Swiss Currency Peg Reminds Us That In Central Banking There Is No Try

Ryan Avent did a great post from the American Economics Association meeting in Chicago wondering why so many economists seem to think it would be difficult for a determined central bank to raise inflation expectations. The social psychology explanation seems to be that it would be unduly rude and cause too much cognitive dissonance to say that the FOMC’s members are screwing up so badly, so we “must” infer that it’s a capacity problem. But as Caitlin Kenny reminds us with a glance back at the experience of Switzerland’s exchange rate peg last year, the evidence is lacking. When the Swiss Central Bank announced that it would force the Franc:Euro exchange rate to fall and then not allow it to rise again, many observers initially questioned whether this was feasible. Others—like me—thought it would be easy. The central bank can create unlimited quantities of Swiss francs instantly. If a man with the ability to create an unlimited quantity of diamonds warned you that the price of diamonds was about to fall, would you bet against him? You’d have to be insane. What you’d do is unload any diamonds you happen to own ASAP.

Charles Wyplosz, a Swiss economist, was skeptical the peg would work. But Kenny called him up, and he’s throwing in the towel: “Before the decision in September, [the Swiss National Bank] took in something like 200 billion euros which means a tripling of their balance sheet, since then nothing much has happened. The day they made their announcement that spooked the markets and the markets stopped pressing.”

Some people seem confused by the fact that currency peg policies do regularly fail. But the way they fail is that speculators force the pegging country to devalue. It can be quite difficult for a country to maintain a peg against downward pressure. But maintaining a peg against upward pressure is trivial. If banks don’t make it happen, it’s because they don’t really want to make it happen. And for all the same reasons that you can always push your exchange rate down, you should always be able to push your medium-term price level expectations up.