossbach von Storch Research Institute based in Cologne and professor at the University of Leipzig.
