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News from Swiss Plus - Financial Excellence
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Issue No. 3 - Basel, 01.12.2003

Text of speech by Mr. Ulrich Kohli, Chief Economist, Swiss National Bank

Thank you for giving me the opportunity to express here my views about what the euro means for Switzerland, and why Switzerland is still best served by an independent monetary policy.
The Swiss monetary environment has changed drastically with the introduction of the euro back in 1999. Switzerland now looks like an island amidst the euro-ocean. But rest assured, we have had no difficulties keeping our feet dry, and, all in all, European monetary integration has been a very positive development for Switzerland.
Monetary union brings many benefits to its members. Transaction costs are sharply reduced. Exchange-rate volatility and uncertainty vanish within the union. Price comparisons are facilitated and transparency more generally is enhanced. Trade and capital flows between the participating states are invigorated. Monetary integration under the Maastricht Treaty also promises price stability to those countries that, in the past, have been incapable of achieving it on their own.
Naturally, monetary integration has its costs too. The most important one is the loss of monetary sovereignty. That is, member countries are no longer able to pursue a monetary policy of their own. There is now just one policy for the entire euro-zone. "One size fits all" is the saying. This can lead to difficulties in case of asymmetrical shocks. Under monetary union, adjustments that would otherwise occur through changes in the exchange-rate and domestic interest-rate conditions must imperatively take place through changes in prices and wages, and through adjustments in quantities, all of which can be very painful.
There is no question, though, that Switzerland greatly benefits from the existence of the euro. It makes life much easier for all of us who travel and do business in Europe. We all gain from the lower transaction costs and uncertainty, and from the greater transparency and stability. Moreover, the single currency has made our job somewhat easier at the Swiss National Bank since we are now surrounded by countries that all share our concern for price stability.
If monetary integration is such a good idea, shouldn't Switzerland join in as well? Adopting the euro is not an option for Switzerland since we are not part of the European Union, but we could conceivably tie the Swiss franc to the euro, effectively adopting a fixed exchange rate regime. Many calls, coming from industry and the unions, demand no less than that. Our critics argue that the movements of the franc against the euro are undermining the Swiss export industry and, if left unchecked, will generate mass unemployment.
Unfortunately, things are not this simple. For a start, fixed exchange-rate regimes are arrangements that never last for very long, and they have a habit of collapsing at the worst possible time in an environment of crises and confusion. Second, even if it were feasible for a while, fixing - or even only attempting to stabilize - the nominal exchange rate against the euro would yield few benefits, and it would create many new difficulties.
Thus, the policy would do nothing to stabilize the exchange rate against the U.S. dollar, the Japanese yen or the British pound. More importantly, it is well known that in the long run monetary policy has no hold on real variables. The real exchange rate, which is the only one that matters for production decisions and trade flows, cannot be manipulated by monetary policy for any length of time. The tendency towards real appreciation that the Swiss franc has exhibited over the past few decades would most likely persist, but, given a fixed nominal exchange rate, it would take the form of a rate of inflation higher in Switzerland than elsewhere in Europe. This is to say that fixing the value of the Swiss franc against the euro is not compatible with the Swiss National Bank's objective of price stability. This in itself would stretch the credibility of such a policy, and our resolve would quickly be tested by the markets.
Even more seriously, nominal interest rates would necessarily increase to the same level as in the euro-zone, which would mean that Switzerland would lose its interest-rate advantage. The user cost of capital would increase even though labour costs would remain unchanged. This would put additional pressure on the competitiveness of our industry. This rise in interest rates would also have serious repercussions for the Swiss financial center and it would lead to a drop in asset prices. Real investment would most likely collapse, depressing aggregate demand, possibly for many years. Given that we would have lost our ability to charter our own course, there is nothing the Swiss National Bank could do about it. It is easy to see that this would be a high price to pay for the illusion of exchange-rate stability.
Recent history has demonstrated that the Swiss National Bank is perfectly able to conduct an independent monetary policy. Our policy actions have often been taken well in advance of similar moves by the European Central Bank. Thus, as the Swiss economy has come to a standstill over the past two years, we have been able to move very aggressively, lowering interest rates from 3.50% to 0.25% as far as the three-month Libor is concerned. As for our goal of price stability, by which we mean an inflation rate of less than 2%, we have achieved it for ten years running.
Although the Swiss franc weighs much less compared to the euro than it did against the German mark or the French franc, it has gained in stature simply because it is a member of the dwindling family of international currencies. As Mr. Mirabaud already mentioned it, the Swiss franc is now the world's fifth most important currency, admittedly far behind the dollar, the euro, the yen and the pound, but well ahead of the Canadian, the Australian and the Singapore dollars. For this reason, we would expect it to remain attractive as an instrument of portfolio diversification, for lenders as well as for borrowers. Moreover, the return on Swiss franc money- and capital-market instruments exhibits both a low volatility and a low correlation with the return on foreign assets. This adds to the appeal of our currency and contributes to explain why we have such low interest rates. Let us face it, the Swiss franc is a very successful product and it is an important asset for the Swiss financial center. Moreover, we have exclusive rights to this bestseller, so why should we give it up?
In many ways, we have got the best of both worlds. We enjoy most of the advantages offered by the euro, without having lost an important degree of freedom. We benefit from the simplicity, the transparency and the more stable European monetary environment brought by the euro, but we keep the trump card of an independent monetary policy, a monetary policy that is custom made for Switzerland. The Swiss National Bank should therefore continue to be able to offer Switzerland the advantages of a stable currency and of low interest rates for many years to come.

Presentation [PDF 95KB]
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