Everyone has to have a Swiss National Bank post

Why did the SNB jettison it’s commitment to a minimum exchange rate between francs and euros?

One of the stated reasons was that the Franc had weakened against the dollar, so the ‘peg’ could afford to be dropped against the euro.  This seems a bit unlikely, to put it mildly.  No-one, including the SNB, would know whether the new dollar exchange rate would last.  The SNB itself could not know the exchange rate peg it would need to maintain to hit its target for inflation so precisely anyway.  If the dollar exchange rate was a concern, there was another option, namely, maintain the peg with the euro, but comment that at some point the peg would be recalibrated to compensate if the dollar rate looked like persisting, and that looked like threatening an uncontrollable overshoot of its inflation target (hardly likely).

Presumably the real reason was that it did not feel comfortable with the implications of potentially unlimited franc printing to buy euros to keep the franc/euro rate low.  This discomfort might have been felt now, or perhaps it was the anticipated discomfort of having to mop up larger quantities of euros once an ECB QE program, which would create new euro reserves, was underway.

Why would such unlimited interventions be problematic?

At face value, there is something contradictory in its minimum exchange rate peg.  The commitment was to create unlimited quantities of francs to purchase euros at the stated rate.  Anything less would have meant an exchange rate schedule as a function of euro demand, not a peg, and not the policy announced.   And creating unlimited quantities of francs implies an indifference to the Swiss price level.  Which is contradictory with its mandate.   The calculation was that if the markets’ bluff could be called, and the off-equilibrium threat to spite its own mandate believed, the mandate would be achieved.  If this was what was going on, then the real question is not why the peg was dumped, but why it was adopted in the first place.

Some have characterised it as the SNB worrying about potentially large ‘losses’.  I think this is another – slightly confusing – way of saying what I already have above:  the losses are the potential fall in value of the euros bought by the SNB in pursuit of the peg, if, as it suspects, it later has to be given up.   These losses could, if necessary, be made good by creating more reserves.  The question for the SNB was whether making up for them was consistent with the path for the price level that it wanted.  If the expectation was that the operation would have to be reversed, eventually, then there would be insufficient foreign exchange to buy its own currency.

It’s possible that the SNB was reading an international macro textbook, thinking:  if this exchange rate path is supportable, it ought to be interchangeable with an interest rate path that we are comfortable with given our mandate, and, therefore, even when we drop it, the rate should float at something similar once we make clear the policy rate path that underlay the peg.  However, the rise in the franc/euro rate flouted this thinking, or has so far.

Surely the SNB didn’t intend to implement a policy tightening?  Growth is relatively healthy.  Unemployment is very low, but has been rising slowly for a while.  Crucially, inflation has been sliding and is now negative, despite rates at, and now below the zero lower bound.

For a small open economy like Switzerland, optimal monetary policy probably involves stabilising – amongst other things – the real exchange rate.  But that doesn’t translate to a nominal exchange rate peg.

Spare a thought for the ‘poor’ Swiss, though.  A small open economy buffeted not just by conventional business cycle shocks, but also by ‘save haven’ shocks makes for extremely difficult policy-setting indeed.  And these are shocks not of its own making, but, in essence, due to the fluctuating confidence in the Eurozone’s ability to manage its monetary and financial affairs, something over which Switerland has no control.

Resorting to innovative negative interest rates doesn’t seem like the right thing to do, however.  The public sector has a debt to GDP ratio in the 30s [pps].  Better to stop tinkering with minor changes to interest rates and implement a large fiscal stimulus.

Paul Krugman worries that the Swiss have damaged their credibility irreparably.  I don’t see it this way.  Another way of looking at it is that they have done their credibility a favour by terminating a bad policy sooner rather than later.  Inflationary credibility can be bolstered by deficit spending instead.


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3 Responses to Everyone has to have a Swiss National Bank post

  1. Jason Smith says:

    I kind of saw it as the exchange rate version of the ECB’s past QE. The ECB did some QE and got zero response in output or inflation, so stopped (although they are supposedly starting up again). The SNB pegged their exchange rate and got more deflation for their trouble. So they stopped pegging their exchange rate (to avoid a risk of ‘losses’ that didn’t have a benefit in terms of inflation or output).

    However, the rumored upcoming QE from the ECB seems like as good a catalyst as any.


  2. Tim Young says:

    “These losses could, if necessary, be made good by creating more reserves.”

    Absolutely not! “Creating reserves” does nothing to fill the hole on the SNB balance sheet left by the losses. And because the SNB distributes most of its profits to the cantons – apparently some of the smaller cantons have little other revenue – the Swiss public tends to be painfully aware of SNB losses.

  3. YVR Housing Analyst (@YVRHousing) says:

    The rate cap (not peg) could be plausibly maintained provided inflation differentials with the eurozone remained close. With QE planned in Eurozone it may have been felt that was at major risk of falling through.

    I can tell you one thing, Swiss non-exporters were smiling mighty wide when the cap removal was announced. Incomes there are very high, and now even higher.

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