On the FT’s Alphaville blog, Matthew Klein reviews Swiss monetary policy over the last years and its effect on the real economy. He concludes that
it seems the SNB’s relentless accumulation of foreign assets has been pointless — at best. More likely, the behaviour qualifies as predatory mercantilism at the expense of the rest of the world, especially Switzerland’s hard-hit neighbours.
The Swiss National Bank has updated its exchange rate indices. In an SNB Economic Studies paper, Robert Müller describes how. The upshot is that the SNB considers the Swiss Franc slightly less overvalued than before. From the abstract:
The key aspects of the revision are: the application of the weighting method used by the IMF, which takes into account so-called third-market effects; continuous updating of the countries incorporated into the index; and calculation of a chained index. The methodological changes in the calculation of the new index have only a slight effect on the development of the nominal index. However, the difference between the nominal and real index (CPI-based) has increased with the new calculation. This is explained by the fact that countries with a greater weighting in the new index have higher average rates of inflation than those whose weighting has been reduced.
Finanz und Wirtschaft, April 30, 2016. PDF. Ökonomenstimme, May 6, 2016. HTML.
The winners and losers of the current monetary environment are not that easy to identify. Investors holding long-term, non-indexed debt gain as unexpectedly low inflation shifts wealth from borrowers to lenders. Governments suffer from increased real debt burdens and reduced revenue due to effectively lower capital income tax rates. Policies that succeed in affecting the real exchange rate entail redistribution.
In a Study Center Gerzensee working paper, Pinar Yesin argues that the IMF’s Equilibrium Real Exchange Rate model (ERER) helps predict medium term exchange rate changes. The reduced form equation relates the real effective exchange rate to macroeconomic fundamentals.
… one of the models, namely the ERER model, outperforms not only the other two in predicting future exchange rate movements, but also the (average) IMF assessment. … the IMF assessments are better at predicting future exchange rate movements in advanced economies than in emerging market economies. Controlling for the exchange rate regime does not yield different results. … the IMF assessments have higher predictive performance in open economies than in closed economies. … safe haven currencies close the misalignment gap predicted by the models faster than other currencies.
… To assess exchange rates only a modified version of the ERER model is being used since 2012. The modified versions of the MB and ES models, while still being utilized, do not have a direct link to the exchange rate anymore. That is, the IMF ceased making a direct link from equilibrium current accounts to equilibrium exchange rates for now.
Is the Swiss France (CHF) overvalued? The following graph plots the nominal and real exchange rates since 1981 (the real rate is computed based on Swiss and Euro area producer price indices, 2010=100; data file).
Relative to the long-term average, the CHF currently is overvalued in real terms by 14%. In December 2014, it was overvalued by 4%; and in August 2011, by 11%. But in December 2007, it was undervalued by 21%. According to the real exchange rate metric, importers (households) thus suffered more in 2007 than exporters suffer today. For a related assessment based on consumer (Big Mac) prices, see this blog post.
The real exchange rate is just one metric to assess whether a currency is overvalued. There are many others, see for example this IMF paper or this book. Also, foreign exchange market participants are willing to buy and hold CHFs and EURs at the going market rate; they seem to think that the price is right.
If the price were right and policy weakened the CHF, then Switzerland would trade off “competitiveness” of the export sector on the one hand, and expected capital losses on the country’s EUR holdings that would have to be purchased to temporarily strengthen the EUR on the other. Back-of-the-envelope calculations by my colleague Harris Dellas suggest that weakening the CHF would not be worth it, financially speaking.
Even if, for whatever reason, society favored a weaker CHF it is not clear that the SNB should intervene. The SNB should only act if its mandate of pursuing price stability calls for such action. In the short run, a weaker CHF would indeed help to push the inflation rate in the desired range. In the longer run, however, a further lengthening of the SNB’s balance sheet (resulting from forex market interventions) could undermine the SNB’s flexibility, in particular if political constraints were to bind.
This does not rule out, however, that other institutions in Switzerland could or should enter the exchange rate business. In principle, fiscal policy makers could institute a sovereign wealth fund that is financed by issuing CHF bonds and invested in EUR assets. Fiscal policy makers could also try to redistribute from those currently benefiting to those suffering from the CHF/EUR exchange rate. Export subsidies could be an instrument. They would be hard to implement though if one wanted to account for intermediate inputs.
That Switzerland has an independent currency is a choice that reflects repeated, in depth deliberations. Advantages of pursuing an independent monetary policy include the option value to pursue price stability even if other currency blocs don’t; and the ensuing credibility benefits for Switzerland as a whole. Disadvantages include temporary, but potentially long-lasting real exchange rate misalignments that strain some groups (e.g., workers in the export sector) while benefiting others (e.g., consumers). These advantages and disadvantages do not come as a surprise; Switzerland has chosen them.
In a Vox column, Michele Ca’Zorzi, Jakub Mućk and Michał Rubaszek argue that exploiting the “Rogoff’s consensus” helps beat the random walk forecast.
… a calibrated half-life PPP model beats overwhelmingly the random walk in relation to real exchange rate forecasting.
… if the speed of mean reversion is estimated, rather than calibrated, the model performs significantly worse than the random walk due to estimation error.
… the mean reverting nature of real exchange rates can be exploited to outperform the random walk in relation to nominal exchange rate forecasting. For both the case of the euro and the dollar we find that the nominal exchange rate has contributed to the mean reversion process of the real exchange rate rather than just followed a random walk.