Archive for the Category Switzerland

 
 

The Fed needs to stop trying to reduce interest rates

Here are two possible messages from the upcoming September Fed meeting:

1.  We are coming out of this meeting with all guns blazing.  We will cut the interest rate on reserves–to below zero if necessary, and do so much QE that we expect NGDP growth to accelerate sharply.  Indeed we expect to have to raise the fed funds target at some time during the next 18 months to prevent NGDP growth from exceeding 7%.

2.  We are growing increasingly glum about the prospects for the economy.  As a result we feel confident that we can hold interest rates near zero for at least another 3 years, and probably much longer.

Which does the Fed see as the more expansionary option?

Over the past few years I’ve been surprised at how hard it is for central banks to move away from interest rates as the lever of monetary policy.  It’s not impossible, just this morning the Swiss National Bank used the exchange rate as a policy tool.  But consider the plight of the Fed.  First they cut rates to zero.  When short term rates can’t be cut any more, they start QE.  But they insist the purpose of QE is not to increase the money supply, but rather to lower long term rates–even though low long term rates are a sign that monetary stimulus has failed.  When QE2 doesn’t seem enough, they move on to promises to hold short rates near zero for an extended period of time.  The Fed seems extraordinarily reluctant to use policy tools that actually would be effective—particularly an explicit nominal target, level targeting.  And then they wonder why their “extraordinarily accommodative monetary policies” never seem to be enough.

Low interest rates didn’t work for the Fed in the 1930s, and they haven’t worked for Japan since 1994.  Why would anyone expect a different result in America today?

The Swiss devaluation

Lars Christensen recently sent me the following report from the Swiss National Bank:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

Even at a rate of CHF 1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures.

I don’t have a link, but this Bloomberg news report summarizes the move.  A few comments:

1.  Swiss stocks rose over 4% on the news, but the gains have been pared back as all markets are falling on recession fears.  I’d guess the move was partly expected, and hence the actual impact on the market was much more than 4%.  The exchange rate immediately fell by over 7%, to a level close to the target.  This suggests that the policy is credible.

2.  Unless I’m mistaken, this is close to what Lars Svensson recommended.  I’m relying on memory–perhaps a commenter can dig up an old Svensson paper on “foolproof escapes” from a liquidity trap.  The key idea is to create expectations of currency depreciation.  The final paragraph of the Swiss statement seems to have that aim, although a more specific target path might have been more credible.  The idea is to make investors think that the Swiss franc (base money) is not a good investment.

3.  I believe the Swiss central bank did the right thing.  Whether it’s done enough is hard to say.  Open economies like Switzerland (and Sweden) can only do so much in the face of falling demand for their highly specialized exports.  If the world continues to slide toward recession, I’d expect both countries to see some decline in output, even with optimal monetary policy.  But at a minimum the Swiss can and should prevent deflation trigger by falling demand.

4.  The market reaction to the Swiss move is one piece of evidence in support of my recent post arguing that Switzerland was not out of ammunition.  One more piece of evidence that money matters–especially when monetary shocks are destabilizing the world economy.  But the Swiss still need to carry through with the commitment.  And as the statement indicates, even further moves may be necessary.

PS.  I wish Lars could convince the Danes to devalue.  If enough countries act, maybe the ECB would take a hint.

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:

DESCRIPTION

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.

Why are the Swiss so happy?

Because I head to George Mason University tomorrow, this will be my last post for a while.  You might want to follow the discussion on Cato Unbound, where I will be posting replies to Hamilton, Selgin and Hummel.

Right after my last post extolling the virtues of Swiss-style democracy I read Bryan Caplan’s persuasive attack in The Myth of the Rational Voter.  He argues that voters aren’t just misinformed; rather they hold deeply ingrained biases that lead them to make poor public policy decisions.  Naturally I wondered if this refuted my argument.  I don’t think it does, but it weakens it a bit.
Den ganzen Beitrag lesen…