Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan...
-
Upload
em-journal -
Category
Documents
-
view
213 -
download
0
Transcript of Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan...
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
1/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION 1
Considerations for Swiss Policy Makers
Regarding Membership in the European Monetary Union
Nathan Cornett
Eastern Michigan University
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
2/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION Abstract
This paper explores the implications and policy considerations associated with the
question as to whether or not Switzerland should forego their national currency (Swiss Franc)
and pursue membership in European Monetary Union. Collectively analyzing existing research
relating to this topic, this paper describes the many factors that need to be considered when
attempting to answer this question including the currency unions possible effects on trade and
exchange rates, potential impact on the Swiss Francs role as a global safe haven currency, and
also effects on seigiorage and government financing. Additional research questions are also
mentioned as important areas of study that need greater analysis to help aid Swiss policy makers
in deciding whether or not to join the European Monetary Union.
Keywords: Switzerland, European Monetary Union, currency unions
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
3/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION Consideration for Swiss Policy Makers
Regarding Membership in the European Monetary Union
Complexities involving international trade including barriers such as taxes, exchange
rates, and different product regulations have long been seen as inefficiencies in the global market
place. It is the recognition of such restrictions that has called for more open markets and limiting
these trade barriers. Diverse and powerful economies such as the one found in Switzerland have
lots to gain from diminishing trade restrictions. Switzerland, a country of only 7,639,961 boasts a
GDP of over 320 billion accounting for a GDP per capita which ranks them 12th in the world
(Central Intelligence Agency, 2011). The Swiss are primarily a service economy; however
industries also help contribute to their vast export revenues including machinery, chemicals,
watches, and textiles equating to 230 billion dollars (Central Intelligence Agency, 2011).
Industrial modern economies such as Switzerland have much to gain in terms of trade,
and it has only been in the last few decades that policies have been implemented to limit trade
barriers. Many policies have been developed and implemented throughout the world in order to
increase commerce between nations including trade organizations and currency agreements, all
with varying degrees of commitments from member states. In Europe, organizations such as the
European Union act as forums to discuss trade and different economic matters. On January 1,
1999 a major initiative to promote trade was realized when the European Monetary Union
enacted the Euro form of currency (though not in physical form at the time). The goals expressed
by the EMU in which they believed the adoption of the Euro would help them achieve included
greater choice and stable prices for consumers, greater security and more opportunities for
businesses, improved economic stability, and more integrated financial markets (European
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
4/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION Commission: Economic and Financial Affairs, 2011). In many ways the European Union, EMU,
and the Euro have all been extremely successful in these endeavors. Danny Mcgowan of the
University of Nottingham attributes a 6-11% increase in trade resulting from the EMU currency
union (Mcgowan, 2008). Figures vary as to the precise amount of growth attributed directly to
the adoption of the Euro; however there seems to exist a certain school of thought that states
countries who share a common currency may trade up to three times as much as they would with
different currencies, and from this increase in trade comes economic growth (Rose, 2001).
Just as this school of thought was beginning to make headway as an effective tool for
economic growth, recent economic events and various political rational suggest that adoption of
a single common currency may prove to be detrimental to economic growth. Increased
sensitivity to foreign debt among the EMU members shows volatility in new monetary union
movement. This scenario has manifested itself in Europe as the countries of Germany and France
struggle support countries with weaker economies such as Greece while attempting to control the
massive amount of Greek public debt. Current events show the importance of understanding
these issues and why more analysis needs to be done regarding the two different beliefs.
Interestingly enough, Switzerland has chosen not to become an official member of the European
Union or EMU, and still employs its local Franc currency. Membership in the European Union
does not necessarily require membership in the EMU; however there does exist trade agreements
involving European Union members that could potentially benefit Switzerland separate from
joining the European Monetary Union. To the outside observer it may seem odd seeing as
Switzerland is surrounded by European Union Countries, and 3 of its top four trading partners
(Germany, Italy, and France) are all European Union and EMU members (Central Intelligence
Agency, 2011). It is this fact among others that makes Switzerland a particularly interesting case
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
5/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION study with regards to the EMU in particular. Why would this modern industrial nation choose not
to partake in the growth that their neighboring states have enjoyed as a result of involvement in
the EMU? How has this impacted Swiss industry, and are the Swiss actually benefitting from
not being in the EU or EMU? It is these questions that this paper will answer, and possibly
provide counter-arguments against the movement to form more currency unions
Literature Review
Switzerlands decision to remain independent from its European trading partners as it
pertains to the European Monetary Union has been explored by researchers in considerable
depth. It is characterized in the literature that ascending countries in particular aim to be full
members of the EMU (Levasseur, 2004); however an economically powerful Switzerland may
benefit from remaining independent. A great majority of the research has centered on trade and
exchange rates but there has also been research conducted in areas of public finance and different
political aspects. Many of the scholastic research articles below highlight these arguments as
well as some a few less publicized aspects of a potential currency union.
