Tuesday, September 6, 2011

The Fed Gets Schooled Again on Central Banking: the Swiss National Bank Edition

I have continually stressed the need for the Fed to (1) publicly and forcefully announce a level target and to (2) back up such an announcement with a commitment to buy up as many assets as needed so that the target is hit.  Well, the Swiss National Bank has amazingly just done that in a way that would make Lars E. O. Svensson proud.  Below is the press release (my bold):
The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.
Any question as to the SNB's resolve here?  Didn't think so.  Swiss monetary officials are concerned about weakening economic activity and deflation and therefore have made a forceful, unambiguous commitment to expand the central bank's balance sheet until these problems are gone.  Moreover, in the last sentence they note more will be done if necessary. 

Someone I know in the financial industry in Europe wrote me the following when the SNB made this announcement:
The trading floor that I am sitting for very natural reasons exploded in trading activity and general jubilation on the announcement...

Now we can only hope that the ECB and the Fed learn a bit...
Indeed. First the Fed gets schooled on central banking by the Swedish central bank and now by the Swiss National Bank.  This is getting embarrassing.  It is like watching a talented basketball player getting dunked on by Kobe Bryant and then by Lebron James.  Normally, such a talented basketball player would go study these other players and learn from them.  But the Fed seems determined to get repeatedly dunked on.  Fortunately, it has a teammate, the ECB, that is willing to get dunked on too and thus share the embarrassment.  It is time for the Fed and the ECB to go back to basketball camp.  I recommend the ones put on by the Swedes and Swiss.

HT: Lars Christensen


  1. David
    The "dunking" analogy got me thinking that just as small men - Churchill, Napoleon, Hitler, for example - left their mark, small countries are more "fearless"!
    I also did a post on the topic (and so has David Glasner). Pity Scott is "sipping italian wine"!

  2. speculation is that japan will follow suit...

    what happens if all central banks resolve to "buy foreign currency in unlimited quantities"?

  3. rjs
    You get massive world monetary stimulus, just as if all the countries had dropped out of the gold standard at the same time in the early 1930s. Eventually they all did, but the ones to drop out first recovered sooner.

  4. Joao,

    In the 30's those economies devalued against gold. Today, how would a serial global deval work? The ECB would target 1.6 EUR/USD, but the Fed would target 1.0 EUR/USD. Perhaps every central bank would agree to purchasing the others' currency? Why wouldn't the purchases just end up in foreign banks' ER's?

  5. David Pearson, Barry Eichengreen is answering that question here:

  6. Lars,

    Thanks. Eichengreen says CB's should buy each other's currencies, amounting to global QE. That QE could just end up in ER's, just as the first few rounds did.

    When global CB's exited the gold standard, they removed a key constraint on all future money growth. This had the effect of reversing the effects of the gold standard on real interest rates (which were as high as 12%). Today, no such constraint exists and real interest rates are low or negative globally. Aside from signaling future intent, what would be the direct effect of Eichengreen's suggestion?

  7. David,

    I think the perspective is that we should not be afraid of a second currency war. Currency wars are not trade wars. Rather they are not actually wars - they are zero sum games in a deflationary world. But ultimately each country should conduct monetary policy in their own national interest, but one country's can have huge impact on other countries monetary policy. Equally one country's money demand for another country's currency can significantly impact monetary conditions in both countries. For example Hungarian or Polish demand for Swiss franc. Or European demand for dollars.

    David, what you are suggesting is reminding me of the Federal Reserves failed OMO policies of 1932. FDR's actions of 1933 on the other hand, where extremely successful.

  8. Lars,

    Contrast the effect of a real depreciation of a currency against Eichengreen's global, coordinated QE. Would Svensson describe that QE as "foolproof"?

  9. David,

    Good point. Svensson is not a monetarist and in his world it is not about increasing the money supply, but purely about inflation/deflation expectations as I see it. So no, he would probably not have the exact same view as Eichengreen (or myself). That said, I generally think he would argue that a global "currency war" would "work".

  10. David Pearson,

    Eichengreen's global coordinated monetary stimulus, if done, would largely leave exchange rates and trade flows the same as he notes in the end of his piece. Thus, the point is not to stimulate external demand for domestically produced goods. The idea is to stimulate domestic demand for domestic goods. The real exchange would remain unchanged, but all countries would have pushed up inflation expectations and ultimately their price level.

    See also this Eichengreen and Irwin piece:

  11. I'm an undergrad econ major so this may seem like a simplistic question but,
    Why couldn't the Fed drop its rate to 0.10% like the BOJapan? I'm guessing that the effect would be hyper-minimal.

  12. There are certainly SOME parallels between what the Swiss are doing and Prof Beckworth’s NGDP ideas, but I don’t think the parallels are quite as close as the Prof. suggests.

    The MAIN objective of NGDP targeting in the US is to optimise the level of demand from US consumers and businesses, with little regard for the rest of the world. In contrast, Switzerland’s main concern is (or should be) the damaging effects of an over-valued Swiss Franc on their export industries. The latter is where the “deflationary risks” to which they refer comes from.

    So the US needs to combat deflation by printing money and spending it inside the US (and/or cut taxes) – or continue with the QE asset purchase program. In contrast, Switzerland needs to print money and purchase other currencies. Quite a difference there.

  13. "Now we can only hope that the ECB and the Fed learn a bit..."

    Not going to happen. That's it has been as obvious for going on years now that policy in both Europe and the US (+Japan) has been too tight, what this should give us is a very stong "signal" (or we could just say "proof") that the Fed and ECB are, in fact, led by incompetent men.

    Hard to imagine that they'd one day realize that they've been fools this whole time. At best, what the Fed & ECB will do is some very small, placative measure designed to prevent armageddon but not enough to restore normal growth...