I have written a couple of comments on other blogs about the Swiss National Bank's decision to let the Swiss Franc float, and the resulting 20 percent appreciation against the Euro. The SNB held a substantial amount of Euro denominated assets, and so the result was heavy financial losses. The rise in the value of the Swiss Franc will result in cheaper imports from the Euro-zone, and so exacerbate consumer price deflation in Switzerland. That is inconsistent with the Swiss National Bank's inflation target.
Robert Murphy reproduced a graph that showed a large increase in the Swiss monetary base. It was approximately equal to Swiss GDP. I wrote a comment pointing out that creating base money is easy. What is the problem?
Of course, I do realize the problem is possible losses on the assets that the Swiss National Bank is purchasing. I discussed that in a comment on a post on Sumner's Money Illusion blog. He reproduced it in a later post on Econlog. If the demand for Swiss base money increases temporarily, then the proper response is for the SNB to expand the quantity temporarily. However, if it finds itself purchasing risky assets to match the added liabilities, then it should lower the interest rate it pays on reserve balances, perhaps below zero. As Koning pointed out in a post on his blog, if the interest rate on SNB reserve balances falls below zero, then this will create an incentive to hold currency. This would be an incentive by banks (especially Swiss ones) to hold vault cash and for people to keep currency in safe deposit boxes. I endorsed Koning's point that if the SNB is charging for reserve balances, then it needs to stop issuing large denomination banknotes convenient for hoarding. I argued that it should limit its issue of currency to denominations appropriate for retail trade in Switzerland.
Now, I don't believe that the SNB should be targeting the Euro or consumer price inflation. The SNB should not worry about deflation of import prices, but only the impact on the demand for Swiss exports and the secondary effect of import deflation on the demand for Swiss import competing products. Well, more exactly, it should be targeting Swiss nominal GDP which includes exports and import-competing (and other) Swiss goods and services.
Given its close trading ties to the Euro-zone, keeping nominal GDP growing on a stable growth path (say 3 percent) would likely result in depreciation of the Swiss franc relative to the Euro as long as the ECB continues with a deflationary policy. A commitment to allowing the Swiss franc to depreciate in that way would tend to reduce the demand for Swiss francs. Or at least, it will tend to reduce the demand for currency issued by the SNB and by refraining from raising the interest rate paid on reserve balances, the SNB could reduces the demand for reserve balances. Swiss banks, similarly could limit the increase in deposit interest rates to limit growth in their deposits.
Murphy's response to my brief comment on his blog was to describe a scenario where the huge increase in the quantity of Swiss francs starts to cause inflation. The SNB needs to reduce the quantity of base money to prevent the inflation. But at that same time, the Swiss franc rises relative to the Euro and so the SNB takes large losses on Euro-denominated assets. More importantly, sales of these lower valued Euro-denominated assets will cause a smaller reduction in the the quantity Swiss base money. In the extreme, the SNB may not be able to reduce its issue of base money enough to prevent inflation because it lacks sufficient assets to sell.
The first problem with the argument is the presumption that any increase in the quantity of money is inflationary. While this is true if we start in equilibrium and the demand for money is held constant, it is false if the quantity of money only rises to match an increase in the demand to hold money. It is supply and demand, not just supply.
So, the worry isn't some kind of inevitable inflationary impact of an increase in the quantity of Swiss francs, but rather the possibility that the demand to hold Swiss francs might fall. The SNB must be in a position to sell off assets and reduce the quantity of Swiss francs to match possible reductions in the demand to hold them.
Now, how exactly is it that the Swiss franc is going to appreciate against the Euro in this scenario? If anything, the reduction in the demand to hold the Swiss franc would cause it to depreciate. This would increase the value of Euro-denominated assets and make them more able to absorb Swiss francs when sold.
Suppose that the Euro-zones deflationary problem shifts to inflation. This could cause the Euro to depreciate. And so now, the SNB has Euro-denominated assets that have lost value. But is this realistically a situation where the demand for Swiss francs would fall? Wouldn't inflation in the Euro-zone instead result in a higher demand for Swiss francs?
And finally, as Sumner has pointed out, maybe the SNB should diversify its asset portfolio--don't just purchase Euro-denominated assets, purchase dollar (and yen) assets too. Remember, the problem isn't that the increase in the quantity of base money is inherently inflationary. It is to avoid net losses on the SNB's asset portfolio.
Consider a scenario that has been common in history, but far removed from the current situation:
Suppose the SNB was propping up the Euro by purchasing Euro-denominated assets. The problem is that the Euro zone is suffering from inflation and the SNB is responding to concerns by Swiss exporters. A higher Swiss franc will hurt their sales and profits. The SNB is purchasing Euros with newly-created Swiss francs, causing an excess supply of Swiss francs. Eventually (after the long and variable lags,) this excess supply of Swiss francs will lead to inflation in Switzerland. It would be a classic case of imported inflation. If and when the SNB gives up on the policy and no longer supports the Euro, the Euro will fall. Just when Switzerland needs to reduce the quantity of Swiss francs, its Euro-assets will have fallen in value.
Well, that would be a bad policy. But that is not what is happening. The demand for Swiss francs has risen. And the SNB needs to accommodate the higher demand to hold its liabilities by issuing more or else come up with a way to dampen the increase in demand by lowering the interest rate paid (or raise the amount charged) for deposit balances. As for hand-to-hand currency, it can quit issuing denominations convenient for large scale hoarding. I believe that the SNB, like other central banks, should get out of the hand-to-hand currency business, so that this would not be a policy matter, but rather a decision by private banks to limit their issue of hand-to-hand currency when they find it profitable to do so.
