Here is from The Street Light:
“You may recall that in September the Swiss National Bank (SNB) announced that it was going to intervene as necessary in the currency markets to ensure that the Swiss Franc (CHF) stayed above a minimum exchange rate with the euro of 1.20 CHF/EUR. How has that been working out for them?
It turns out that it has been working extremely well. Today the SNB released data on its balance sheet for the end of September. During the month of August the SNB had to spend almost CHF 100 billion to buy foreign currency assets to keep the exchange rate at a reasonable level. But in September — most of which was after the announcement of the exchange rate minimum — the SNB’s foreign currency assets only grew by about CHF 25 billion. Furthermore, this increase in the CHF value of the SNB’s foreign currency assets likely includes substantial capital gains that the SNB reaped on its euro portfolio (which was valued at about €130 bn at the end of September), as the CHF was almost 10% weaker against the euro in September than in August. Given that, it seems likely that the SNB’s purchases of new euro assets in September after the announcement of the exchange rate floor almost completely stopped.”
This is a very strong demonstration of the power of monetary policy when the central bank is credible. This is the Chuck Norris effect of monetary policy: You don’t have to print more money to ease monetary policy if you are a credible central bank with a credible target. (Nick Rowe and I like this sort of thing…)
And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it? Obviously some would say that not all central banks in the world can devalue at the same time – but they can. They can easily do it against commodity prices. So lets say that the ECB, the Federal Reserve, the Bank of Japan, the Bank of England and the SNB tomorrow announced a 15% devaluation against commodity prices (for example the CRB index) and that they will defend that one sided “peg” until the nominal GDP level returns to their pre-Great Recession trend levels. Why 15%? Because that is more or less the NGDP “gap” in the euro zone and the US.
The clever reader will notice that this is the coordinated and slightly more sexy version of Lars E. O. Svensson’s fool-proof way to escape deflation and the liquidity trap.
Is a coordinated 15% devaluation of the major currencies of the world (with the exception of RMB) a crazy idea? Yes, it is quite crazy and it could trigger all kind of political discussions, but I am pretty sure it would work and would very fast bring US and European NGDP back towards the pre-crisis trend. And for those who now scream at the screen “How the hell will higher commodity prices help us?” I will just remind you of the crucial difference between demand and supply driven increases in commodity prices. But okay, lets say we don’t want to do that – so lets instead do the following. The same central banks will “devalue” 15% against a composite index for stock prices in the US, the UK, the euro zone and Japan. Ok, I know you are very upset now. How can he suggest that? I am not really suggesting it, but I am arguing that monetary policy can easily work and all this “crazy idea” would actually do the trick and bring back NGDP back on track in both the US and Europe. But you might have a better idea.
JP Koning
/ November 3, 2011“And now to the (not so) crazy idea – if the SNB can ease monetary policy by announcing a devaluation why can’t the Federal Reserve and the ECB do it? ”
The Fed and ECB can’t ease through a mere announcement because they don’t yet have credibility. They would have to expend tremendous amounts of firepower to reach their target.
The SNB was able set the peg via a mere announcement because by the time it came out in early September, the SNB had already spent some CHF 200B in a war against speculators through most of August. And the SNB was winning that war, and thereby demonstrating its resolve.
When the announcement came, they didn’t have to throw many more punches.
If the Fed and ECB announced the same sort of policy today, they’d have to expend massive amounts of firepower to achieve it. Just like the SNB did in August. The market doesn’t give away credibility for free.
Lars Christensen
/ November 3, 2011JPK, you are obviously right – both the ECB and the Fed lacks credibility, but I also think that credibility could be established very fast by acting aggressively, while at the same time announcing very clear targets – entry and exit strategies.
Furthermore, I am pretty certain that the amount of money put into QE in the US could have been much smaller if proper and clear rules had been announced early on. Bernanke for some odd reason, however, remain reluctant (Japanese-style) to do so.