I’m just home from Switzerland, where I gave the Karl Brunner Lecture. It is always eye opening to travel and see how other countries do things, and leads me to question basic assumptions.
A part of it, yes. In general building a central bank balance sheet is a good idea, within reason, along with smaller federal deficits, and moderate inflation.
The person you want as a leader is the person who doesn't crave being the leader. The person you want to lend to is the person who doesn't want more credit.
Switzerland seems to have a structural current account surplus. Assuming this stems from a gap in savings and investment decisions by the private sector and not currency manipulation, the interesting fact is that the political economy appears to be that the Swiss are happy to have the Central Bank manage the accumulated holdings as reserves. Norway is similar and different. It also has a huge current account surplus, but the accumulated resources are managed in a separate balance sheet from the Central Bank. Both are very small economies, it makes sense that huge stocks of savings are diversified away in the world capital markets. In one case it is the Central Bank, in the other a SWF (managed by the CB anyway).
Your suggestion makes sense from an investment perspective. Norway can do it because they invest oil proceeds that are owned by the state for the long term.
In contrast, the Swiss CB soaks up capital flows that result from (mainly Swiss) investors that repatriate or currency-hedge their foreign holdings, in order stabilise the CHF for the benefit of main street business. You can think of it as individuals depositing FX at the CB in accounts callable daily. Not a sane funding basis for long-term investment.
"The main problem with our trade deficits is that they financed government spending which subsidized consumption." You don't say. That's the whole point behind Trump's tariffs, which are 80% or so taxes on consumption, and which are aimed at incentivizing more domestic investment. Some of us have been beating that drum for a while, while the "free trade" fundamentalists have ignored the financing side of the BoP (See Gramm and Boudreaux in the WSJ). It would also be good to reduce out of control government spending and grotesque fiscal deficits which induce the "need" for borrowing from foreigners and/or printing money.
I greatly appreciated substance and style of your Brunner lecture, a memorable talk!
The SNB year-end balance sheet bookings cannot be understood without the political deal made between the SNB and the Swiss Treasury to preserve CB independence in presence of wildly fluctuating asset returns. To make comprehension even more difficult, balance sheet items are confusingly named in English.
You are right on "provisions for FX reserves" as provisions for future losses. Also, within the mentioned agreement, this item is shielded from distribution to the state, and is increased every year, even when the annual result is negative.
Whatever is left of equity is called the "distribution reserve" which *can* be distributed to the state. After a huge loss of -132bn in '22, this item turned negative and nothing was paid out until the miraculous '24 recovery with an "annual result (ie investment return)" of +80bn.
In year-end bookings, these 80bn were allocated as follows:
12bn to provisions (ie shielded from the state)
53bn to make the negative distribution reserve whole
16bn carried over to the distribution reserve, of which 3bn were paid out, carrying over a distribution reserve of 13bn for '25.
The state (confederation and the cantons) was actually happy about this 3bn payout after a dry-spell of 2 years which proves that the agreement successfully set low expectations.
And so it should because average annual return on FX assets in CHF was:
over 5y: -0.1%
over 10y: 0.8%
It turns out it is hard to generate a real positive yield if your liquidity requirement is dictated by bank reserves that are callable daily.
A side-note on Covid response in Switzerland: Covid loans were extremely quick, fronted by the bank that already dealt with the business, backed (possibly refinanced) by the government, interest-free, but time-limited and REPAYABLE. Handouts were limited to unemployment benefits that are mainly finance through premiums, so they were sizable but financed entirely within the terms of the debt brake.
Following your framework, the Swiss Covid inflation spike should be a textbook example of inflation ONLY caused by the supply shock. Actually, on closer inspection, such a spike seems to be absent; it looks like the 3% spike only came later, starting with the 2022 Russian invasion of Ukraine which drove up energy prices. Long-term rates rose as well, followed by indexed prices (rents, mortgages).
