Last year Paul Krugman did a post criticizing my argument that currency depreciation was a surefire way out of a liquidity trap:
Oh, and about the exchange rate: there’s this persistent delusion that central banks can easily prevent their currencies from appreciating. As a corrective, look at Switzerland, where the central bank has intervened on a truly massive scale in an attempt to keep the franc from rising against the euro — and failed:
I accepted his facts at face value, but disagreed with is interpretation. More recently, Bogdan Enache sent me a paper by Jean-Pierre Danthine of the Swiss National Bank that suggests Krugman was wrong about Switzerland:
The substantial increase in the value of the Swiss franc since the beginning of financial crisis represented an inappropriate tightening of monetary conditions. Yet, it was imperative that monetary conditions be kept as loose as possible, a fortiori to avoid a further monetary tightening. Given that the interest rate was effectively at a zero level, the SNB decided to prevent any appreciation in the Swiss franc with respect to the euro from March 2009 on. . . .
One can summarise this historical episode as follows. From March 2009 to the end of the year the SNB decided, in view of providing the most appropriate monetary conditions to an economy in recession, and given that traditional monetary policy had hit the zero lower bound, that it would prevent any appreciation of the Swiss franc against the euro. It maintained this policy stance until the MPA of December 2009. As Chart 7 shows, the nominal export weighted value of the Swiss franc which had appreciated by more than 10% since August 2007 was halted. In fact, over the March to December 2009 period, the Swiss franc depreciated by a little over 2% with respect to the euro and by less than 1% on an export-weighted basis. In December 2009, the SNB updated its view of the economy and decided that some appreciation of the franc would be tolerable but that an excessive appreciation needed to be prevented. It maintained this policy until June 2010. Over the course of this period, while the franc gained almost 8% with respect to the euro it lost about 10% against the dollar. Chart 7 shows that the export-weighted value of the franc increased by approximately 2.5% during this period. After June 2010, the SNB refrained from intervening. Until the end of the year the franc gained around 10% on the euro, 15% on the dollar and more than 10% on an export-weighted basis.
What can we conclude from this? We can certainly not conclude that the SNB was not able to hold on its policy, or was “defeated by the markets”. On the contrary, the SNB did what it had announced it would do and thus provided the Swiss economy with monetary conditions that have contributed to a reasonably swift recovery from the crisis and an early return to pre-crisis GDP levels, while, importantly, assuring price stability. Chart 8 shows the evolution of the Swiss GDP in comparison with a few other industrialized countries. The downturn has been less severe in Switzerland and Swiss output has been the first to reach its pre-crisis level. Overall, GDP rose by 2.6% in 2010, after having fallen by 1.9% in 2009. Chart 9 shows the evolution of inflation together with our most recent conditional forecast. The inflation rate recovered to 0.7% in 2010 after hitting a low of -0.5% in 2009.
Why are the SNB interventions often perceived as unsuccessful? For outside observers studying the performance of the Swiss economy going in and out of the crisis and looking at Charts 8 and 9, this must be a puzzle. All the more so when they realise that this performance was not the result of an amply expansionary fiscal policy; on the contrary, the Swiss policy mix, a very expansionary monetary policy combined with a more contained fiscal policy, was appropriate given the circumstances. With the crisis originating almost entirely in foreign markets and hitting the export sector very strongly, a large domestic fiscal stimulus would have missed the target. The results of this appropriate policy mix, which placed the burden of the response to the crisis on the shoulders of the SNB, can be seen in the remarkable accounts of the Swiss general government: public surpluses in both 2009 and 2010 (+0.8% and +0.2% relative to GDP, respectively) and a reduction of the debt level to less than 40% of GDP.
One reason for the misperception is probably the view, propagated by the academic literature on the subject, that central bank interventions in foreign exchange markets are geared to achieving an exchange rate target and that they are generally unsuccessful at doing so. As has been repeatedly emphasised, this was not the objective for the SNB in 2009-2010. The SNB’s objective was to provide appropriate monetary conditions to the Swiss economy. A given exchange rate level in that context may be maintained for a limited time period, but it is subject to review as macroeconomic conditions evolve. And as the SNB’s experience in 2009 demonstrates (illustrated in Chart 7), influencing the exchange rate level temporarily is feasible and makes sense at the zero lower bound when the traditional monetary policy instrument is exhausted.
I love the Swiss. They’ve shown that even at the zero bound a determined central bank can hit its macro targets without any help at all from fiscal stimulus. There’s no zero bound on exchange rates. And as Ben Bernanke has repeatedly emphasized, the Fed isn’t even close to being out of ammo–they’ve got lots of tools that they haven’t yet even tried.