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ABSTRACT
The purpose of this paper is to consider certain consequences of large post-crisis capital flows in advanced economies. Specifically, I offer an examination of the Swiss response to large capital inflows during the early stages of the global financial crisis. Why did the Swiss National Bank (SNB) intervene in the foreign exchange market and introduce an exchange rate floor? Why did the SNB gamble with its highly valued anti-inflationary reputation in attempting to stem the appreciation of the Swiss franc? To answer these questions, this paper suggests a broader and more complete explanation than one that focuses solely on the configuration of domestic interests. Specifically, the paper argues that a thorough explanation of the SNB’s response requires accounting for the changing monetary paradigm of the central banking community. This emerging monetary paradigm influenced the SNB’s policy decisions by making the SNB particularly sensitive to financial stability risks and by providing it with the policy space to experiment with (macroprudential) tools to manage these risks.
ACKNOWLEDGEMENTS
The author is grateful to Ilene Grabel, Kevin Gallagher, Randy Germain, Eric Helleiner, and three anonymous reviewers for helpful comments on earlier drafts of this paper. The remaining shortcomings are the author’s responsibility alone.
Notes
1. The situation is different at the time of writing. In particular, the May 2013 announcement of the potential tapering of the US Fed asset purchase program triggered downward pressures on a number of emerging market currencies, most notably on the Indian rupee.
2. Focusing on a case of currency appreciation, this paper complements analyses of policymakers’ responses to pressures toward depreciation. See, for instance, Walter and Willett (2010).
3. The observation that advanced economies have ended official interventions is not meant to suggest that these countries never intervene in the forex markets to affect the exchange rate. Research has found that central banks in floating markets intervene under a fairly consistent set of conditions (Almekinders and Eijffinger, 1996; Edison, 1993). Intervention has, for example, often been deployed to counter disordered markets by leaning against short-term fluctuations such as those triggered by large capital inflows.
4. Whereas a central bank has a finite stock of international reserves to defend its currency against downward pressures, central banks can intervene indefinitely in forex markets to resist currency appreciation (at least in principle) because there is no limit to the volume of domestic currency they can print to be sold in forex markets.
5. In particular, sterilization leads to an increase in the differential between the interest rate on domestic government debt and international reserves, which creates a quasi-fiscal deficit. Furthermore, by preventing a decrease in the interest rate differential, sterilization does not eliminate the incentive for capital inflows to continue (c.f. Calvo, Leiderman and Reinhart, 1993: 147).
6. Although the risk of deflation was the main driver of the SNB actions (as discussed below), inflation was still an important challenge for domestic macroeconomic management, particularly because managing the intervention requires determining the exact moment the monetary base must be normalized before damaging the export sector.
7. In the Swiss case, exchange rate policy is the responsibility of the SNB and not of the federal government. This is different from what occurs in the United States (US) for instance, where exchange rate policy decisions are made by the Treasury and then enacted by the central bank.
8. On the emergence of the pre-crisis consensus see, for instance, Goodfriend (2007).
9. Among advanced economies, the US and Japan have been notable exceptions to the trend toward inflation targeting. As for the ECB, although this central bank adopts a numerical inflation objective of below, but close to, 2 percent over the medium term, it does not claim to be an inflation targeter.
10. Opinions diverge about the extent to which monetary policy contributed to the build-up of pre-crisis imbalances. For opposing views see, for instance, Ahrend et al. (2008) and Bernanke (2007).
11. IMF Conference on Rethinking Macro Policy II: First Steps and Early Lessons, Washington, DC, 16–17 April 2013.
12. On the process through which these previously marginalized arguments gained the upper hand in the financial regulatory debate, see Baker (2012).
13. As has been widely documented elsewhere (e.g. Baker 2012), it was exactly because the pre-crisis prevailing consensus largely ignored financial stability that the BIS suggestions fell on deaf ears. To put it differently, the pre-crisis monetary consensus was solid to the point that it made central bankers unreceptive to the warnings on the risks that were mounting in the financial sector.
14. As clarified above, although the SNB does not consider itself to be ‘pure’ as an inflation targeter, it has nonetheless incorporated key features of that framework, including a numerical definition of price stability.
15. Although exchange rate policy is part of the central bank’s monetary function because of its effects on price and interest rates, it is standard practice to study the two functions separately.
16. In the pursuit of its functions, the Swiss Federal Constitution grants the SNB operational independence. As a counterweight to this independence, the SNB has a duty of accountability; it must report regularly to the government and the general public on monetary policy matters.
17. The Swiss franc depreciated 5 per cent against the euro in the six days that followed the March 2009 announcement of the forex interventions.
18. Communication of the Swiss National Bank ‘Swiss National Bank sets minimum exchange rate at CHF 1.20 per euro ’, 6 September 2011.
19. As reported by Bloomberg, ‘RBA’s Stevens Calls Switzerland’s Aussie Purchases “Remarkable”’, by Michael Heath, 24 August 2012.
20. Swissinfoch.com, ‘SNB toughens stance with euro rate target’, by Jessica Dacey, 6 September 2011, Available at <http://www.swissinfo.ch/eng/specials/swiss_franc/SNB_toughens_stance_with_euro_rate_target.html?cid=31070180>.
21. In particular, in 2008, the banking sector contributed 7.6 per cent of the Swiss GDP, whereas the insurance industry contributed 4per cent of GDP.
22. The CCB was formally adopted by the Federal Council based on working group recommendations from the Federal Department of Finance, which also has representatives of the Swiss Financial Market Supervisory Authority and the SNB among its members.
23. In addition to the CCB, in June 2012, the Federal Council announced a set of measures that included more stringent requirements for residential mortgage lending (i.e., an increase in the risk-weighting for the loan tranche exceeding the 80 percent loan-to-value ratio). A revision of the banking industry’s self-regulation guidelines was also adopted.
24. For an accessible account of the 1978–1981 events, see Kugler and Rich (2001).
25. The monetary base increased by 17percent from September 1978 to March 1979 (Kohli and Rich, 1986: 923)
26. Since 1975, the SNB has set targets for annual growth in the money stock (M1) within the framework of a monetary policy whose main objective was that of achieving price stability.
27. For an easily accessible review of the economics literature behind this thinking, see, for instance, Roberts, 2010: Ch. 2.
28. However, by contrast to current events, in the 1970s, restrictions on inflows of foreign capital were also used to stem the appreciation of the Swiss franc.
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Notes on contributors
Manuela Moschella
Manuela Moschella is Assistant Professor at the University of Turin, Italy. Her research focuses on global financial governance, the politics of financial regulation, and processes of ideational and institutional change in macroeconomic and financial regulatory issues.