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.
On VoxEU, Adrian Jäggi, Martin Schlegel and Attilio Zanetti report that the safe-haven currencies Swiss franc and Japanese yen react strongly to non-domestic macro surprises, and did so especially during the financial crisis. For European macro surprises, only German data influence safe-haven currencies.
In a Bank of England Financial Stability Paper, Olga Cielinska, Andreas Joseph, Ujwal Shreyas, John Tanner and Michalis Vasios analyze transactions on the Swiss Franc foreign exchange over-the-counter derivatives market around January 15, 2015, the day when the Swiss National Bank de-pegged the Swiss Franc. From the abstract:
The removal of the floor led to extreme price moves in the forwards market, similar to those observed in the spot market, while trading in the Swiss franc options market was practically halted. We find evidence that the rapid intraday price fluctuation was associated with poor underlying market liquidity conditions, in particular the limited provision of liquidity by dealer banks in the first hour after the event. Looking at longer-term effects, we observe a reduced level of liquidity, associated with an increased level of market fragmentation, higher market volatility and an increase in the degree of collateralisation in the weeks following the event.
In Die Volkswirtschaft, Ernst Baltensperger and Peter Kugler summarize the history of the Swiss Franc since the mid 19th century:
After 1973, the Swiss Franc has been strong. Swiss Franc yields have been lower than what uncovered interest parity would suggest.
Before 1914, the Swiss Franc was weak in the sense that it enjoyed only limited credibility. In periods with fixed exchange rates, Swiss Franc yields typically exceeded yields in French Franc or Sterling.
Throughout the 20th century, the Swiss Franc appreciated by more than what inflation differentials would suggest, potentially reflecting the Balassa-Samuelson effect.
In the NZZ, Thomas Fuster reports about a consequence of the introduction of new banknotes in Switzerland: Old notes become invalid after a transition period of 20 years.
Nach der Emission des letzten Notenwerts einer neuen Serie kündigt die Schweizerische Nationalbank (SNB) jeweils den Rückruf der alten Serie an. Danach können die Banknoten zwar noch während zwanzig Jahren bei den Kassenstellen oder Agenturen der Nationalbank zum Nennwert umgetauscht werden. In der Folge sind die Noten aber wertlos – oder haben bestenfalls noch Sammlerwert. Eine solche Guillotine fällt das nächste Mal am 30. April 2020. Nach diesem Datum wird die Ende der 1970er Jahre ausgegebene sechste Banknotenserie, von der Ende vergangenen Jahres noch immer 1,14 Mrd. Fr. im Umlauf waren, ihren Geldwert verlieren.
The Federal Council dismisses the popular initiative to implement a Vollgeld regime—the “Swiss Chicago plan.” The Council argues that the proposal to abolish inside money creation runs counter to the government’s financial stability strategy and might undermine credit creation as well as trust in the Swiss Franc.
As the central bank issued more money, the government points out, its liabilities (cash) would rise without any increase in its assets. This, the government fears, would undermine confidence in the value of money. … There would need to be heavy-handed rules to make sure that banks did not create “money-like” instruments. … Finance, a huge part of the Swiss economy, would be turned inside-out, with unpredictable but probably expensive consequences. … The government also points out that the initiative only guards against one particular form of financial instability.
In jusletter.ch, Corinne Zellweger-Gutknecht argues that the legal status of central bank reserves is more equity- than debt-like—at least as far as the Swiss National Bank (SNB) is concerned. According to Zellweger-Gutknecht, reserves constitute debt only if the SNB is legally obliged to redeem them in exchange for central bank assets.
If the SNB purchases dollars against Swiss Francs in an open market operation, it creates reserves which are equity-like. But if it acquires dollars against Swiss Francs and is committed to engage in a reverse transaction in the future (a swap), then it (temporarily) creates reserves which are debt-like.
The Swiss National Bank has published information about its June 2015 balance sheet positions. The graph (excel file) depicts the evolution of foreign currency investments and sight deposits since 2010.
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.
Markus Hertrich and Heinz Zimmermann argue in a working paper that after August 2014, financial markets priced in a significant probability that the Swiss National Bank would abolish the exchange rate floor vis-a-vis the Euro. Hertrich and Zimmermann write in the abstract:
We observe a drastic increase in the break-probabilities after August 2014, reaching a level of nearly 50%, which was the level before the announcement of the details of the “Draghi put” in September 2012. The credibility of the SNB in maintaining the floor, as seen from the option market, was thus substantially lower than publicly claimed.
abnormally low values of net flows were not necessarily driven by surges of private capital inflows. In fact, declined capital outflows that are less correlated with capital inflows appear to be the main factor. These findings suggest that the financial crisis generated a breaking point for capital flows to and from Switzerland.