1

Klas EklundApril 7, 2003

THE EURO

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STARTING POINT: GLOBALISATION POSES CHALLENGES

• Globalisation makes it more difficult to go against international trends: “The golden straight-jacket”

• The national state is turning obsolete in important aspects

• Stronger transformation pressure also on business

• How to react? Stand at the sidelines? Share responsibility? Grasp opportunities? Ponder super nationalism?

• Practical people are already making these choices...

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CURRENCY SYSTEMS AND GOALS

• Three goals•Stability, liquidity and autonomy

• Three currency systems•Fixed (but adjustable) currencies•Floating rates•Currency union or dollarisation

• No system fulfils all goals• No system is perfect. Greatest risks with

fixed rates – and greatest opportunities in a currency union

• The trend is towards larger blocs which float

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CALMFORS COMMISSION (1996)• Political advantages in joining

•More important as the union grows

• Higher growth•Larger market, increased trade, economies of

scale, transparencey, stiffer competione•Results in more rapid productivity growth

• But risks of instability•EMU is no “optimal currency area” •Sweden had budget deficits, inflation history,

instable currency•“Asymmetric shock” may cause unemployment

• Conclusion: Enter at a later stage - when Sweden has become more stable

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IS THE CALMFORS ANALYSIS STILL VALID?• A larger union makes it politically more

costly to stay outside•Suspicions arise that we are willing to export

problems to others

• A (larger) currency union gives stronger impetus to trade and growth•New research strengthens this case

• But a larger union also makes one-size-monetary policy more difficult•Although the risk of shocks is smaller

• Conclusion: Both opportunities and difficulties are greater

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MORE TRADE – ESPECIALLY FOR SMALL COMPANIES• Vertical specialisation has become more

important•Currency volatility is problematic

• Investments are needed to expand abroad•Currency volatility an obstacle

• New insight: The existence of different currencies itself is problematic

• Conclusion: Elimination of currencies should have great repercussions•Empirical evidence has been lacking – until

recently

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TRADE EFFECTS FROM CURRENCY UNIONSRose (2000) 235%Frankel & Rose (2002) 290%Engel & Rose (2002) 240%Glick & Rose (2000) 100%Rose & Wincoop (2001) 140%Lopez & Meissner (2001) 100%Levy (2001) 50%Flandreau & Maurel (2001) 220%Nitsch (2002) 85%Klein (2002) 50%

Source: Alesina, Barro, Tenryo, NBER 2002(only significant results)

Rose (2002, meta-survey) ca 100%

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EXPORTS OF GOODS FROM EU TO REST OF WORLDValue, index 1998=100

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EFFECTS OF INCREASING TRADE

• Increasing trade means higher growth•Economies of scale•Sharper competition

• 100% more trade can give 30% higher per capita income after 20 years (Frankel and Rose)

• Increasing freedom of choice for consumers

• Means higher welfare• And stronger correlation of business

cycles

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ADVANTAGES OF A LARGE CAPITAL MARKET• Savings and investments gradually decouple for

individual countries• A larger and more liquid currency gives greater

stability• Better chances of absorbing shocks• More problems will be ”internalised”

• Smaller risk premium lowers bond yields• Higher liquidity means lower costs

…not least in government budgets• Greater access to funding, also for SMEs• Signs of higher valuations (Tobin’s Q)• Increasing investments

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MORE MERGERS AND ACQUISITIONS• Common currency enhances market

integration• Less price segmentation in a currency

union • Vertical trade integration should mean

more M&A• Half the rulings in EU Commission has

been about competition on a national level•Cf Volvo and SAAB

• May change in one common market?

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EURO WILL PUT PRESSURE ON PRICES• National boundaries and currencies create

price segmentation• Increased transparency for consumers

means long-term price pressure through stiffer competition

• Important for Sweden, with a price level 20 % over EMU average

• Heaven or hell for different companies. Effects depend on sector, price elasticities

• Need for new pricing and branding strategies

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”HAVEN’T FLOATING RATES BEEN GOOD FOR SWEDEN?”• Exports have been helped by weak krona.

But purchasing power has eroded•A weak currency may give increased

competitiveness in the short run – but not long-term growth and transformation

•Less pressure for structural reforms

• Floating krona has not been the cause of stability

• The reasons are reform of public finances, EU membership, convergence programs, inflation target and Riksbank independence

• Krona has been unstable despite all this!

