The Swiss National Bank announced today that it was committing itself to keep the euro-franc exchange rate above 1.20 francs per euro. Here is the opening of the Bloomberg story.
The Swiss central bank imposed a ceiling on the franc’s exchange rate for the first time in more than three decades and pledged to defend the target with the “utmost determination.” The Swiss National Bank is “aiming for a substantial and sustained weakening of the franc,” the Zurich-based bank said in an e-mailed statement today. “With immediate effect, it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs” and “is prepared to buy foreign currency in unlimited quantities.”
The euro had fallen to 1.11 francs per euro on Friday. Citing the deflationary threat to the Swiss economy of a massively overvalued franc, the Swiss central bank pledged to buy euros in unlimited quantities to meet its exchange rate target.
The euro is now trading at just over 1.2 francs per euro. The dollar has appreciated against both the euro and the franc, the dollar rising from $.787 on Friday to $.857 today.
The two-fold lesson that the Swiss are teaching us — not that it hasn’t been taught before, e.g., by FDR in 1933 – is simply this:
1) A country adopting a meaningful exchange rate peg against another currency surrenders control over its domestic money supply and its domestic price level to the monetary authority (or in case of a gold standard to the international gold market) controlling the currency against which the peg is established.
2) However, if a country wishes to increase (decrease) its domestic money supply and price level from their current levels, it can do so by pegging its exchange rate against another currency at a rate significantly below (above) the current exchange rate against the targeted currency.
It is therefore simply wrong to assert that the US or any country could not achieve any desired price-level target, because the US monetary authorities (i.e., the Fed and Treasury) could announce that they would peg the dollar to another currency at a rate significantly different from the current exchange rate. By making such an announcement in a credible fashion (as the Swiss have done) there is nothing to stop the US from achieving any desired level of prices (corresponding to a particular exchange rate peg). Monetary policy is never ineffectual except by the choice of the monetary authorities .
HT: Lars Christensen
Update: Marcus Nunes has an excellent post on the Swiss National Bank announcement