Simply put, the decision to enter a monetary union can be described as a tradeoff
between macroeconomic flexibility against microeconomic efficiency (Krugman, 1992).
However measuring these tradeoffs is no simple task as the literature points out. Torsten
Persson(2001) references this dilemma in his critique of Andrew Roses findings (Rose, 2001)
stating that, accurately measuring the effects on trade of currency unions can be quite difficult as
the determinants of trade become increasingly complex. Those who are proponents of currency
unions often express the trade benefits associated with these unions. These people often cite the
findings of Roses One Money One Market in which he suggests that currency unions can
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
6/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION increase trade 300%, as well as have positive impacts on price stability and more trade
convergence (Rose, 2001). The authors of The Currency Union Effect on Trade: Early Evidence
from EMU critique Roses findings, suggesting that the impact is not quite as significant, and
expand their research to include trade between members of the currency union and non-
members. In the Currency Union Effect on Trade, the authors research suggests that the data
from 1999 to 2002 shows an impact on bilateral trade from the European Monetary Union to be
around 4-16% depending on the two particular countries (Micco,etal.2003). Interestingly enough,
the data does not show any signs of diversionist practices among the EMU members suggesting
that the creation of the EMU has benefited all parties and not just the members of the currency
union (Micco,etal.2003). This observation could be of particular interest to Swiss policy makers
when deciding whether or not to eventually enter into the currency union because it may
diminish the vast tradeoff that is perceived to exist when a country chooses to join a currency
union. If Switzerland is able to benefit from the currency union without surrendering their
exclusive economic control i.e. monetary policy, then microeconomic efficiency could be
maintained while also sharing in the macroeconomic benefits from the increased trade due to the
currency union their neighbors operate.
There does exist a disproportionate impact level however, where intra Euroland trade
between 2 EMU members was measured at 34% and trade between 1 EMU member and non-
member was calculated at 15% between the 1993-2002 (Micco, etal.2003). Understanding the
complexities of the factors that need to be taken into account in order to decide whether or not to
commit to a currency union, Micco, etal. offer some benefits and weaknesses of a single
currency. First the authors reference the claims in that suggest a single currency eliminates
bilateral nominal exchange rate volatility, which in turn should reduce the risks and uncertainty
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
7/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION involved in trade transactions (Rose, 2001). Costs associated with a multi-currency system stem
from more than just risk, but also from the seemingly practical cost from exchanging currencies
(De Grauwe, 1994). De Grauwes research points out that in 1992 estimate costs from
exchanging currencies for trade was .5% of GDP for the European Union as a whole, and this
cost for smaller more open countries could amount to 1% of GDP (De Grauwe, 1994).
Discussions as to optimal currency areas as it pertains to population size often come up in
debates. It can be noted that economies in countries such as Iceland, Liechtenstein, San Marino,
and Monaco in which their populations are so small and economies so dependent on trade with
neighbors that it would be economically inefficient to have their own currency (Goodhart, 1995).
Switzerland may seem to fall in this same category of being too small to effectively benefit from
its own currency; however despite Switzerlands relatively small geographic boundaries and
population, the countries diverse service based economy, highly skilled work force, and a self-
sufficient manufacturing sector have contributed to a GDP of 340.5 billion dollars in 2011,
ranking them 38th in the world (Central Intelligence Agency, 2011). Part of the difficulty in the
decision of whether or not to join the EMU for Swiss policy makers will be to determine if their
size has been hindering them from possibly increasing GDP, or whether Switzerland is large
enough on its own for it to be economically viable to continue with the Swiss franc.
For many years, the Swiss Franc been recognized as a safe haven currency for investors
looking to hedge their risk in the global money market. In a report issued by BFI Consulting AG,
the Swiss Franc is studied as to whether or not its role as a safe haven currency will continue
with the adoption of the Euro. It is important for potential Swiss policy makers to realize the
costs and benefits of adopting the Euro as it pertains to their current role as a worldwide safe
haven (Suess, 1999). Suess states the proponents of the EU argue that a potentially weak Euro
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
8/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION could drive up the value of the franc greatly hurting Swiss exports. There also exists the
argument according to Suess that the franc could potentially become a clone of the Euro and as
such diminish its significance and role as a world currency. Neither of these scenarios has
occurred according to the author, and he credits the Swiss National Bank (SNB) for playing a
large role in this outcome. Initially targeting exchange rates when the Euro was adopted, the
SNB focused its monetary policy on remaining relatively close to the Euro limiting currency
volatility (Suess, 1999). Later as exchange rates fluctuated between the Euro and Dollar, the
SNB shifted its policy towards price control preparing for the resulting currency market
adjustments (Suess, 1999). It is this ability of the SNB to efficiently react to the changing global
economy that will allow it to be a safe-haven currency despite the adoption of the Euro for the
foreseeable future (Suess, 1999).
