Stefan Elfwing on Swiss monetary policy

Stefan Elfwing sent me a very good comment regarding the recent spate of posts on the Swiss National Bank’s exchange rate peg:

The Swiss data was not totally correct. .  .  . And there was no inflation in April. It decreased slightly to -0.99% from the -0.95% rate in March. The deflation expectations now seem anchored at about -1%.

The mean of the eur/chf average annual exchange rate 2002-2009 was about 1.55 (min:1.47 max: 1.64). The floor of 1.2, which has become, binding then represents an approx 29% stronger swiss franc than the “normal” level. It is kind of the evil twin of LEO S [Svensson’s] failproof method, create deflation expectations instead of inflation expectations.

So, I really don’t understand the Swiss hype among the NGDP crowd. Yes, expectations works extremely well for central banks. But, central banking is not about “proving” theoretical hypotheses and using the theories for evil purposes.

The exchange rate figures are presumably nominal and hence slightly overstate the Swiss franc overvaluation, but I accept his point.  I think many people (perhaps including me) have become too excited about the Swiss policy.  Stefan’s right, it is too deflationary.  Indeed it’s not a good idea to peg your currency to another currency, you should adjust monetary policy according to the needs of the domestic economy.

Other commenters pointed out that the SNB might abandon the peg tomorrow, if a eurocrisis causes a huge flood of money to pour into Switzerland.  That’s true, but it’s not really relevant.  Here’s what the Swiss case actually showed:

1.  The standard assumption is that monetary stimulus requires a larger monetary base, an enlarged central bank balance sheet.  That might be true in some cases, but in many cases exactly the opposite is true.  Last summer the Swiss monetary policy was so contractionary that the SF was soaring in value.  That naturally made lots of people want to hold SFs, and to keep the franc from soaring even faster, the SNB rapidly increased its balance sheet.

2.  Then the SNB then decided to ease monetary policy, by depreciating the SF and then pegging it at 1.2 per euro.  Now it was a less attractive investment, and the SNB balance sheet stopped increasing in size.

That was the point, it takes more “effort” to do a failed monetary policy than a successful one, a point I often make in the US context.  Now I regret not indicating that even the current Swiss policy is far from optimal.  As Stefan points out the SF is still overvalued, and hence Switzerland has deflation.  By the way, it’s interesting to compare Japan and Switzerland, which both have very overvalued currencies, as both suffer from mild deflation.  Many people who have never studied international economics actually claim these currencies are undervalued.  They say that because both countries have current account surpluses of close to $100 billion.  But never reason from a CA balance, it tells us nothing about whether the currency is under or overvalued.  Indeed both countries have capital account deficits of roughly $100 billion, so by that logic one could argue their currencies are undervalued.  The only meaningful measure of under or overvaluation is relative to what is required to achieve macro equilibrium in the domestic economy. If a country has (unwanted) deflation, then ipso facto its currency is overvalued

PS.  There is a separate issue of government saving.  Some economists like Paul Krugman claim the Chinese currency is undervalued because their government saves too much.  I don’t agree, but that’s better thought of as being an argument about government saving, not monetary/exchange rate policy.  And BTW, it has nothing to do with the Chinese government artificially controlling the nominal exchange rate—it’s the government saving that reduces the real exchange rate for the yuan, it would happen even if the yuan was floating.

PPS.  If the Swiss insist on pegging the franc, they should do a crawling peg with a gradual depreciation over time.



21 Responses to “Stefan Elfwing on Swiss monetary policy”

  1. Gravatar of marcus nunes marcus nunes
    3. June 2012 at 18:41

    Applying the Meade-Swann diagramatic analysis to Switzerland, it seems it´s positioned on the Internal Balance line and off the External Equilibrium locus, i.e in “Quadrant III” of the diagram. That would mean the SF could APPRECIATE along side an increase in domestic absorption, maintaining IB (unemployment = “natural” rate) and decreasing the CA surplus.

  2. Gravatar of Stefan Elfwing Stefan Elfwing
    3. June 2012 at 20:31


    Thanks for the post!

