Thursday, November 3, 2011

The Fed Gets Schooled Again: Swiss Central Bank Edition

I once argued that all incoming Fed officials should spend six months interning at the Swedish central bank given their relative success in stabilizing nominal GDP.  I was wrong.  What I should have said is that all incoming Fed officials should spend six months interning at the Swiss central bank.  Lars Christensen explains why:
Here is from The Street Light:
“You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?
It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.”
This is a very strong demonstration of the power of monetary policy when the central bank is credible. This is the Chuck Norris effect of monetary policyYou don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target. (Nick Rowe and I like this sort of thing…) And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it?
Exactly. Instead of having a central bank that sets an explicit target and commits to doing whatever is necessary to hit it, we have a central bank that at best has a fuzzy inflation target and operates in a manner that does little to create certainty about the future path of monetary policy.  This lack of clarity was on display yesterday at the post-FOMC news conference when journalist pointed out to Bernanke that the Fed's forecast is worsening yet the Fed wants to wait for further information before acting.  These journalists wanted to know what would trigger the Fed to act and Bernanke could not give a clear answer.  This is because he is simply unable to make a conditional forecast of future monetary policy with no explicit target.  This is crazy.  Here we have the most powerful central bank in the world stumbling, tripping, and occasionally getting lost as it moves forward because it chooses not to set a clear, explicit path of where it wants to go.  If only we could learn from the Swiss...


  1. Congrats to David Beckworth on his piece in the New Republic. Smashing!

  2. You're basically calling for a currency peg as a form of sustainable monetary policy. Currency pegs rarely work in the long-term interest of the country maintaining the peg as they are essentially adopting the monetary policy of a foreign country which may or may not have the same economic needs as that country. This generally works for a trade surplus nation, but would not necessarily work to stimulate a trade deficit nation.

    The Swiss have pegged their currency to the Euro in order to stop its ascent. This isn't stimulative per se. It just stops the bleeding. Effective monetary policy? I guess you could say that. Sustainable? No chance. Japan has been intervening in the Yen for the last 20 years. Look where its gotten them. Granted, they haven't named a price. If on the other hand, you're essentially advocating a Chinese RMB strategy then I think you have it all wrong. Pegs such as this always result in massive inflation and the potential for a currency crisis. Russia and Argentina learned this the hard way.

  3. MarkS, to say the "risk" the Swiss face is "massive inflation" is bizarre. The risk they face is deflation; import prices have been falling, and their HICP has been flat/falling all year. They are acting to avoid that. If inflation takes off, they can act again and e.g. move or remove the limit.

    - Britmouse

  4. MarkS,

    All I am trying to show is that the the Fed needs a clear, credible commitment to an explicit target. Specifically, a nominal GDP target. The Swiss case is useful because it shows that such a commitment means the market itself will do much of the heavy lifting.

  5. Sorry to be persistently sceptical in my comments, David, but I have visited the SNB, and was impressed by their no-nonsense approach to maintaining the value of the CHF. Ironically it is this credibility in a world where nearly all other significant-currency central banks have gone soft that gives the Swiss their currency problem in the first place.

    As for the SNB's currency peg itself, its introduction certainly drew a line that has deterred speculation, but for euro holders, the peg provides a useful backstop if the euro's existence ever does come seriously into question. In that event, I would expect the SNB's intervention to be overwhelmed.

  6. Can you respond to this?

    I recall you wrote a post on this topic.