One of the main promises behind the euro was economic convergence. By sharing a common currency, European economies were expected to become more alike over time, making a single monetary policy work for everyone.
A new IREF Policy Paper by Tom Bugdalle and Moritz Pfeifer suggests the picture is much more complicated.
A new way to measure divergence
The authors introduce a Divergence Monitor, a new indicator that tracks how closely euro area countries move together over time.
Unlike traditional measures, the index compares countries directly rather than measuring how far they are from an average. It also accounts for the fact that economies rarely move in perfect sync. One country may simply be a few months ahead or behind another.
The result is a more realistic picture of how synchronized Europe’s economies really are.
Business cycles have converged – but financial cycles have not
The good news is that business cycles have become somewhat more synchronized since the introduction of the euro in 1999.
The bad news is that financial cycles tell a different story.
Credit growth, housing markets, stock prices, and government bond markets continue to move quite differently across member states. Financial divergence remains persistent and often intensifies during periods of economic stress, such as the global financial crisis, the euro debt crisis, and the COVID-19 pandemic.
One currency, different economies
The paper identifies a persistent split within the euro area.
Countries such as Germany, Finland, and the Netherlands tend to form one group, while Greece, Spain, and Portugal form another. These differences are especially pronounced in financial markets.
This creates a difficult challenge for the European Central Bank. A single interest-rate policy may be appropriate for one group of countries while being too loose – or too restrictive – for another.
The experience before the 2008 financial crisis illustrates the problem. Low interest rates helped fuel housing and credit booms in southern Europe, while Germany experienced much weaker economic growth. A one-size-fits-all monetary policy ended up reinforcing, rather than reducing, economic imbalances.
More countries, more divergence?
The paper also raises questions about the future of the euro area.
With Bulgaria joining the euro in 2026 and additional countries hoping to follow, the monetary union is becoming even more diverse. Unless member states become more economically flexible and better aligned, adding new members could make it even harder for the ECB to deliver a monetary policy that fits everyone.
The authors argue that tools such as the ECB’s bond-buying programs may temporarily reduce tensions, but they do not solve the underlying structural differences between member economies.
Their conclusion is straightforward: a successful monetary union requires genuine economic convergence – not simply a shared currency.
Policy Paper: Eurozone: Convergence or Divergence? by Tom Bugdalle and Moritz Pfeifer.
