Can a Weaker Euro Revive the Eurozone Economy?

Over the past seven years, nearly all of the economic news to emerge from the group of European Union member states that share the euro as their currency, the Eurozone, has been poor at best.  In fact, economic output in the Eurozone is essentially at the same level today as it was in 2007, indicating that the economies of the Eurozone have failed to record any growth over the past seven years.  Today, the headlines in the Eurozone are dominated by the latest debt crisis in Greece and its potential to rekindle the debt crises that recently stretched across the whole of southern Europe.  However, a ray of hope has emerged for the Eurozone economy in recent months, the tremendous weakening of the euro against the US dollar and most of the world’s other leading currencies.

Since mid-2014, the euro has contracted by nearly 25% against the US dollar, and, despite a rally in recent days, the euro remains weaker than at any time in the past 12 years.  In fact, among the world’s leading currencies, only the Russian ruble has weakened more in recent months than the euro.  This weakness is the result of a number of key factors.  First, the outlook for the Eurozone’s economy has been very poor, particularly when compared to the recoveries underway in countries such as the United States and Britain.  Second, the European Central Bank’s decision to finally implement a program of quantitative easing has pushed down the value of the euro, much as similar programs in the United States and Japan weakened their currencies after these programs were implemented.  Altogether, the euro has returned to levels not seen since 2002 and this is not a moment too soon for the beleaguered Eurozone economy. 

The most obvious impact of the sharp depreciation of the euro has been a major improvement in the Eurozone’s economic competitiveness.  For more developed Eurozone economies such as Germany, this weak euro improves what was already a high level of export competitiveness that has allowed German exporters to continue to expand in faster-growing export markets outside of Europe.  However, its impact will be even greater on those Eurozone economies that have hemorrhaged export competitiveness in recent years, allowing less competitive exporters such as Italy, France and Spain to realize improvements in export growth.  Meanwhile, the weak euro is likely to result in a surge in investment in the Eurozone from North America, Britain and Asia, as cheaper Eurozone assets will prove very attractive to companies seeking to expand in Europe.  Europe’s tourism sector is also likely to see a sharp increase in growth in 2015, and this will have a particularly significant impact on southern Europe’s battered economies.

While the benefits of the weaker euro will undoubtedly outweigh the negative aspects of the euro’s sharp depreciation, there are nevertheless a number of risks posed by the weaker currency.  First and foremost, the Eurozone’s struggles with weak levels of domestic demand will be exacerbated by a depressed currency.  As we have seen in Japan, the sharp depreciation of the yen led to a major increase in export growth over the short-term, but this was more than offset by the continued weakness of Japan’s domestic market that brought a premature end to Japan’s economic recovery.  Meanwhile, outside of the United States and Britain, many of the Eurozone’s leading export markets are weakening at the moment, offsetting the benefits of the Eurozone’s improved export competitiveness.  As a result, while the weaker euro will provide a much-needed boost to the Eurozone economy, it is unlikely to provide the level of stimulus needed to restore pre-financial-crisis growth levels in the Eurozone.