The whole episode petered out after the SNB hiked short-term rates to combat inflation. For FTPL it would probably have been more interesting if the SNB had not reacted to the spike at all.
Even better. FTPL (see Brunner Lecture) likes the central bank to raise rates quickly when fiscal inflation breaks out, making it smaller but more persistent.
You might check some of these substacks... Switzerland's been fascinating to watch in recent years. Yes, totally the exception. https://substack.com/@swissmacro . You might know him "Stefan Gerlach writes on monetary policy and central banking, occasionally with a historical perspective. He is Chief Economist at EFG Bank in Zurich and was Deputy Governor of the Central Bank of Ireland."
Yes, under the label "SNB Observatory", Gerlach, Lengwiler and Wyplosz are a voice in the public debate. Depending on your point of view, a more modern, anglo-saxon or left counterweight to the arch-conservative SNB tradition.
On the open econ policy trilemma (can't fix E, set M, and have no capital controls). Those are all 3 "extreme cases" meaning, you can't FIX E allow k-flows and then fix M-growth (in traditional models) anywhere. You run into unpleasant arithmetic. BUT... it's extremely common for countries to play in the gray middle ground. They don't "fix" E but mess with it a little, nudge here and there. They set M (or int rates) too and even play sterilize across domestic and international markets to prevent policy rate changes from influencing E and so on. In "normal times" all these seems to work fine. It's still true they can't do these things simultaneously but a little E management now, a little M adjustments next quarter, and so on and there's a lot of gray area to play with. Again, if you are conceptually just deviating from steady state, it's pretty safe. Calvo-Reinhart's "Fear of Floating" and related research touches on a lot of these issues. Anyway... you are right. In theory, they "can't do these together". In practice...many countries do for long, long periods of time and just balance it out. ... Switzerland is VERY interesting in the context of your work and was very interested to hear your thoughts. Thank you!
Switzerland has 2 major problems: too many foreigners want to work and live in Switzerland (mind you: those are mostly very qualified foreigners and not migrants into the welfare system) and too much foreign money wants to invest in the Swiss Franc. Both because Switzerland is so attractive and successful. At some point, Switzerland will have to curb the inflow of people as well as the flight into the Swiss Franc.
Swiss immigration is not a problem but a choice. Public opinion has a preservation mindset which puts pressure on free immigration policies. In that sense I concur. Economically, it works.
On capital inflow, I disagree. Where do you see such a thing? Swiss savings exceed investment, and have been exported for as longs as records are available. The problem now and through the centuries has always been that Swiss investment abroad does not always fare so well.
I know immigration works economically and that's why the mostly qualified immigration which Switzerland has adds value to GDP and to citizens. I am just thinking about the numbers (one of our sons lives/works in Zurich and has assumed Swiss citizenship). There simply must be a limit where Switzerland becomes too small for the number of people, however value-adding, who want to live there. Regarding the capital, I have no doubt that whenever there is a financial crisis, the flight into CHF will erupt again. The SNB cleverly sends that capital back offshore in different currencies but here, too, there is a limit to how much foreign currency assets the SNB can digest. Today, it's about one year's GDP. That trend cannot go on forever and as Warren Buffett once wrote: "If something can't go on forever, it will stop!"
Thanks for this, John. Speaking of Switzerland, I'd be very interested in hearing your thoughts on the history of Swiss banking secrecy....e.g., to what extent did it really exist, what were its consequences on Switzerland and on crime and tax evasion elsewhere, and whether it would be outmoded today by offshore banks and e-currency. Perhaps not something you really want to write....but I'd be very interested:)
1. I second Chris Ball's comment on how monetary policy can work in the spaces between the vertices of the trilemma. The problem is that in working in that space, if central banks persist too long with sterilized intervention rather than reducing the monetary base when demand for it falls, they face an unpleasant choice between depreciation and deflation. Usually they opt for depreciation.
