Tyler’s test now has an answer

In January 2015, the Swiss made the foolish decision to allow the franc to appreciate strongly, ending a highly successful 3 1/2 year peg with the euro. The Danish krone was also pegged to the euro, and came under intense pressure from speculators. The Financial Times had this to say at the time:

It’s been a long time since so many developed central banks were tested by free market forces. And free market forces aren’t finished yet.

Hot on the heels of the SNB giving up on its euro ceiling policy, the market is zoning in on the Danish central bank and its ability to maintain its euro-peg.

As Dan already pointed out, the Danes have had to cut rates three times in in the last two weeks: January 19, January 22 and January 29.

If that looks and feels desperate, perhaps that’s because it is?

After discussing speculators buying the krone, the FT suggested:

All that, say the analysts, increasingly puts the Danes in the position of the Swiss National Bank: having to gobble up euro-assets they may not want or care for.

The economics world is divided up into two groups. Mainstream economists believe the Swiss National Bank (SNB) was having to buy so many assets because of its weak franc policy, and that allowing the franc to appreciate would reduce this problem, allowing them to buy fewer assets. Many suspected that the Danish central bank would eventually be forced to follow suit.

I argued that this was exactly backwards. A strong franc policy merely whets the appetite of speculators, and the franc is popular partly because speculators correctly anticipate that it will gradually appreciate over the long run. If you don’t like having to “gobble up” so many euro assets, the right policy is to maintain the peg, not allow the franc to appreciate.

At roughly the same time, Tyler Cowen had this to say:

And if the Danes cut their peg, I am loathe to call this [Swiss franc appreciation] a “mistake” (even though it likely will hurt their economy), rather it would be an inevitability.

After more than 6 years, we have a pretty definitive answer to Tyler’s test. It wasn’t inevitable. The Danes did not allow the krone to appreciate. As a result, after a brief surge in early 2015 their central bank balance sheet returned to normal:

Switzerland didn’t do nearly as well. Their monetary base soared right before the revaluation, as markets anticipated that the SNB was about to allow the franc to appreciate, and then continued to grow over time. Countries with the lowest inflation rates (Switzerland, Japan, etc.) tend to have the largest central bank balance sheets.

I’ve talked about this issue before, and long time readers might think I’m beating a dead horse. But I find it maddening that the conventional wisdom still seems to assume that the SNB was forced to revalue the franc under speculative pressure back in 2015. This feeds into the (false) perception that central banks are powerless to inflate, that Lars Svensson’s “foolproof” way of escaping the liquidity trap won’t work. And that’s just wrong. Central banks are never unable to depreciate their currencies.

When people have their minds made up, no amount of empirical evidence seems to budge them.

PS. Ever meet someone who worries about countries engaging in competitive devaluations, and yet also believes that monetary policy doesn’t have any effect on inflation? If monetary policy is powerless, then how can a central bank devalue its currency?



29 Responses to “Tyler’s test now has an answer”

  1. Gravatar of rayward rayward
    29. April 2021 at 10:58

    Sumner saw The Princess Bride. https://www.youtube.com/watch?v=rMz7JBRbmNo

  2. Gravatar of Paul Selesko Paul Selesko
    29. April 2021 at 12:17

    Re: Puritan bleg

    Prof Sumner,

    Sorry, I seem to have missed this one 2 weeks ago and am writing now because I may have at least a small piece of the puzzle for you.

    In 1920’s Vienna there was a fascinating psychoanalyst, Wilhelm Reich. He was a student and then trusted colleague of Freud and though his name is gone his early work has made a huge impact upon the world. He went crazy later in life and the world has thrown the baby of his early work out with the bathwater of his eventual insanity.

    I stumbled upon him in college while thinking about War and its proximate and ultimate causes. One of my professors put me onto Reich. He is the only scholar I know of who even makes an attempt to describe what a monetary economist would call a transmission mechanism for the negative energy which culminates in war..

    As an economist you might find him interesting because he sees human psychology in economic terms. Regarding war he asks the question – What energy source is “funding” all of this mass destruction? – and based on his work with psychotherapy patients he puts forth the notion that individual negativity, destructive behavior etc. is funded by mis-directed sexual energy which the body produces abundantly to ensure procreation. And if one has at hand enough young men all suffering from this same condition one has the basis of an army which will perform destructive sadistic acts on a grand scale,ie. war

    Example: Imagine a 19 century mother who stumbles upon her young son masturbating. She has an emotional outburst and screams at the child… he is disgusting and evil, the devil has gotten into him and he is vile, he will go blind etc. The horrible feeling she creates in her young son becomes encrusted in the musculature/nervous system of the body and causes a mis-allocation of sexual energy which manifests as anger, sadism, emotional coldness etc.

