Lessons from Switzerland
When central banks want to shift towards a different policy stance, market expectations are usually carefully and gradually managed through speeches, hints, and off-the-record leaks. The steps required to move the Bank of England from “not doing forward guidance” to “doing forward guidance”, for example, started with the appointment of Mark Carney in November 2012, continued through the various hints and nudges toward MPC remit review, only concluding with the actual guidance announced in August 2013. With forward guidance at best a fine-tuning of the short-run trade-off under the inflation target which the Bank should have been doing anyway, that’s really a tortuously slow process.
Policymakers like to think they maintain “credibility” by not making policy announcements which surprise the market. This makes sense to an extent, but it can go too far. To abuse a nautical metaphor, as is traditional, it’s sometimes too easy to imagine central bankers like the captain of the cruise liner who refuses to make a large course correction after spotting that the ship is going to hit the rocks, because making large course corrections might undermine confidence in the ability of the crew.
The insistence on not making large policy changes creates an environment which is actually very convenient for central bankers who want to hide their mistakes. In particular it lends a lot of credence to the theory that monetary policy has “long and variable lags”. If you only ever make small adjustments to policy it is never going to be very obvious that large changes could affect the economy in near real time. After the fact, you can always blame unexpected shocks, uncertainty, the imprecision of forecasting, etc, if your steering looks questionable.
British central bankers have announced for much of the last six years they expect to “hit the rocks” – undershoot the inflation target, and in private they might admit they could devalue the pound by 10 or 20% at any time, which would raise inflation a lot during the forecast period, i.e. avoid those rocks. But a 20% devaluation is a such crazy, non-serious idea that only an ultra-naive blogger would even suggest it, and surely most people realise that such a policy shock would undermine the credibility of the MPC?
I took a long-winded route to Switzerland. Here is the FT:
On January 15, the Swiss National Bank shocked markets by abandoning a three-year old ceiling on the franc’s value against the euro. In the hours that followed, the currency chart looked like the sheer face of an Alpine mountain as the franc shot up.
Swiss business soon felt the impact, and the economy contracted by 0.2 per cent in the first three months of the year.
Meanwhile, January’s turmoil and persistent, below-zero inflation rates threaten the central bank’s credibility. The SNB forecasts inflation will fall to a low of minus 1.2 per cent in the third quarter of 2015 and turn positive again only in early 2017.
I find it strange that it’s so simple to associate a monetary shock with an almost immediate contraction, but harder for people to imagine how a monetary shock can cause an almost immediate expansion. Could monetary policy possibly be so asymmetric? The FT article discusses four options for the SNB, all of which “entail risks, pushing the traditionally-conservative SNB further into untested policy territory”. Yes, switching from Policy A (the old weak franc policy) to Policy B (new strong franc policy) has caused things to get worse… so… what should they do now? It’s a real head-scratcher.
In case anybody thinks I’m pulling a fast one and weaker Swiss RGDP was just one of those funny co-incidences, the Swiss Federal Government’s official forecast group was very clear about cause and effect when revising their forecasts back in March; they do not expect the the slow down to be particularly severe, but slightly higher unemployment and lower output and inflation has achieved… what, exactly? The FT article contains one suggestion:
The SNB’s concern is financial stability, says Mr Harvey. “It has kind of given up on its price stability mandate, and prioritised balance sheet risk,” he says. “It is a very Swiss approach.”
A quick look at the SNB’s web site appears to confirm the expected: the tight money (strong franc) policy has been associated not only with lower interest rates but also a larger balance sheet, so if there are “risks” from expanding the monetary base, they are not going away with tighter money. It all sounds rather Swedish to me.