2. Switzerland's exchange rate peg to the euro was eminently sustainable, because the central bank was accumulating rather than losing foreign reserves. There was no technical reason why it couldn't endure indefinitely. The Swiss government decided not to sustain it because it didn't want to import the moderately higher inflation rate of the euro area.
3. Trying to discourage unwanted foreign capital has a long history in Switzerland. For instance, during the end of the Bretton Woods period Switzerland temporarily imposed negative interest rates on nonresident accounts of Swiss francs.
4. On international macro, I commend to your reading Leland Yeager's book International Monetary Relations: Theory, History, and Policy, which is online free and on Kindle cheap. It weaves together the strands in a way I have not seen any other book do as well. Though old (1976) it contains much that is still valuable. If you have not read Yeager's book The Fluttering Veil: Essays on Monetary Disequilibrium, you should read it as well.
5. Holding a huge stock of foreign assets is not the same for a central bank as holding a huge stock of domestic assets. If the exchange rate floats, I don't see the rationale for holding a huge stock of foreign assets, but in any case, buying and selling foreign assets doesn't have the same effect as buying or selling domestic assets because the two classes are not perfect substitutes.
7. Don't try to fit everything into the Procrustean bed of the fiscal theory of the price level.
On 2: technically, that is true. But even if Switzerland wanted to follow the further easing planned by the ECB, how should they do that? The SNB was already at -0.75%. The government had all the money it could spend. Private investment was as high as always with no lack of savings. And capital controls à la 3. were considered "not done". A step move of the peg could have been done, but then why not return to the peg in the first place. What am I missing?
Switzerland could have pledged to have the central bank act as a currency board fixed to the euro. Then it would not even have needed an interest rate policy, though for the sake of appearances the Swiss National Bank could have mirrored the policy rate of the European Central Bank, as the Hong Kong Monetary Authority mirrors the policy rate of the Federal Reserve System in the operation of Hong Kong's currency board, which has endured for more than 40 years The underlying problem was that market participants perceived that Switzerland wanted lower inflation than the euro area, so the peg to the Swiss franc was under frequent pressure to appreciate. Events showed that market perceptions were correct.
Also, in my original post I see that the numbered points skip number 6. Number 7 should be 6.
Ok, I see what you mean. But it is inconceivable that the Swiss public vote in favor of a permanent peg of the currency board or even the Danish flavor. The Swiss "minimum exchange rate" was from the beginning a defense against an obvious and temporary overvaluation of the CHF
Nice paper on the peculiar Swiss case. Many of the questions that you raise are dealt with on https://snb-observatory.ch/en_US/ where we try to go beyond the awkward way the SNB presents its strategy. In a nutshell:
1. Switzerland is very open, very small, so the exchange rate is the key channel of monetary policy. But the SNB will not admit for a variety of reasons.
2. It uses the interest rate to guide the exchange rate and, when needed, it conducts exchange market operations to go where it wants.
3. The SNB is completely independent, with a constitutional guarantee and strong popular support, which allows it to be opaque.
4. The SNB does not finance the budget as the bulk of its operations involve foreign assets(liabilities, as you describe.
5. The current account is in permanent surplus as S vastly exceeds I. Swiss residents, many of them foreigners, invest their savings abroad where returns are higher, but subject to losses as the franc appreciates. In the long rate, the interest parity condition broadly applies.
6. The main threat to SNB independence is its huge balance sheet, which leads periodically to large losses, hence no remittances paid to the federal and cantonal governments, which bear the exchange rate uncertainty.
7. The safe haven nature of Switzerland, due to its economic and political stability, means that capital flows in during periods of global instability. It is a big pain for the SNB, hence its opaqueness.
5. My take on the SNB balance sheet is that Swiss investors go abroad FX hedged, and the result of these hedging operations ends up on the SNB balance sheet. I think policies should be devised that lead to the FX risk being carried privately again, like before the GFC. Does that make sense?