    From SNBs Monthly Statistical Bulletin May 2012, p. 84:

    The real Exchange rate indices (export-weighted vis-à-vis 40 trading partners, 1999=100).

    2008 values:
    Total: 97.1
    Eurozone: 92.6
    USA: 108.5

    2012/04 values
    Total: 114.7
    Eurozone: 115.5
    USA: 121.5

    So, about 20% instead 30%. Still bad!
    And both the real values for the total and the eurozone is slowly trending up since about 2011/11.


  3. Gravatar of Nic Johnson Nic Johnson
    3. June 2012 at 23:52

    Hey Scott,

    Don’t know if you’ve seen this, but apparently Hayek made comments to the effect that not targeting expectations will result in an absence of mini-recessions:

    “They must be directed more at forestalling changes before they occur than at correcting them after they have occurred. If a central bank always waited until rule or mechanism forced it to take action, the resulting fluctuations would be much greater than they need be. . . .”

    Thought you might be interested.

  4. Gravatar of Saturos Saturos
    4. June 2012 at 00:15

    If Chuck Norris actually has to beat people up, he’s doing it wrong.

    “Never reason from a CA balance.” And here’s a post all journalists should read:

  5. Gravatar of Max Max
    4. June 2012 at 00:39

    “The only meaningful measure of under or overvaluation is relative to what is required to achieve macro equilibrium in the domestic economy.”

    Purchasing power parity isn’t meaningful?

  6. Gravatar of Saturos Saturos
    4. June 2012 at 02:41

    Max, no, there’s very little evidence that PPP drives exchange rates in anything but the very long run.

    Nic, someone get Major Freedom to read that post.

  7. Gravatar of Nishant Nishant
    4. June 2012 at 04:22

    A couple of questions:

    “Then the SNB then decided to ease monetary policy” – so would you say that the preceding rapid expansion of the SNB’s balance sheet would not in itself count as easing of monetary policy? And only when the currency peg was established would you say that monetary policy was eased?

    So if the above is true, then the actual ‘easing’ of monetary policy took place more through credibly targeting (exchange rate) expectations rather than just expanding the balance sheet?

  8. Gravatar of Morgan Warstler Morgan Warstler
    4. June 2012 at 04:33


  9. Gravatar of ssumner ssumner
    4. June 2012 at 05:52

    Marcus, I must be misreading that graph. If Spain is in quandrant I then the graph says their exchange rate is undervalued. But that can’t be right. Or do I have it backwards?

    Stefan, Thanks, that’s roughly the adjustment I expected.

    Thanks Nic, I’ll take a look.

    Saturos, Thanks, I can never find these old posts–someday I need to get organized.

    Max, No, there is no reason why the price level in one country should be the same as in another. Why should haircuts in India cost $20 when wages there are 50 cents an hour?

    Nishant, That’s exactly what I am saying. And the same is true of the US. The big balance sheet expansion wasn’t easing.

  10. Gravatar of Mark A. Sadowski Mark A. Sadowski
    4. June 2012 at 07:09

    “That was the point, it takes more “effort” to do a failed monetary policy than a successful one, a point I often make in the US context.”

    That reminded me of this statement by Miles Kimball:

    “Balance sheet monetary policy is like moving the economy with a giant fan. It can be done, but it takes huge open market purchases of assets to move the economy much once the Fed funds rate is more or less at zero.”

    It sounds like he’s brought pushing on a string up to the electric age.

  11. Gravatar of marcus nunes marcus nunes
    4. June 2012 at 07:14

    You´re reading it backward. Spain´s real rate (competitiveness measure) is ovevalued (uncompetitive). So either e goes up (can´t) or Spanish wages (and prices) come down.

  12. Gravatar of Andy Harless Andy Harless
    4. June 2012 at 07:20

    Your assertion about China is only valid under certain very restrictive conditions. More generally, a currency peg can affect private saving or investment and thereby change the current account balance. (I think it would be equally correct for me to say it can affect the current account balance and thereby change private saving or investment, but I’ll adopt your idiom.)