A less publicized and often overlooked aspect of currency changes how seigniorage will
be affected in a countries national banking system, and whether or not gains or losses will be had
by a change in currency. Seigniorage denotes the revenue stemming from the monopolistic right
to issue central bank money, i.e., currency and bank reserves (Fischer, Jordan, & Lack, 2002).
Fischer Jordan and Lack explore this aspect of changing currencies through their research and
conclude that overall the loss of potential revenue generated from seigniorage should not be the
determining factor on whether or not Switzerland should join the European Monetary Union;
however it is a factor that should not be ignored. Revenue generated by the Swiss National Bank
through this financial instrument is either held in foreign currency reserves or redistributed for
government financing (Fischer, Jordan, & Lack, 2002). As of 1999 2% of cantonal or local
government and .8% of federal government revenue is generated through this means (in terms of
Euro) (Fischer, Jordan, & Lack, 2002).
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
9/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION
What the bulk of these authors research examines is the potential real losses that could
incur to government revenue if a move to the euro where to take place. Based on 2002 EMUs
derivation of member countries capital share which is the determining factor on their seigniorage
distribution, Switzerland stands to suffer a loss in revenue. Characteristics of the Swiss economy
including currency holdings and circulation negatively affect their ability to receive
proportionately fair revenue given the 2002 EMU policy (Fischer, Jordan, & Lack, 2002).
According to the authors calculations, Switzerland looks to lose as estimated 13 billion Euros in
seigniorage generating revenue that would result in a seigiorage loss from 313 million euros to
700 million given the interest rate at the time of entry into the union (Fischer, Jordan, & Lack,
2002). Aside from the obvious financial losses from this hypothetical move to the European
Monetary Union, the authors suggest that division between the cantonal government and the
national government as a result of the disproportionate revenue loss, and that the federal
government will have more direct control over the funds they receive from the EMU (Fischer,
Jordan, & Lack, 2002).
Political literature has also touched on the potential impact of currency unions. Benjamin
Cohen (2000) describes the magical virtues of money which includes the sense of national
identity which is enhanced through a state currency and suggests that currency underscores the
fact that everyone is part of the same social entity. For any country considering joining a
currency union, this idea of a nations currency being tied to a national identity is certainly
something to consider when deciding whether or not to join/form a currency union. Politically
speaking, politicians who may want to be perceived as progressive and open to the world by their
constituents may consider the currency union. On the other side, a politician may want to show
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
10/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION how patriotic he/she is and as such may choose to continue with the countries original currency.
Depending on who is making the decision and whether or not a political backlash may occur
from a currency switch, the policy makers will have to undoubtedly consider the political
ramifications from their decision.
A great deal of the literature regarding the effects of monetary unions and in particular
the European Monetary Union focuses on the effects on trade and interest rates. There is good
reason for this seeing as these two factors are often at the center of the argument to create a
union In The Economics of Monetary Unions, Paul de Grauwe (1994) outlines in great detail
how exchange rate uncertainty relates to the benefits of monetary unions as well as how the
single currency notion relates to trade openness. Limited research however has examined the
direct effect the union has had as it pertains to fiscal and monetary policy; mainly if
inefficiencies have resulted due to the collective nature of the monetary unions under one central
bank. There is also limited literature about the possible effects the EMU has had on the often
criticized Swiss banking system. This is most likely attributable to the secretive nature of Swiss
banking, nevertheless it would be interesting to see if deposits have increased as a result of
European Union banking regulations. In light of the current economic events surrounding Greece
and the Euro, it would be interesting to see the effect of their economic woes on EMU members
and whether or not Switzerland will be affected as great. All these questions could factor into a
Swiss policy makers decision as whether or not to enter into the EMU.
Conclusion
With regards to the question of why Switzerland has elected to retain its own currency
and in all other monetary aspects remain separate from the EMU, the current literature presents
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
11/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION many reasons. Understandably much of the research is centered around the impacts on trade and
exchange rates. As expressed in How Large is the Treatment Effect by Torsten Persson,
measuring the impacts of currency unions on trade proves to be an extremely difficult task.