6. so the SNB-Treasury agreement to rein in state greed is a good thing after all?
7. glad to hear a somewhat unexpected praise of opaqueness out of the SNB Observatory
Yes, but isn’t Switzerland about the size of Orange County? Also, let’s get real…. The study of Economics is not a fixed science, as for example the Periodic Table of Elements…. It’s really just a basket of theories. Some, partially proven. With many as yet unidentified inputs and environmental factors, I’d have to say the Realm of Economics resembles a laboratory environment rather than an operational workhouse. And the workers resemble Wizards rather than professionals. Still, we’re always encouraged to Seek, Ask, Knock…. No question is dumb. Keep digging. I love your complex formula maps by the way. A sincere attempt. If we can proceed knowing we don’t have ALL the answers, humbly, we might just learn more.
I would like to add something about the trilemma and the size of the balance sheet. Caveat: I am not a monetary economist.
1/ Regarding the Trilemma: the SNB does not independently target the FX rate and inflation but only inflation (see 1. and 2. by Wyplosz in this thread). In a flight-to-safety scenario, the SNB can react by lowering the interest rate or by buffering the inflows, ie by buying FX. Both measures act in the same, desired, direction on inflation. I would think that in this case, both measures can be used interchangeably and that this does not violate the trilemma?
2/ Now, why would the SNB opt for FX purchases? My somewhat unusual take on this (at least I have not heard it elsewhere) is that the SNB ist willing to step in with FX purchases when Swiss investors retreat from abroad, and is willing to be the final counterparty when Swiss investors FX-hedge their foreign investments. In so doing, the SNB:
- ensures CHF convertibility without disruptions
- shields the real economy from capital market fluctuations
- smoothes the exchange rate to help the calculation problem (in an Austrian sense)
- ensures that its FX interventions are neutral wrt the "free" long-term FX and interest rate path
Why would FX purchases be necessary? Past reasons were at the lower bound (policy rate at -0.75%) and in defense of the peg. But in general, it has to do with the scale of Swiss gross investment abroad: 5(!)x GDP. In turbulent times, inflows quickly become sizable vs. GDP and M3. Also, investors in full flight barely react to interest rate differentials. Neutralizing the inflows looks like the appropriate thing to do.
Are there examples? I see two events. The first expansion of the SNB balance sheet happened following the GFC 2007 when both UBS and CS shrank their balance sheets (mostly their foreign components) from a combined 6x GDP to 2x GDP. The second step expansion of the SNB balance sheet took place during the 2010 EUR crisis when Swiss insurers, pension funds, banks and multinationals all got out of suddenly risky EUR debt. Ever since, and certainly after the peg and its end, Swiss investors FX hedge, which is why the SNB balance sheet persists.
Why can't the FX risk be privately hedged? First, toughened regulations make carrying FX risk unthinkable for financials. Second, after the sudden end of the peg, this is a difficult proposition in any case. There are no takers.
While the SNB underwriting basically all currency risk has its own problems, at least the SNB takes care to limit this service to the needs of the Swiss economy (at least that is how I interpret its actions). If this is true, we should see an upper bound of the SNB FX assets at the value of the Swiss NIIP (ca. 1x GDP). Which is satisfied, so my hypothesis has at least not been disproven.
With all this, I believe I can also give elements of an answer to John Cochrane's question of why the Swiss seem to be OK with the SNB balance sheet:
- the SNB saved Swiss industry when CHF appreciation threatened to kill it
- Inflation is under control and SNB profit distribution helps the state
- the more insightful realise that to this date, the SNB allows them to cash their foreign claims for Swiss Francs, and takes the net position of their FX hedges
Maybe the Fed should monetize the national debt.
A part of it, yes. In general building a central bank balance sheet is a good idea, within reason, along with smaller federal deficits, and moderate inflation.
The person you want as a leader is the person who doesn't crave being the leader. The person you want to lend to is the person who doesn't want more credit.
