Have the Swiss National Bank’s currency interventions actually been good for Switzerland?

The Swiss franc has appreciated more than 50 per cent against its trading partners in the past decade:

You might think this would have affected the Swiss economy, perhaps by hurting exporters and domestic companies that compete with imports from abroad. That in turn might have led to cuts in business investment, hiring, and consumer spending.

You would, however, be wrong. The Swiss economy has shrugged off this apparent monetary tightening, and in some respects the currency appreciation has had the opposite of the predicted effect. Household consumption and business investment continued to grow at the same rates as before, while even the enormous trade surplus refused to shrink.

The Swiss National Bank has felt differently. Since the start of the crisis, the SNB has tried to limit exchange rate appreciation by spending 633 billion francs on foreign currency assets and foreign currency deposits at other central banks:

These interventions, plus some modest capital gains, have swollen the SNB’s foreign reserves to almost 700 billion francs — continuing its steady climb as a share of the Swiss economy’s yearly output:

It’s unclear what the SNB got for its trouble.

From the fourth quarter of 2007 through the third quarter of 2011, the SNB spent 246 billion francs trying to hold the currency down. That failed, so the SNB announced on September 6, 2011 that it was “prepared to buy foreign currency in unlimited quantities” to achieve a “substantial and sustained weakening of the Swiss franc”. There would be a hard floor of at least 1.2 francs per euro — cheaper than today, but still about 40 per cent higher than before the crisis. The official explanation was that the strong currency “poses an acute threat to the Swiss economy and carries the risk of a deflationary development”.

The SNB succeeded in enforcing its exchange rate target for a while, but only because it backed up its words with extreme actions. After a slight decline in foreign currency reserves at the end of 2011, the SNB spent about 165 billion francs to suppress the exchange rate in 2012, 17 billion in 2013, and 41 billion in 2014. All this just to keep the franc from appreciating even more than it already had thanks to the decreasing willingness of Swiss residents to invest abroad.

The SNB abandoned its exchange rate floor on January 15, 2015. No one has a compelling explanation for why the change occurred when it did, although one common argument was that the Swiss didn’t want to be forced to match the European Central Bank’s bond-buying programme. Regardless of the thinking at the time, the net effect has been a sustained 10 per cent appreciation of the franc and another 300 billion francs of foreign exchange reserves added to the balance sheet. Traders now think there is a “soft” floor of about 1.08 francs per euro.

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So what has all this done to the real economy? The short answer is: not much.

Start with the real output figures. Like most countries, Switzerland experienced recessions in the early 1980s, the early 1990s, the early 2000s, and in 2008-9. Switzerland bounced back from each setback and is currently growing at about 1.5 per cent each year:

If you squint, you can spot the impact of the January 2015 decision to abandon the hard floor, but it’s just as plausible the downturn in output in 2015 was linked to the fate of Switzerland-based commodity traders or weakness in the euro area, rather than anything relating to monetary policy.

That blip can likely be explained by a mild contraction in the trade surplus rather than anything related to the domestic economy. Real household consumption spending has been remarkably stable over the past few decades, with exception of the major recessions:

To be fair, the picture looks somewhat different when you account for the relatively rapid growth in the Swiss population, but even then, it’s tough to see the currency moves having much of an impact separate from the slowdown among Switzerland’s neighbours:

Investment spending has also held up well:

In both categories, which together account for almost 80 per cent of the Swiss economy, it’s basically impossible to see the impact of either the September 2011 decision or the January 2015 decision.

One reason Switzerland seems to have handled such an extreme currency appreciation with such aplomb is that the real exchange rate hasn’t moved nearly as much as the nominal rate. The rise of the franc has been mostly offset by quiescent inflation in Switzerland relative to Europe, America, and other trading partners:

But even after accounting for differences in inflation, the franc has appreciated more than 20 per cent in real terms since the trough on the eve of the financial crisis. Surely that must have had some kind of impact?

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As far as we can tell, the most we can attribute to the strong franc is that it has prevented Switzerland’s net capital outflows from growing even larger than they actually did. The chart below shows two different measures of those net outflows, one based on data from the financial account, the other from the current account:

Thanks in part to the almost 20 per cent depreciation in the real value of the franc from 2003 to 2008, Swiss residents increased their combined savings rate and boosted the share of national income invested abroad. This coincided with a significant drop in the share of national income spent on household consumption:

You’ll notice that the household consumption share stopped shrinking around the time the real exchange rate began to appreciate. This suggests that, as in China, Switzerland’s problem hasn’t been currency strength but insufficient household spending, perhaps motivated in part by currency weakness that depressed purchasing power.

After all, the decline in the consumption share was offset by a shift in Switzerland’s trade balance in goods — not services — from a rough balance to a massive surplus:

The surplus didn’t stop rising until the franc’s real exchange rate reached its current level, although it dipped temporarily during the spikes in 2011 and 2015. All of this suggests the Swiss franc is still too cheap, and that the SNB’s efforts to prevent its natural appreciation are harming Swiss households.

To understand why, it helps to remember that part of the appeal of floating exchange rates is they help balance out the preferences of savers and spenders across countries. People who consistently spend more abroad than they earn, let’s call them Brits, can only do so if foreigners, such as the Swiss, finance the difference.

Investors should be willing to finance deficits when the extra spending is on worthwhile projects that will boost productive capacity. If investors want to provide less financing, the international purchasing power of the spendthrifts has to fall. Floating exchange rates help smooth the adjustment process by minimising the need for debt defaults, wage cuts, and consumer price deflation.

Floating exchange rates also help by boosting the purchasing power of the tightwads that had been spending less than they earn and investing the difference with the spendthrifts. If the pound depreciates a lot against the franc, Brits might no longer be able to buy as many imports from Switzerland, which hits British living standards and Swiss exports, but Swiss consumers and businesses now have an easier time buying British exports. Maybe they switch from Nutella to Cadbury, or from Floradil to Advair. Instead of relying on deflation to make British exports more attractive — which increases debt burdens for British borrowers — both the Swiss and the Brits benefit from letting the exchange rate bear the brunt of the adjustment.

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The one potential cost of the exchange rate appreciation might be the modest slowdown in Swiss inflation since the financial crisis. But it’s hard to blame this on the currency. Relative to the 1995-2007 average, consumer price inflation in Switzerland has slowed by a little less than a percentage point. That compares to slowdowns of 0.4 percentage points in Germany, 0.6 percentage points in France, 1.1 percentage points in America, 1.2 percentage points in Italy, and 1.9 percentage points in Spain, for example. (The UK, unusually, experienced slightly faster average inflation since 2008 than in 1995-2007.) Clearly the strong franc isn’t posing some unique disadvantage.

Put it all together, and 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.

Related links:
Anatomy of a currency floor removal — FT Alphaville
Sweden’s central bank Riks-rolls the market — FT Alphaville
Switzerland’s problem isn’t an expensive currency but anemic consumption — FT Alphaville
The Swiss currency bombshell – cause and effect — Gavyn Davies

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