    It is a necessary condition that saving and investment do not respond to the real interest rate (or, alternatively, that the peg is expected to be permanent, but that seems thoroughly implausible). Otherwise the weak currency will result in a lower expected future inflation rate (because agents will anticipate future currency appreciation), thus raising the real interest rate, which will make saving more rewarding and increase the hurdle return for domestic investment. Thus the peg does affect the current account.

    Also, you have to assume either that NGDP is exogenous or that the SRAS curve is vertical. Otherwise the weak currency will increase net exports and thereby increase nominal income, which will mean an increase in real income and therefore (unless the marginal propensity to save is zero or negative) an increase in savings. I know you’re comfortable assuming NGDP is exogenous, but it’s certainly a contestable point.

  13. Gravatar of ssumner ssumner
    4. June 2012 at 09:09

    Mark, Yes, and he needs to focus more on explicit policy targets. It does no good to do massive QE if the Fed’s targeting inflation at 1%.

    Marcus, So you are calling a higher “e” currency depreciation? No wonder I had it backward. Is e the value of the euro, or one over the value of the euro–i.e. the value of the dollar?

    Andy, No, I can’t assume NGDP is exogenous if the Chinese are pegging the yuan. But I am ignoring the SRAS as I’m looking at the long run. The Chinese CA surplus “problem” is a long run issue, not a cyclical issue.

    It seems to me that if the yuan is undervalued it leads to more inflation, as prices rise more rapidly in order to push the real exchange rate to equilibrium. But again, I’m focused on the long run, and in that case it’s a question of S&I, and real exchange rates. Nominal pegs don’t matter.

    BTW, I replied to your query on the NGDP futures. You were right that I reversed the long and short position, and I tried to better explain why there is little risk to the central bank.

  14. Gravatar of Gregor Bush Gregor Bush
    4. June 2012 at 11:40

    “Other commenters pointed out that the SNB might abandon the peg tomorrow, if a eurocrisis causes a huge flood of money to pour into Switzerland. That’s true, but it’s not really relevant.”

    Whoa Scott. Why would the SNB allow a worsening of the euro zone crisis to result in more contractionary monetary policy in Switzerland? As you point out they need easier policy right now, not tighter. If the euro zone crisis worsened and the euro zone (where 60% of Swiss exports are destined) slipped into a deeper recession, I would expect them to move the floor to 1.30 or 1.35.

    Also, remeber that 1.20 is a floor not a peg. In my view it makes no sense to be long the CHF right now. There’s no upside (the SNB was no reason to allow the CHf to apprecaiate) but the currency can still sell off agaisnt the euro and the floor can be raised 9and I beleive will be). In the end, they link the policy to their inflation objective so I think its more Svenssonian than you give it credit for. And that’s why i think they’ll move the floor higher (depreciate the currency). In absense of a depreciation, inflation won’t move back into thier target range of 0-2%.

  15. Gravatar of marcus nunes marcus nunes
    4. June 2012 at 12:07

    Scott e=euro price of dollar. This exchange rate thing is always confusing. For most currencies it´s the currency price of a dollar, except for the Euro, pound Aussie dollar and Kiwi dollar (that I can remeber). Funny that before the euro it was the franc, dm, etc price of the dollar!

  16. Gravatar of Matthias Matthias
    4. June 2012 at 14:26

    Scott: If you use NGDP an indicator for the stance of monetary policy I don’t think the SNBs policy was contractionary. Au contraire, the SNB long struggled last summer with the fact that their policy for the domestic economy was too easy and hence causing many people to cry “housing bubble!” (still discussed now but in the meantime parliament is finally about to implement some other measures like increasing minimum equity in a loan or a mandatory amortisation plan in case a house is more than 2/3 debt financed). The problem was just that investors perceive the CHF as a better investment in times of crisis compared to most other currencies. So the SNB was trapped between keeping rates low (a good decision if one looks back now, also construction numbers were down Q1. Then again, that was a super-cold quarter) or raise rates and make the CHF even more attractive, hence more CHF appreciation and hence killing the export industry.

    So my point being: By your own definition (Swiss GDP at the time was at/above trend-growth) the monetary policy shouldn’t be called contractionary for Summer 11.