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YIELD SPREAD TO GERMANY10 year government bonds

cma 5Source: EcoWin

91 92 93 94 95 96 97 98 99 00 01 02

-0,5

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

5,0

First convergence program

Floating kronaInflation target

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THE KRONATCW

Sweden TCW index, close daily [cma 5]

93 94 95 96 97 98 99 00 01 02100

105

110

115

120

125

130

135

140

145

150

Calmfors commission

Göran Persson’s EMU plans

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EUR/SEK and ERICSSON

Ericsson B, SEK Spot Rates, EUR/SEK

Source: EcoWin

sep98

dec99

mar jun sep dec00

mar jun sep dec01

mar jun sep

EU

R/S

EK

8,00

8,25

8,50

8,75

9,00

9,25

9,50

9,75

10,00

Price/S

EK

20

40

80

160

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PRICING ON CURRENCY MARKETS IS OFTEN IRRATIONAL• Signal effect of currency is overrated• Market prices may stray far from

”fundamentals”•Uncertain expectations•Financial markets dominate•Herd behaviour, incentive systems•Desired FX exposure

• Risks that the krona becomes a “swing currency” if No

• Is Sweden too small for a currency of its own?

• FDI effects? Will companies move out?

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THE EURO WILL INCREASE STABILITY

• Currency union does not mean a ”fixed rate” but a disappearing krona! Sweden will still have a floating currency – but with fewer partners

• 40% of Swedish foreign trade is with EMU members, 45% including Denmark. More when candidate members join

• Half of krona volatility in trade will be ”internalised”

• Means more stability for business – not least for small companies

• …and for economic policy

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CONCLUSION – SO FAR

• Common currency creates a significant increase of trade

• Productivity gains• Transparency and freedom of choice for

consumers• A more liquid capital market, lower risk

premium• Better access to funding, increasing

investments• Result: Higher growth rates, increased

welfare

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WHAT DO BUSINESS AND ECONOMISTS SAY?• 83 % of CEOs of listed companies will vote

yes• 70 % of CEOs in small companies• 60 % of economics professors will vote Yes• 20 % No• 19 % Undecided

•Political pros: 57 %•Political cons: 11 %•Economic pros: 40 % (Lower price level, higher

growth)•Economic cons: 29 % (Unemployment risks)

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WILL STABILISATION PROBLEMS BE DIFFICULT?• Larger currency area means more

stability on currency markets• Lack of national monetary policy is a

problem only if Sweden deviates strongly

• But Sweden is in step – and integration will continue further

• Conclusion: Normally, the ECB will stabilise also Sweden

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SWEDEN IN STEP WITH THE EMUOutput gap differential

0402009896949290888684828078

6

4

2

0

-2

-4

-6

6

4

2

0

-2

-4

-6

Percentagepoints

Sources OECD, SEB

Sweden minus EMU

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BUT IF SWEDEN DEVIATES?

• Asymmetric shocks less likely• But deviations may occur e.g because of

wage formation• National fiscal policy is still here, if needed

• Important role in post-bubble periods

• Automatic stabilisers are strong• Tough surplus target needed to meet

stability pact• Nonetheless - a need to strengthen rules for

discretionary fiscal policy

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A SOUNDER FRAMEWORK FOR FISCAL POLICY• Sweden may stray• Low real rates could create asset price

bubbles• Can politicians handle increased

responsibility?• Budget policy should learn from monetary

policy•Well-defined target•Clear means•Transparency•Competence

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”WON’T ERM BE DANGEROUS?”

• No! ERM is not like the old fixed rate•A temporary phase before the krona disappears

•Central parity probably becomes conversion rate

•Central parity will be negotiated with market reaction in mind

•Some room for fluctuations within the band•Central parity to be defended by the ECB system

• No country has experienced speculative attacks in new ERM system

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”WON’T ERM MEAN HIGHER INTEREST RATES?”• The contrary! Interest rate parity holds:

ySw = yGe + FXe + rp• In ERM rates will be dominated by (stable)

currency• Means lower bond yields as risk premium

falls• Riksbank can cut repo rate

• Inflation forecast low•High rates won’t help; transmission mechanism is

weakened (both via currency and bond yields)

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KEY RATE FORECAST

040302010099989796

9

8

7

6

5

4

3

2

1

9

8

7

6

5

4

3

2

1

Sources: EcoWin, SEB

Forecast

Per cent Per cent

SEB

EMU: Refi rateSweden: Repo rate

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”GERMANY’S PROBLEMS TELL US: AVOID THE EURO”• No, the German problems are deeper• The problems are domestic:

•Costs of reunification•Rigid labour market•Sloppy budget disciplin

• Rate cuts can give short-term relief – but not long-term growth

• Germany cannot devalue - not even with a currency of its own!

• Germany needs structural reforms

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GERMANY: LONG-TERM EMPLOYMENT PROBLEMS

0100999897969594939291

110

108

106

104

102

100

98

96

110

108

106

104

102

100

98

96

Sources: OECD, SEB

Index 1991=100

Euro-zone excl. GermanyGermany

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CONCLUSION• From a business point of view, the euro

means• Larger markets • Greater stability• Lower transaction costs• Lower rates• Better access to funding• Price pressure• Stiffer transformation pressure

• New environment means need for strategic decisions