Switzerland seems to have a structural current account surplus. Assuming this stems from a gap in savings and investment decisions by the private sector and not currency manipulation, the interesting fact is that the political economy appears to be that the Swiss are happy to have the Central Bank manage the accumulated holdings as reserves. Norway is similar and different. It also has a huge current account surplus, but the accumulated resources are managed in a separate balance sheet from the Central Bank. Both are very small economies, it makes sense that huge stocks of savings are diversified away in the world capital markets. In one case it is the Central Bank, in the other a SWF (managed by the CB anyway).
Your suggestion makes sense from an investment perspective. Norway can do it because they invest oil proceeds that are owned by the state for the long term.
In contrast, the Swiss CB soaks up capital flows that result from (mainly Swiss) investors that repatriate or currency-hedge their foreign holdings, in order stabilise the CHF for the benefit of main street business. You can think of it as individuals depositing FX at the CB in accounts callable daily. Not a sane funding basis for long-term investment.
"The main problem with our trade deficits is that they financed government spending which subsidized consumption." You don't say. That's the whole point behind Trump's tariffs, which are 80% or so taxes on consumption, and which are aimed at incentivizing more domestic investment. Some of us have been beating that drum for a while, while the "free trade" fundamentalists have ignored the financing side of the BoP (See Gramm and Boudreaux in the WSJ). It would also be good to reduce out of control government spending and grotesque fiscal deficits which induce the "need" for borrowing from foreigners and/or printing money.
Thought-provoking.
I hope someday you look at Bank Indonesia's building a balance sheet through the pandemic era. The Bank of Japan has a huge balance sheet too.
Most orthodox US macroeconomists oppose a large central bank balance sheet.
However, such balance sheets can deleverage government, reducing credit risks to government bond buyers, and ease taxpayer burdens.
As seen in Switzerland, Indonesia and Japan, large balance sheets are not axiomatically inflationary.
Cochrane, take a look!
Why do we not save more?
a) Big tax reductions by Reagan, GWB, Trump 1 and Trump 2 not accompanied by big spending reductions so as to keep deficits = public investments.
b) Taxes that remain are mainly on income, not consumption.
I greatly appreciated substance and style of your Brunner lecture, a memorable talk!
The SNB year-end balance sheet bookings cannot be understood without the political deal made between the SNB and the Swiss Treasury to preserve CB independence in presence of wildly fluctuating asset returns. To make comprehension even more difficult, balance sheet items are confusingly named in English.
You are right on "provisions for FX reserves" as provisions for future losses. Also, within the mentioned agreement, this item is shielded from distribution to the state, and is increased every year, even when the annual result is negative.
Whatever is left of equity is called the "distribution reserve" which *can* be distributed to the state. After a huge loss of -132bn in '22, this item turned negative and nothing was paid out until the miraculous '24 recovery with an "annual result (ie investment return)" of +80bn.
In year-end bookings, these 80bn were allocated as follows:
12bn to provisions (ie shielded from the state)
53bn to make the negative distribution reserve whole
16bn carried over to the distribution reserve, of which 3bn were paid out, carrying over a distribution reserve of 13bn for '25.
The state (confederation and the cantons) was actually happy about this 3bn payout after a dry-spell of 2 years which proves that the agreement successfully set low expectations.
And so it should because average annual return on FX assets in CHF was:
over 5y: -0.1%
over 10y: 0.8%
It turns out it is hard to generate a real positive yield if your liquidity requirement is dictated by bank reserves that are callable daily.
Thanks for writing!
A side-note on Covid response in Switzerland: Covid loans were extremely quick, fronted by the bank that already dealt with the business, backed (possibly refinanced) by the government, interest-free, but time-limited and REPAYABLE. Handouts were limited to unemployment benefits that are mainly finance through premiums, so they were sizable but financed entirely within the terms of the debt brake.