    About deflation: That’s mostly imported deflation, domestic inflation (y/y) posted positive prints (now in April a 0.0% print) and also the GDP deflator for Q1 posts a +0.5% so I’d hesitate to draw comparisons to Japan (although to be honest I have no idea about the Japanese deflation numbers but I just assume it’s not only imported but also domestic as I’ve read of falling RE prices in Japan. But maybe it’s the same for them.). However, therefore I fully agree with your conclusion “If a country has (unwanted) deflation, then ipso facto its currency is overvalued”.

    BTW I remember you somewhere complained about discrepancies about Japanese CPI/GDP deflator: Could that be due to importet inflation (showing fully in CPI but much less in GDP defl.)?

  17. Gravatar of Tom Tom
    5. June 2012 at 04:25

    If 1.20 is a floor (1.2 SWF for a Euro), than the Swiss bank is stopping appreciation (strengthening, few SWF for a Euro).

    they should do a crawling peg with a gradual depreciation over time.
    With the Euro about to crash, the investors are expecting the SWF to increase in value.
    Perhaps Soros will decide to test the Swiss Bank — or perhaps the SNB will actually print money to keep the rate.

  18. Gravatar of ssumner ssumner
    5. June 2012 at 12:37

    Gregor, I don’t disagree with your prescription, but doesn’t the SNB target inflation? If the euro collapses then they’d have to appreciate the SF to prevent inflation, as the price of imports would soar if they stayed fixed and the euro plummeted.

    In any case, I wasn’t trying to defend the SNB policy, it’s not NGDP targeting, but rather show that they got better results by trying to set expectations, rather than the brute force approach.

    Marcus, That’s fine, but do you see it’s a slightly misleading way to do a graph. If the graph is for euros, one would naturally think a higher exchange rate is appreciation, not depreciation. But thanks for clearing that up.

    Matthias, The housing bubble seems unrelated to your argument, I’d need to know NGDP growth in recent years, let say since 2006.

    Tom, I agree that investors expect appreciation, but they should announce depreciation.

  19. Gravatar of Gregor Bush Gregor Bush
    6. June 2012 at 06:26

    “Gregor, I don’t disagree with your prescription, but doesn’t the SNB target inflation? If the euro collapses then they’d have to appreciate the SF to prevent inflation, as the price of imports would soar if they stayed fixed and the euro plummeted.”

    Scott, I really don’t think so. Their target range for inflation is 0-2% but I think they’re sufficiently flexible to realize that the increase in import prices will have a price level effect and would not likely unanchor inflations expectations – so they’re wouldn’t be any increase in the forecast of inflation at the two-year horizon from a plunge in the euro. But the negative impact of a collapse in euro zone domestic demand would be longer lasting and likely push the forecast of inflation lower absent any change in monetary policy. In addition, Swiss banks would likely come under severe strain in this scenario which would also be contractionary and therefore would further argue for easier policy. Maybe I’m just imposing my normative view here but I think they would be crazy to let the CHF appreciate in this scenario.

    Also, just as an aside, I don’t even think that the level impact on Swiss CPI from say, a 30% decline in EURUSD, would necessarily be that large. 75% of Swiss imports are from the euro zone and would not be affected much by a decline in the EUR. In addition, the pass-through from import prices to CPI looks quite low, on the order of 0.25.

    So, in sum, the depreciation of the EUR would not have a large impact on the CPI and I think the SNB would “see through” whatever impact there was and focus on the things that impact its forecast of inflation at the two year horizon: the collapse in euro zone domestic demand and the stress in the financial/banking sector.

  20. Gravatar of ssumner ssumner
    6. June 2012 at 07:01

    Gregor, You may be right, but I’ve forgotten our original debate. Certainly your comments here are not inconsistent with anything in my post.

  21. Gravatar of Skepticlawyer » Easy Guide to Monetary Policy Skepticlawyer » Easy Guide to Monetary Policy
    6. June 2012 at 21:49

    […] simply stopped. Without endorsing the rest of the monetary policy of the Swiss central bank (such as why the Swiss franc was appreciating so strongly in the first place), it was an excellent example of […]

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