The Swiss experiment: from the lower bound to flexible exchange rates.

• Author: Bernholz, Peter
• Position: Essay

On January 15, 2015, to the perfect surprise of markets, business firms and politicians, the directorate of the Swiss National Bank decided to abolish the lower bound for the euro of CHF 1.20, which had been introduced on September 6, 2011. (1) Obviously, the SNB had limited the number of people involved so that no leaks to the outside world occurred. In fact, a short time before the decision the Bank had still insisted that it would stick to the lower bound. Thus, the old truth had been confirmed that if a change of a foreign exchange regime is planned, central banks are obliged to lie.

The surprise was the greater since the lower-bound regime had been a big success. (2) It had been introduced after a strong fall of the euro to nearly CHF 1 to prevent damages to the real Swiss economy. During the 40 months of the peg's existence, the SNB only had to intervene about 4 months to maintain the lower bound and prevent the Swiss franc from appreciating against the euro. When the lower bound was announced the Bank pledged to defend it by

creating as many Swiss francs as needed to maintain the peg. This announcement stabilized expectations so that nobody wanted to risk losses by betting against the SNB. The Bank had to intervene strongly only during three months in the summer 2012. That intervention was not due to speculation. (3) Rather, two different related reasons may have been important for these interventions. First, the eurozone experienced a crisis of confidence. Second, Switzerland was enjoying a current account surplus that had to be financed. If the Swiss people and business firms were no longer prepared to invest in euros because they mistrusted the euro at the time, the SNB had to take over this task, which may have been an important reason for the interventions in 2012. After that episode no new interventions were necessary until the end of 2014. For some time the euro even reached CHF 1.24. And until the end of 2013 foreign reserves even fell by CHF 22 billion.

The absence of interventions in most months since 2011 marked quite a contrast to their substantial volume of CHF 200 billion from the end of 2008 to August 2011, which had scarcely been able to influence the fall of euro against the Swiss franc. This difference was presumably caused by the failure to shape expectations by introducing a lower bound.

In fact, with the introduction of the lower bound for the euro the SNB had successfully sheltered the Swiss real economy (including tourism) and unemployment against a sizable recession and deflation, even though at the rate of CHF1.20 an overvaluation of the franc still existed compared to its purchasing power parity, and thus a weak deflation took place in 2012-13.

It has been argued that the introduction of the lower bound of CHF 1.20 for the euro by die SNB has been a mistake. But the reasons given for this opinion are in no way convincing. First, the exchange rate fell from CHF 1.64 for the euro in 2007 as a consequence of the international crisis to 1.0663 on August 4, 2011. Even if we take the average value of CIIF of 1.565 for the years from 1996 to 2008, this implies a revaluation of about 47 percent. It is unthinkable that such a shock would not have had disastrous consequences for the Swiss real economy and Swiss tourism. Even with the lower bound of CHF 1.20 a strong overvaluation remained. Second, the Swiss franc not only appreciated against the euro, but also against other currencies. For instance the dollar fell from CHF 1.6886 in 2000 tol.030 in 2008 and 0.8873 in 2011. Third, foreign trade as a share of GDP is the more important the smaller the country. For Switzerland the share of exports (without gold) amounted to 35.7 percent of GDP in 2013. Finally, 46.3 percent of Swiss exports go to the eurozone. As...