Following your framework, the Swiss Covid inflation spike should be a textbook example of inflation ONLY caused by the supply shock. Actually, on closer inspection, such a spike seems to be absent; it looks like the 3% spike only came later, starting with the 2022 Russian invasion of Ukraine which drove up energy prices. Long-term rates rose as well, followed by indexed prices (rents, mortgages).
The whole episode petered out after the SNB hiked short-term rates to combat inflation. For FTPL it would probably have been more interesting if the SNB had not reacted to the spike at all.
Even better. FTPL (see Brunner Lecture) likes the central bank to raise rates quickly when fiscal inflation breaks out, making it smaller but more persistent.
You might check some of these substacks... Switzerland's been fascinating to watch in recent years. Yes, totally the exception. https://substack.com/@swissmacro . You might know him "Stefan Gerlach writes on monetary policy and central banking, occasionally with a historical perspective. He is Chief Economist at EFG Bank in Zurich and was Deputy Governor of the Central Bank of Ireland."
Yes, under the label "SNB Observatory", Gerlach, Lengwiler and Wyplosz are a voice in the public debate. Depending on your point of view, a more modern, anglo-saxon or left counterweight to the arch-conservative SNB tradition.
On the open econ policy trilemma (can't fix E, set M, and have no capital controls). Those are all 3 "extreme cases" meaning, you can't FIX E allow k-flows and then fix M-growth (in traditional models) anywhere. You run into unpleasant arithmetic. BUT... it's extremely common for countries to play in the gray middle ground. They don't "fix" E but mess with it a little, nudge here and there. They set M (or int rates) too and even play sterilize across domestic and international markets to prevent policy rate changes from influencing E and so on. In "normal times" all these seems to work fine. It's still true they can't do these things simultaneously but a little E management now, a little M adjustments next quarter, and so on and there's a lot of gray area to play with. Again, if you are conceptually just deviating from steady state, it's pretty safe. Calvo-Reinhart's "Fear of Floating" and related research touches on a lot of these issues. Anyway... you are right. In theory, they "can't do these together". In practice...many countries do for long, long periods of time and just balance it out. ... Switzerland is VERY interesting in the context of your work and was very interested to hear your thoughts. Thank you!
Switzerland has 2 major problems: too many foreigners want to work and live in Switzerland (mind you: those are mostly very qualified foreigners and not migrants into the welfare system) and too much foreign money wants to invest in the Swiss Franc. Both because Switzerland is so attractive and successful. At some point, Switzerland will have to curb the inflow of people as well as the flight into the Swiss Franc.
Swiss immigration is not a problem but a choice. Public opinion has a preservation mindset which puts pressure on free immigration policies. In that sense I concur. Economically, it works.
On capital inflow, I disagree. Where do you see such a thing? Swiss savings exceed investment, and have been exported for as longs as records are available. The problem now and through the centuries has always been that Swiss investment abroad does not always fare so well.
I know immigration works economically and that's why the mostly qualified immigration which Switzerland has adds value to GDP and to citizens. I am just thinking about the numbers (one of our sons lives/works in Zurich and has assumed Swiss citizenship). There simply must be a limit where Switzerland becomes too small for the number of people, however value-adding, who want to live there. Regarding the capital, I have no doubt that whenever there is a financial crisis, the flight into CHF will erupt again. The SNB cleverly sends that capital back offshore in different currencies but here, too, there is a limit to how much foreign currency assets the SNB can digest. Today, it's about one year's GDP. That trend cannot go on forever and as Warren Buffett once wrote: "If something can't go on forever, it will stop!"
Thanks for this, John. Speaking of Switzerland, I'd be very interested in hearing your thoughts on the history of Swiss banking secrecy....e.g., to what extent did it really exist, what were its consequences on Switzerland and on crime and tax evasion elsewhere, and whether it would be outmoded today by offshore banks and e-currency. Perhaps not something you really want to write....but I'd be very interested:)
1. I second Chris Ball's comment on how monetary policy can work in the spaces between the vertices of the trilemma. The problem is that in working in that space, if central banks persist too long with sterilized intervention rather than reducing the monetary base when demand for it falls, they face an unpleasant choice between depreciation and deflation. Usually they opt for depreciation.