Authors Micco, etal. add to the ideas express by Torsten (2001) highlighting the fact that their
findings on the impact of currency unions on trade differ from the controversial findings from
Rose suggesting that currency unions can potentially increase trade 300% (Micco, Stein,
Ordoez, Helene, & Viaen, 2003). Inconclusive results on the perceived gains from currency
union formation may add to the uncertainty and perceived risk of entering into such a union.
Further research could be done to quantify this risk and describe its overall role in Switzerlands
decision making process as whether or not to join the EMU. As it relates to exchange rates and
the Swiss francs role as an international safe haven currency, Suess credits the Swiss National
Bank and their monetary sovereignty from preventing the franc from becoming a clone of the
Euro or becoming priced too high as a result of Euro dumping (Suess, 1999).
A potential research question stemming from the existence of the SNB is the possible loss
in monetary policy efficiency from switching to a more collective national banking system such
as the European National Bank. Limited research has been done in this area, and understanding
the possible losses or gains due to the collective nature of the ECB could help Swiss policy
makers in their decision as whether or not to remain separate from the EMU. Analyzing the
impact of the potential adoption of the Euro from an internal perspective, authors such as
Fischer, Jordan, & Lack conclude that Switzerland could lose between 313 million euros to 700
million euros from lost revenue due to a decrease in seigniorage base of 13 billion euros if they
joined in 2010 (depending upon current interest rates) (Fischer, Jordan, & Lack, 2002). Stating
that this loss in seigniorage should not be a determining factor in Switzerlands decision to
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
12/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION remain independent, Fischer, Jordan, and Lack do conclude that it should be a factor in the
equation. Overall the research does not conclude that Switzerland should or should not join the
EU. Relatively limited data due to the newness of the EU and currency unions have led to great
disparity in potential gains from these unions, and further research questions need to be explored
before definite conclusions can be made. This point is iterated in Miccos, Steins, Ordoezs,
Helenes, and Viaens critique on Roses findings stating that assumptions such as linear
relationships and random sampling errors may contribute to inaccurate findings (Micco, Stein,
Ordoez, Helene, & Viaen, 2003).
These indefinite conclusions and weaknesses in the research call for more research
questions to be explored in order to truly understand the impact of currency unions, and
specifically whether or not Switzerland should join the EMU. Such possible research questions
could include the Euros impact on specific industries i.e. do currency unions favor economies
with heavy manufacturing bases vs. service oriented economies? Also would forgoing financial
sovereignty (which is often associated with belonging to organizations such as the EMU) with
regards to regulations hurt the Swiss economy; specifically the possibility of increased banking
regulations? These questions among others all need to be explored and analyzed effectively by
policy makers to determine the proper course of action as it pertains to Switzerland joining the
European Monetary Union.
-
8/2/2019 Considerations for Swiss Policy Makers Regarding Membership in the European Monetary Union by Nathan Cornett
13/13
SWITZERLAND AND MEMBERSHIP IN THE EUROPEAN MONETARY UNION
Works Cited
Cohen, B. J. (2000). Monetary Union: The Political Dimension. Santa Barbara: University of
California at Santa Barbara.
De Grauwe, P. (1994). The Economics of Monetary Integration. Oxford: Oxford University
Press.
Fischer, A. M., Jordan, T., & Lack, C. P. (2002). Giving Up the Swiss Franc: Some
Considerations on Seigniorage Flows under EMU. Swiss Journal of Economics andStatistics, 61-82.
Goodhart, C. (1995). The Political Economy of Monetary Union. In P. B. Kenen, The
Macroeconomics of the Open Economy. Princeton: Princeton University Press.
Krugman, P. R. (1992). What Do We Need to Know about the International Monetary System?Princeton: Princeton: International Finance Section.
Levasseur, S. (2004, May). Why Not Euroisation. Revue de l'OFCE, pp. 121-156.
Micco, A., Stein, E., Ordoez, G., H. K., & Viaen, J.-M. (2003, October). The Currency UnionEffect on Trade: Early Evidence from EMU. Economic Policy, pp. 315-356.
Persson, T. (2001, October). Currency Unions and Trade: How Large is the Treatment Effect?
Economic Policy, pp. 433-488.
Rose, A. K. (2001, December 25). One money, one market: the effect of common currencies on
trade. Economic Policy, pp. 7-46.
Central Intelligence Agency. (2011, October). The World Factbook. Retrieved October 5, 2011,from cia.gov: https://www.cia.gov/library/publications/the-world-factbook/geos/sz.html
European Commission: Economic and Financial Affairs. (2011, January 14). Why the Euro?
Retrieved October 5, 2011, from European Commission:http://ec.europa.eu/economy_finance/euro/why/index_en.htm
Mcgowan, D. (n.d.). Has the Euro Increased Trade? Leverhulme Centre for Research inGlobalization and Economic Policy.