Krugman was wrong about Switzerland

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:

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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.


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16 Responses to “Krugman was wrong about Switzerland”

  1. Gravatar of marcus nunes marcus nunes
    8. July 2011 at 11:57

    “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”.
    He can but he won´t!!!
    That´s what can be called conscious inconpetency- deserving of jail time for submiting people to “cruel and unusual punishment”.

  2. Gravatar of Policy Wank Policy Wank
    8. July 2011 at 13:35

    Are there more types of ammo than what you usually cite: 0 or negative IOR, NGDP level targeting, more QE (what can you buy besides longer-term Treasuries?)?

  3. Gravatar of Bogdan Enache Bogdan Enache
    8. July 2011 at 18:16

    I did not know you are blogging again; I like this post very much! :)

  4. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 05:06

    Marcus, He’s certainly hard to figure out.

    Policy wonk, Those are the key tools. I suppose there are others, such as buying foreign exchange to depreciate the dollar. But I wouldn’t recommend that. The key tool is price level or NGDP level targeting.

    Thanks Bogdan. Your information was very helpful.

  5. Gravatar of W. Peden W. Peden
    10. July 2011 at 02:42

    Prof. Sumner,

    Couldn’t the Fed also alter RR, if they really had to do so for some bizarre reason? Also, they could do some very clear signalling anent their discount rate or altering the composition of RR.

    Also, do you have an opinion on Operation Twist?

  6. Gravatar of Scott Sumner Scott Sumner
    10. July 2011 at 06:32

    W. Peden, There are three broad classes of policy. Less base supply now, less base demand now, and tighter expected money in the future (signaling.). Your RR idea affects base demand, just like IOR. Your signaling idea affects base supply and demand in the future, just like inflation or NGDP targets.

  7. Gravatar of Scott Sumner Scott Sumner
    10. July 2011 at 06:33

    Oh, and op. twist is a waste of time.

  8. Gravatar of Good Habit Good Habit
    10. July 2011 at 10:49

    First, I’m Swiss, and follow our domestic debate about the issue. Practically all our economic and political leaders consider the results of the exchange rate policy of the SNB an abyssmail failure. They would call the statement you quoted a failed attempt to justify the policy. Some people demand more intervention, others demand a currency board, but all agree that buying a lot of Euros and then giving up (allowing the Euro (and Dollar) to appreciate even further, is more or less a disaster. (This, of course, is also mostly seen from a fiscal POV – due to the large holdings of Euros and the declining exchange rate, the SNB had to post a huge loss in it’s 2010 balance sheet, and this hole is growing. And our national and state (canton) treasurers were used to see the SNB as a cash-cow, which has now dried up. So the SNB board takes a constant beating).

  9. Gravatar of ssumner ssumner
    11. July 2011 at 18:30

    Good Habit, You raise many issues that need to be disentangled.

    1. Did the policy fail to meet the macro goals?

    2. Did the SNB lose money on investments?

    If one, they needed a different target. I wouldn’t worry much about #2, as the EMH says loses and gains will average out over time.

  10. Gravatar of W. Peden W. Peden
    12. July 2011 at 10:05

    Prof. Sumner,

    Thanks for the clarification. I’m starting to get my head aroun the practice of monetary policy now.

  11. Gravatar of W. Peden W. Peden
    12. July 2011 at 10:09

    * around.

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