    Whether we know his name or not, his work has directly affected our lives. The title of his 1945 book “ Sexual Revolution” is in fact the origin of that phrase. The phrase may have taken on a life of its own, but the core message of the book is that parents must accept sexuality in children as a normal bodily function like eating and breathing. Sexuality must never be demonised. He and his followers set up makeshift clinics across northern europe to spread this idea of healthful sexuality. I believe he was ground zero for this idea which is today received wisdom in the west. He was an early advocate for birth control which would allow teenagers to experiment sexually without life altering repercussions.

    One could argue that his teachings have contributed to the relatively peaceful state of the world over the last 80 yrs.

    Here is a good recent Biography : Fury On Earth by Myron Sharaf

  3. Gravatar of Joseph Calhoun Joseph Calhoun
    29. April 2021 at 17:21

    We have a great example of this in recent times. Rubin’s strong dollar policy worked just as you say. A rising dollar attracted speculators which caused the dollar to rise more and attract more inflows until, voila, dot.com bubble (a term I hate by the way). It’s probably not coincidence that Rubin started his career as a trader.

  4. Gravatar of jj jj
    29. April 2021 at 21:01

    It just makes no sense! Every country with its own currency should be praying for appreciation pressure!

    How to maintain a peg in the face of appreciation pressure:
    1) Run the presses for a few hours… buy BNP Paribas.
    Still appreciating?
    2) Run the presses for a few more hours… buy Volkswagen.
    Repeat as necessary.

    If you run out of assets to buy: distribute your assets to the citizenry, dollarize the economy, and call it a day. You lost the currency war but now you own Europe.

    Of course any currency market with 0.1% of a brain will back off 2 minutes into the press conference where the central bank announces this policy, so unfortunately you can’t actually get away with this.

  5. Gravatar of postkey postkey
    30. April 2021 at 01:06

    “Ever meet someone who worries about countries engaging in competitive devaluations, and yet also believes that monetary policy doesn’t have any effect on inflation?”
    Ever meet someone who doesn’t believe ‘this’?

    ‘The falsity and worthlessness of forecasts based on the behaviour of the base and M1 . . . ‘

  6. Gravatar of dlr dlr
    30. April 2021 at 04:28

    This is relevant and you’re not beating a dead horse. But are you too glib? Let’s agree that Denmark’s fidelity to their peg was more likely to shrink, not raise, the CB balance sheet in the long run. But what about the unlikely outcomes? Denmark’s CB assets were fairly modest as a percent of GDP. But the short run can be strange. What if the market’s peg skepticism was much more stubborn, and the fairly small DNB had to acquire foreign assets equating to, say, 300-400% of GDP in order to hold the peg? Suddenly a material chunk of Danish fiscal space (or its price level) is at risk from an exogenous shock to those balance sheet assets, and such a shock might turn out to be highly correlated with foreigners’ interest in holding DKK. Isn’t that something you would start to worry about at some point of asset accumulation if you are running the DNB, and isn’t the fact that such a point might exist support for a possible equilibrium where the market anticipates it and ignores the peg? (not bc they want to lose all their money when it all blows up but because you might well blink at the inherent leverage and eventually break the peg to allow appreciation).

  7. Gravatar of Todd Ramsey Todd Ramsey
    30. April 2021 at 05:35


    Honest questions, not trolling:

    Do you think the fact that the Swiss National Bank is 22% privately owned plays a role in their decision making?

    And if so, do you think that those private owners desire that the Swiss Franc appreciate over time, and create pressure towards allowing the Franc to appreciate?

  8. Gravatar of ssumner ssumner
    30. April 2021 at 05:51

    dlr, Yes, that’s possible, and it’s one more argument for raising the inflation target. On the other hand, I think that risk is pretty low, so I wouldn’t raise the inflation target by too much.

    Todd, That’s possible, but I don’t feel I know enough about the SNB to give an informed answer. Another possibility is that they are sincere inflation hawks, like the Germans.

  9. Gravatar of Michael Sandifer Michael Sandifer
    30. April 2021 at 13:41

    Off-topic, do Packers fans think it’s as crazy as I do that they aren’t loading the roster a la the Bucs, Saints, or Chiefs to help Rodgers win a Super Bowl? If it were up to me, I’d get rid of the GM and keep Rodgers.

  10. Gravatar of ssumner ssumner
    30. April 2021 at 16:47

    Michael, You asked:

    “Off-topic, do Packers fans think it’s as crazy as I do”


    Even worse, using last year’s first pick for a back-up QB.