2. Switzerland's exchange rate peg to the euro was eminently sustainable, because the central bank was accumulating rather than losing foreign reserves. There was no technical reason why it couldn't endure indefinitely. The Swiss government decided not to sustain it because it didn't want to import the moderately higher inflation rate of the euro area.
3. Trying to discourage unwanted foreign capital has a long history in Switzerland. For instance, during the end of the Bretton Woods period Switzerland temporarily imposed negative interest rates on nonresident accounts of Swiss francs.
4. On international macro, I commend to your reading Leland Yeager's book International Monetary Relations: Theory, History, and Policy, which is online free and on Kindle cheap. It weaves together the strands in a way I have not seen any other book do as well. Though old (1976) it contains much that is still valuable. If you have not read Yeager's book The Fluttering Veil: Essays on Monetary Disequilibrium, you should read it as well.
5. Holding a huge stock of foreign assets is not the same for a central bank as holding a huge stock of domestic assets. If the exchange rate floats, I don't see the rationale for holding a huge stock of foreign assets, but in any case, buying and selling foreign assets doesn't have the same effect as buying or selling domestic assets because the two classes are not perfect substitutes.
7. Don't try to fit everything into the Procrustean bed of the fiscal theory of the price level.
On 2: technically, that is true. But even if Switzerland wanted to follow the further easing planned by the ECB, how should they do that? The SNB was already at -0.75%. The government had all the money it could spend. Private investment was as high as always with no lack of savings. And capital controls à la 3. were considered "not done". A step move of the peg could have been done, but then why not return to the peg in the first place. What am I missing?
Switzerland could have pledged to have the central bank act as a currency board fixed to the euro. Then it would not even have needed an interest rate policy, though for the sake of appearances the Swiss National Bank could have mirrored the policy rate of the European Central Bank, as the Hong Kong Monetary Authority mirrors the policy rate of the Federal Reserve System in the operation of Hong Kong's currency board, which has endured for more than 40 years The underlying problem was that market participants perceived that Switzerland wanted lower inflation than the euro area, so the peg to the Swiss franc was under frequent pressure to appreciate. Events showed that market perceptions were correct.
Also, in my original post I see that the numbered points skip number 6. Number 7 should be 6.
Ok, I see what you mean. But it is inconceivable that the Swiss public vote in favor of a permanent peg of the currency board or even the Danish flavor. The Swiss "minimum exchange rate" was from the beginning a defense against an obvious and temporary overvaluation of the CHF
Nice paper on the peculiar Swiss case. Many of the questions that you raise are dealt with on https://snb-observatory.ch/en_US/ where we try to go beyond the awkward way the SNB presents its strategy. In a nutshell:
1. Switzerland is very open, very small, so the exchange rate is the key channel of monetary policy. But the SNB will not admit for a variety of reasons.
2. It uses the interest rate to guide the exchange rate and, when needed, it conducts exchange market operations to go where it wants.
3. The SNB is completely independent, with a constitutional guarantee and strong popular support, which allows it to be opaque.
4. The SNB does not finance the budget as the bulk of its operations involve foreign assets(liabilities, as you describe.
5. The current account is in permanent surplus as S vastly exceeds I. Swiss residents, many of them foreigners, invest their savings abroad where returns are higher, but subject to losses as the franc appreciates. In the long rate, the interest parity condition broadly applies.
6. The main threat to SNB independence is its huge balance sheet, which leads periodically to large losses, hence no remittances paid to the federal and cantonal governments, which bear the exchange rate uncertainty.
7. The safe haven nature of Switzerland, due to its economic and political stability, means that capital flows in during periods of global instability. It is a big pain for the SNB, hence its opaqueness.
