Home > Monetary Policy > A Central Bank “Does Nothing”, Swiss Edition

A Central Bank “Does Nothing”, Swiss Edition

It’s important to remember that the supposedly “orthodox” interpretation of the liquidity trap theory predicts that it was impossible for the Swiss National Bank to devalue the Swiss Franc in 2011.  Monetary policy is all about interest rates, and when you have run out of interest rates, as the SNB had, there is nothing for your highly-paid central bankers to do.  Perhaps they can meet up every now and then, and write a strongly-worded letter asking for fiscal stimulus if the expected path for inflation is a too low.

Here is how Reuters report the SNB doing nothing this morning:

The Swiss National Bank shocked financial markets on Thursday by scrapping a three-year-old cap on the franc, sending the safe-haven currency soaring against the euro and stocks plunging amid fears for the export-reliant Swiss economy.

Only days ago, SNB officials had described the 1.20 francs per euro cap, introduced in 2011 at the height of the euro zone crisis to prevent the strong currency leading to deflation and a recession, as the cornerstone of the bank’s monetary policy.

The U-turn sent the franc nearly 30 percent higher against euro in chaotic early trading. It came a week before the European Central Bank is expected to unveil a massive bond-buying program that might have forced the SNB to intervene repeatedly to defend the cap.

We’ve also been told a few times that currency devaluation is zero-sum (since global aggregate demand is fixed), and so I presume the European economy will get a welcome boost from the devaluation of the Euro against the Franc.  I suppose somebody, somewhere, is celebrating that the Swiss have stopped “sucking demand out of the world economy”?

Lars Svensson’s Foolproof Way has always seemed like the best option for the SNB to me.

Categories: Monetary Policy
  1. ChrisA
    January 16, 2015 at 00:16

    Pretty strange decision by the SNB. Maybe this FTAlphaville post has some of the answers;
    http://ftalphaville.ft.com/2015/01/15/2090352/the-snb-and-the-russiaoil-connection/ although I always think with Izzy that she is of the school of “if you can’t convince them confuse them”, but I think she does pick up a lot of what the traders are saying to justify themselves.

    At the simplest, I think the SNB basically got scared by the amount of purchasing they had to do to maintain the peg. They could not think of the francs they were using as free (they go home and live in houses paid with francs, and eat their dinners paid with francs and so on). So what they were seeing was paying good francs for likely depreciating euros. Ignoring the fact that those francs were basically free.

    Its a good example of how difficult it is to think clearly on money.

    • January 16, 2015 at 08:44

      Yeah, that is confusing. If they wanted to shrink the balance sheet aiming for higher inflation would surely have been more effective – a controversial view, I suppose. Lars (or Scott?) had a nice post a few years ago, about how the SNB didn’t actually need to hold Euro assets to defend the peg too.

      • ChrisA
        January 17, 2015 at 12:44

        Well it is even stranger than I thought – the SNB balance sheet was actually shrinking in recent weeks, and had basically not grown since mid 2012. Puzzling this all together and reading their press release, I am coming to the conclusion that they had thought the peg was no longer needed for this reason. They did not understand the power of expectations I guess. Their logic was – no longer having to buy Euro assets, so no need to have the peg, lets go back to the free float and move to an alternative policy of lower interest (more negative) on reserves. I am coming to the conclusion that this was just a monumental cock up – they didn’t understand that the reason that their peg didn’t need to be defended was that the market had decided that they could defend it to the death.

  2. January 17, 2015 at 11:21

    We will just have to wait and see if the ECB can come up with a policy by Thursday, or a presentation of the policy, that convinces the markets. The stakes are very high.

    • ChrisA
      January 17, 2015 at 12:46

      James – rarely do we see a “historical” moment, probably we should be thankful for that. But the ECB will make history either way on Thursday.

      • ChrisA
        January 23, 2015 at 05:58

        Well not too bad from the ECB, at least they did make a stab at inflation expectation. And the Euro fell and the stock markets rallied somewhat, so it must have been better than the market expected. The amount was impressive but I can’t quite understand the sovereign bank purchase part.

  3. jamesxinxlondon
    January 17, 2015 at 16:31

    Currency movements have been the main driver of a balance sheet so stuffed with fx reserves. It fell when the Euro was rising catastrophically against the $, but has been rising as the Euro/CHF and everything else fell vs the $ over the last six months. It created “healthy” Mark to market gains for the SNB.

    Draghi knows what it takes to do the right thing, as he has shown a few times over. His historic “do what it takes”/OMT words saved the day in 2012. As we know, essentially target-less monetary policy doesn’t work too well. If German opposition means he can’t get the QE he knows the market is looking for he could try switching, or widening, the target to include nominal growth. Cheap words, but more powerful than QE!

    • January 20, 2015 at 12:24

      That point about fx movement is intriguing, I have not read much discussion of that. When I last read the statistics, it looked like the increase in the SNB balance sheet since introducing the peg was in (large?) part due to printing money and buying stuff, i.e. it was necessary to defend the peg, since there was an increase in liabilities (sight deposits). But there was also an sizable increase in equity which is what you’d expect from balance sheet expansion due to asset/fx changes. It would be interesting to see the breakdown.

  4. james in london
    January 21, 2015 at 17:15

    A very good piece here from Business Insider two days ago on the messy stakeholder politics of the SNB.

    Here is the data on the fx reservers in CHFs. Another messy picture to interpret, or mark to market. And only released quarterly.
    Totals released monthly.

    All eyes on next month’s release of end-December figures. The EUR (and CHF) dropped 9% over the late Summer vs the $ in 3 months, and then nearly 8% in 3 weeks over mid-Dec to mid-Jan. This second drop seemed to be the proverbial straw.

    Who knows what the SNB is spending now to keep the CHF appreciating against the EUR toaday. And who can tell the final details of the ECB hammered out tomorrow and, secondly, what the FX reaction will be.

    I heard a story that Draghi actively watches the EUR on his smartphone during the press conference and speaks accordingly.

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