  11. Gravatar of Michael Sandifer Michael Sandifer
    30. April 2021 at 19:17

    I don’t understand why owners allow GMs to make roster choices that will get the GMs fired. Why allow O’Brien to gut the roster in Houston, or Coughlin to gut Jacksonville’s, for example? If the GM can’t get along with pro-bowlers, gee, maybe there’s a problem with the GM. Let Houston get gutted, and fire O’Brien 4 games into the next season. I don’t get it.

    Rodgers gets paid more than 10x the average GM salary, implying he’s 10x more valuable, so why is this discussion even happening? First ballot Hall of Fame QBs don’t grow on trees. They should ask Miami or Buffalo.

  12. Gravatar of rinat rinat
    1. May 2021 at 20:37

    Would you please write an article that discusses Chomsky’s anarcho syndicalism, or libertarian socialism?

    Specifically, participatory economics.

    Chomsky seems to agree with Paul and the Austrian school in some ways (smaller govt, more power in the hands of individuals and communities), but the process for achieving that – in Chomsky’s view – is to centralize the actor. In this case, the actor is a community collective, in which each individual owns shares in the community.

    Paul, of course, would not seek to centralized communities – But Chomsky seems to think that Paul’s approach would collapse almost instantly resulting in the need for govt subsidies.

    Your thoughts?

  13. Gravatar of joe mama joe mama
    2. May 2021 at 02:54

    remember when SNB head Hildebrand had to resign because his wife was buying USD with Swiss francs and she profited from the SNB’s decision to intervene in the currency markets two days later.

  14. Gravatar of postkey postkey
    2. May 2021 at 02:57

    Speaking of Chomsky on ‘the money illusion’ is like showing a cross to a vampire!

  15. Gravatar of Rinat Rinat
    2. May 2021 at 04:10

    Yes, I presume that is true.

    Nevertheless, the issue of inequality and bigness is tearing western society apart. At some point, we need to reconcile with some of these issues.

    Chomsky sees the private sector as totalitarian, in that it forces others to seek employment. He describes this process as ‘slave wages”, which one may or may not agree with.

    Paul, of course, sees government subsidies, patents, and other interventions has a catalyst for “bigness”. And Sumner seems to have similar views as Paul.

    Chomsky responds to this, by saying that even if we could imagine a society with perfect competition, and with no government involvement, it would soon become very imperfect. Someone would be more productive or more fortunate, or both, and that this would lead to a form of tyranny in itself.

    I’m curious how a “libertarian economist” would respond to that libertarian socialist argument.

    Let’s step back from the efficiency argument for a moment, and focus on equity. How do we reconcile this tremendous divide that exists between those starving, and those worth billions. When is a company too big? When does that companies size prohibit other players from engaging the arena?

  16. Gravatar of ssumner ssumner
    2. May 2021 at 07:33

    Not a fan of Paul or Chomsky.

  17. Gravatar of rinat rinat
    2. May 2021 at 17:15

    Not liking someone, doesn’t dismiss there argument.

    You cannot permit companies to consolidate forever. The bigger a centralized actor becomes – govt or private – the more likely it will become tyrannical.

    Indeed, we see that now from the globalist mega corps.

  18. Gravatar of MichaelM MichaelM
    4. May 2021 at 17:00

    Hey Scott, what do you think of Lar’s prediction of short-term, very high inflation in the US in the next year?


    I tend to go with you on questions like this (and especially this one — the idea that the Fed would just sit aside while galloping inflation started up is ridiculous), but I’m uncertain about this particular prediction. A short, sharp jump and subsequent drop in inflation seems like it would be difficult for the Fed to respond to effectively, so it seems possible.

    Or is Lars just crazy?

  19. Gravatar of ssumner ssumner
    4. May 2021 at 20:10

    Michael, I’d expect some increase in inflation, but not to double digits.

  20. Gravatar of postkey postkey
    4. May 2021 at 23:49

    “Noam Chomsky
    The general population doesn’t know what’s happening, and it doesn’t even know that it doesn’t know.”

  21. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    5. May 2021 at 15:15

    @Postkey re: “The falsity and wothlessness of forecasts based on the
    behaviour of the base and M1 seems to have been responsible for discrediting altogether the monitoring of any money aggregate.”

    Nothing’s changed in > 100 years. There was a perfect correlation between the “BASE” and GDP in 2010. The problem is that the BASE is represented by required reserves. The currency component was contractionary.