Very true.
5. My take on the SNB balance sheet is that Swiss investors go abroad FX hedged, and the result of these hedging operations ends up on the SNB balance sheet. I think policies should be devised that lead to the FX risk being carried privately again, like before the GFC. Does that make sense?
6. so the SNB-Treasury agreement to rein in state greed is a good thing after all?
7. glad to hear a somewhat unexpected praise of opaqueness out of the SNB Observatory
Yes, but isn’t Switzerland about the size of Orange County? Also, let’s get real…. The study of Economics is not a fixed science, as for example the Periodic Table of Elements…. It’s really just a basket of theories. Some, partially proven. With many as yet unidentified inputs and environmental factors, I’d have to say the Realm of Economics resembles a laboratory environment rather than an operational workhouse. And the workers resemble Wizards rather than professionals. Still, we’re always encouraged to Seek, Ask, Knock…. No question is dumb. Keep digging. I love your complex formula maps by the way. A sincere attempt. If we can proceed knowing we don’t have ALL the answers, humbly, we might just learn more.
I would like to add something about the trilemma and the size of the balance sheet. Caveat: I am not a monetary economist.
1/ Regarding the Trilemma: the SNB does not independently target the FX rate and inflation but only inflation (see 1. and 2. by Wyplosz in this thread). In a flight-to-safety scenario, the SNB can react by lowering the interest rate or by buffering the inflows, ie by buying FX. Both measures act in the same, desired, direction on inflation. I would think that in this case, both measures can be used interchangeably and that this does not violate the trilemma?
2/ Now, why would the SNB opt for FX purchases? My somewhat unusual take on this (at least I have not heard it elsewhere) is that the SNB ist willing to step in with FX purchases when Swiss investors retreat from abroad, and is willing to be the final counterparty when Swiss investors FX-hedge their foreign investments. In so doing, the SNB:
- ensures CHF convertibility without disruptions
- shields the real economy from capital market fluctuations
- smoothes the exchange rate to help the calculation problem (in an Austrian sense)
- ensures that its FX interventions are neutral wrt the "free" long-term FX and interest rate path
Why would FX purchases be necessary? Past reasons were at the lower bound (policy rate at -0.75%) and in defense of the peg. But in general, it has to do with the scale of Swiss gross investment abroad: 5(!)x GDP. In turbulent times, inflows quickly become sizable vs. GDP and M3. Also, investors in full flight barely react to interest rate differentials. Neutralizing the inflows looks like the appropriate thing to do.
Are there examples? I see two events. The first expansion of the SNB balance sheet happened following the GFC 2007 when both UBS and CS shrank their balance sheets (mostly their foreign components) from a combined 6x GDP to 2x GDP. The second step expansion of the SNB balance sheet took place during the 2010 EUR crisis when Swiss insurers, pension funds, banks and multinationals all got out of suddenly risky EUR debt. Ever since, and certainly after the peg and its end, Swiss investors FX hedge, which is why the SNB balance sheet persists.
Why can't the FX risk be privately hedged? First, toughened regulations make carrying FX risk unthinkable for financials. Second, after the sudden end of the peg, this is a difficult proposition in any case. There are no takers.
While the SNB underwriting basically all currency risk has its own problems, at least the SNB takes care to limit this service to the needs of the Swiss economy (at least that is how I interpret its actions). If this is true, we should see an upper bound of the SNB FX assets at the value of the Swiss NIIP (ca. 1x GDP). Which is satisfied, so my hypothesis has at least not been disproven.
With all this, I believe I can also give elements of an answer to John Cochrane's question of why the Swiss seem to be OK with the SNB balance sheet:
- the SNB saved Swiss industry when CHF appreciation threatened to kill it
- Inflation is under control and SNB profit distribution helps the state
- the more insightful realise that to this date, the SNB allows them to cash their foreign claims for Swiss Francs, and takes the net position of their FX hedges