Swiss Currency Area

Switzerland is a kind of monetary union. Swiss Confederation consists of 26 cantons and 2’495 communes. Under the Federal Constitution, all cantons have equal rights, and in comparison with the situation in other countries, they have a high degree of independence. They enjoy a large degree of latitude in health care, education and culture.

Switzerland is with 7.8m inhabitants a multilingual country. The laws are formulated as clearly as possible in the official languages of German, French and Italian.

Some cantons are more indebted than others. Some cantons are economically weaker than others. But the currency union works in spite of cultural differences. Why? It is because of institutions.

Switzerland has Swiss Francs (CHF) as a common currency for its different kind of economic regions. As Paul Krugman explains in his book “End This Depression, Now!”, certain conditions must be met in order to make a currency union work from the perspective of economic theory. The model is an optimum currency area (OCA), which must be pursued. This means that the advantages have to outweigh the disadvantages of a common currency.

The cantons in Switzerland are closely intertwined, so that there are substantial benefits that they all have the same currency. The cantons have only limited possibilities for economic stabilization. And they have mainly no monetary policy as a relevant instrument of economic policy.

As regards the criteria labor mobility (Robert Mundell) and fiscal integration (Peter Kenen) Swiss Cantons suite for a single currency (very) well. 

Workers move freely to wherever the jobs are. When canton Valais is in a recession and canton Zurich in a boom, then the unemployed Welsh can go to Zurich, where they find jobs. But the migration of workers do not provide for compensation for different economic developments in the cantons. Switzerland is in that matter not an optimum currency area (OCA). But the fiscal integration is available. The cantons help each other out and the federal government also helps. So there are structural compensations.

The canton Zug pays nearly 20% of its income as financial compensation to other weaker cantons. But Zug benefits like all the cantons from federal payments. Overall the canton Zug is the largest net contributor of all. The canton Obwalden however is the largest net recipient of funds in support. There are only four cantons in total, which pay net more compensation to the other cantons: Zug, Zurich, Geneva and Basel City.

In contrast to the European Monetary Union, the transfer payments (such as fiscal packages) are no loans. They are not owed, so that they don’t lead to a further debt of the beneficiary canton.

Redistribution could basically create a “Moral Hazard”-Problem. The recipients of payments have incentives to behave in a way that payments are made on. The Swiss system tries to reduce the “Moral Hazard” incentive as well as possible. The cantons receive financial support not because of their financial “statements”, but because of their financial “potential”. Moreover, no other cantons are obliged, to come up for a possible bankruptcy of another canton. Thus, the cantons remain in their fiscal policy largely independent particularly in matters of taxation.

Social security is settled at the federal government and plays an important function of stability. It has an important share of the stimulus measures and for the redistribution, if individual cantos or regions get in crisis.

All cantons of Switzerland’s currency area are subject to the same bank supervision. If a major bank in Zurich is at risk, canton Zurich must not cope alone with the problem. The Central Bank (SNB) intervenes and provides the necessary liquidity (as in the case of UBS in 2008) to prevent a bank run, if the survival of the bank essential for the stability of the economy. And there is a common deposit insurance regardless of in which canton the banks are.

Last but not least: The redistribution between the cantons of Switzerland’s currency area based on a relatively large democratic participation, both at the canton level and at the level of Federal Confederation, with direct influence via referenda and initiatives.

PS: Communes are the smallest political units in Switzerland. The next largest political units are the states, which are known as cantons.

PPS: Ich habe mich von Markus Diem Meiers Artikel („Vorbild Schweizerische Währungsunion“) im Blog “Never Mind the Markets” inspirieren lassen und wesentliche Einsichten, die ich auch teile, hier zusammengefasst.