  22. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    5. May 2021 at 15:19

    @Postkey re: “The falsity and wothlessness of forecasts based on the
    behaviour of the base and M1 seems to have been responsible for discrediting altogether the monitoring of any money aggregate.”

    Jerome Powell “When you and I studied economics a million years ago, M2 and monetary aggregates seemed to have a relationship to economic growth,” but, “right now … M2 … does not really have important implications. It is something we have to unlearn I guess.”

    Powell doesn’t know money from mud pie.

  23. Gravatar of Justin Justin
    6. May 2021 at 08:15

    Scott, do you know if the Hypermind forecasting metric accounts for the activeness of forecasters? My reading of the rules says no. One thing I preferred about the old market, over the new system, is it gave the forecaster a mechanism for expressing his confidence in his forecast, and rewards for being modestly ahead of short term changes in the market equilibrium. If I understand the current metric, it will favor forecasters who set their forecasts correctly early on, and then never change it. That is, it strongly rewards those who guess right on day one, take zero risk in terms of H currency for expressing the view and not maintaining the forecast, and penalizes those who chase fluctuating NGDPE over the course of the year. We know, based on financial markets, that US NGDPE was terribly stable in 2020, yet it was it not those who “set it, and forgot it” who did best? Maybe I am misunderstanding the Brier score computation.

  24. Gravatar of Ray Lopez Ray Lopez
    6. May 2021 at 09:07

    Note the comments section has gone to pot since me and Tin Foil Hat economist Ben Cole stopped posting.

    As for the post, give Sumner some credit after all, since after the Swiss Jan 2015 devaluation, their economy went south, which, ceteris paribus, shows money might be weakly non-neutral after all. But it didn’t last long, and today Denmark has a GDP per capita of $60.2 vs Switzerland’s much higher $82.0, proving the Swiss habit of sound money carries over to other things and has positive externalities.

    Bonus trivia: I’ve been banned now from Alt-M site (Cato) as well as Mercatus, Mieses Institute, etc; only this place and Tyler Cowen’s site allows me to vent my rare, 1%, wisdom. And I’m often in the vanguard, naturally, see for example this article which I anticipated by up to one year: https://nicholaswade.medium.com/origin-of-covid-following-the-clues-6f03564c038

  25. Gravatar of MichaelM MichaelM
    6. May 2021 at 16:13

    Thanks Scott. Any particular reason you think Lars is overshooting?

  26. Gravatar of postkey postkey
    7. May 2021 at 03:51

    ‘Noam Chomsky
    “What are the differences between Mark Zuckerberg and me? I give private information on corporations to you for free, and I’m a villain. Zuckerberg gives your private information to corporations for money and he’s Man of the Year.” ~ Julian Assange ‘

  27. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. May 2021 at 05:31

    @MichaelM re: “what do you think of Lar’s prediction of short-term, very high inflation in the US in the next year?”

    LAR’S uses M2 or M3 and that is stupid. Banks don’t loan out deposits. The DIVISA #s are also stupid. Barnett doesn’t use lags. And it is stupid because nothing has changed in > 100 years. The ratio of bank debits to transaction’s deposit accounts is easily > 95:5

    “Powell: “the correlation between different aggregates [like] M2 and inflation is just very, very low”. DAH Powell’s right, non-M1 components are inert, un-used and un-spent, lost to both consumption and investment, indeed to any type of payment or expenditure.

    Inflation plateaus/peaks with the May 12th CPI. Inflation will become transitory after Feb. 2022.

  28. Gravatar of Justin Justin
    7. May 2021 at 07:01

    @S.B. Hall: agree M2/M3 are not good arguments for highish US inflation. There were times when aggregate bank account balances (basically what M series measure) were decent proxies for domestic demand growth, but those days are long gone.

    Households hold cash, as a buffer, in proportion to their cultural memory of financial/social stress. After 2009 US M2 gradually grew relative to personal income, which makes sense, following an economic trauma. Throw in the Wuhan virus, which is highly stressful, but doesn’t result in much middle class job loss, and you’d expect bank accounts to swell.

    The strongest argument for inflation comes from TIPS spreads. If we really will average 2.5% CPIU for 5 years, we’ll see some 3.5% YoY readings. Still, I refuse to believe the Fed will endure 3.5% CPIU, they’ll tamp down expected NGDP by the fall at the latest.

    The Fed gerontocracy lives to be the heroes who beat 1970s inflation.

  29. Gravatar of ssumner ssumner
    7. May 2021 at 21:31

    Justin, Unfortunately, I can’t answer that question.

    Michael, I base my view on the TIPS spreads, which don’t show those sorts of inflation rates.

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