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ReplyDelete"If the demand for Swiss base money increases temporarily, then the proper response is for the SNB to expand the quantity temporarily."
and
"The SNB must be in a position to sell off assets and reduce the quantity of Swiss francs to match possible reductions in the demand to hold them."
and
"The demand for Swiss francs has risen. And the SNB needs to accommodate the higher demand to hold its liabilities by issuing more or else come up with a way to dampen the increase in demand..."
Mr. Woolsey, neither you nor myself nor any one particular person in the world, can know, quantitatively, when and to what extent changes in money holdings times are matched with "sufficient" or "equivalent" or "off-setting" money issuance.
There is a money illusion in your writing. It stems from the fact that money is monopolized and capable of being increased or decreased in supply by a single consciousness. The illusion is that if something is capable of being directed by a single consciousness, that a single consciousness can therefore be in a position to know how much to expand or contract the quantity of money to "meet" or "offset" changes in money holding times in the broader society, so as to bring about a kind of synthesis or balance between that single consciousness' actions and the actions of the rest of the world population's actions.
You cannot know that expanding or contracting the quantity of money by X, such that it has monetary effects on either prices or spending or interest rates, will "meet" or "satisfy" the public's new demand for money.
It is not true that every and all increases in money holding times are efficiently accommodated or responded to by only expansions or contractions in the money supply. It is also not true that changes in the public's money holding times are signals, or communications, for a single consciousness to increase or decrease the aggregate money supply. That is not what is taking place when money holding times change. The public is not saying "We want more money in the aggregate" or "We want less money in the aggregate".
Sometimes such changes are communications to money issuers to expand or contract, but NOT always. It is incorrect to make the blanket statement that every and all changes in money holding times are signals of desires to increase or decrease the total supply which is of course increasing the supply of money in particular bank accounts.
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ReplyDeleteSometimes changes in money holding times are communications directed towards real goods and services producers to alter their investments and output.
Like you said, we should take into account both supply and demand. Money demand changes are also real goods demand changes. Similarly, real goods demand changes are also money demand changes.
It is a fallacy to divorce money from real goods in the way you do. Money demand changes, because they are also real goods demand changes, may sometimes be communications to producers to change real goods production. Expanding or contracting the money supply in this case would be counter-productive, because expansions or contractions in the money supply have their own unique effects on real goods production, it may prevent the actual desired changes to real goods that the public wants which they communicated by changes to money holding times. Not because they are conscious of the total money supply, but because of individuals coordinating their subjective preferences in a "spontaneous", i.e. division of labor and economic calculation self ordering.
Now if the public desires changes to real goods production, sometimes such desires can ONLY be met with that which is associsted with an aggregate price or spending decline or increase. This is the case when only a falling tide can reveal which specific people are not wearing bathing suits, so to speak. Remember, aggregate spending declines are not composed of equal declines in every single individual instance of income. An aggregate spending decline could consist of just one firm experiencing a decreased revenues while there is no decrease in revenues for any other firm. And of course everything in between.
Aggregate changes in NGDP are necessarily relative changes in firm revenues and individual incomes. If NGDP rises or falls, then incomes rise and fall relative to each other. This point is crucial in understanding another very important effect of a single conscious with money illusion attempting to "meet" changes in the public's money holding times with expansions and contractions in the money supply, which itself results in a change to relative spending and relative capital allocations.
If such a consciousness with money illusion is persistent in aggregate price targeting, then what they are doing is risking a prevention of desired changes to real production that only that which is associated with an aggregate increase or decrease in prices can bring about.
The same is true for aggregate spending. If the consciousness with money illusion is persistent with NGDP targeting, then they would be risking a prevention of desired changes to real production that only that which is associated with an aggregate increase or decrease in NGDP can bring about.
If your main worry about the above is "unemployment", then that means your theory on money is incapable of engaging the above considerations.
A bit long, but thank you for your comment.
DeleteThe fundamental proposition of monetary theory implies that changes in actual money holdings are determined by the supply. I have never assumed that all changes in actual money holdings reflect changes in the demand to hold money.
As for your analysis of production, I think you need to start with the economic principle of scarcity.
Now, if people really do prefer more leisure rather than the goods and services that can be produced from labor, then they can quit their jobs. Keeping spending on output growing at a slow and steady rate doesn't prevent that from happening, though it does imply that this would tend to result in higher money prices for goods and higher money wages than a price level target.
The consequence is the exact same as a fixed quantity of money rule, at least as long as the income elasticity of the demand for money is unit elastic.
Well, I do not quite understand the central bank "problem" of acquiring assets for free (by printing money) and then those assets decline in value. Yeah, sure, on paper, the accounting of it raises "problems."
ReplyDeleteIn real life, the central bank can funnel balance sheet interest income to the Treasury and give taxpayers a tax cut. The Swiss should be enjoying tax cuts.
But...if central banks insist on worrying about their balance sheets, try this: monetize tax revenues instead.
If what I read is correct, the SNB now has a balance sheet equal to Swiss GDP, or roughly.
Okay, let us say instead the Swiss declare a tax holiday in Switzerland, and the SNB prints up (digitizes) the "lost" tax receipts and forks the fresh money over to the Swiss Treasury.
If we assume that taxes are one-third of Swiss GDP, then for the same amount of outlays, the SNB could have given the Swiss a three-year tax holiday.
I realize this is considered heretical. But is not the point to peg the Swiss franc lower? If the SNB announced it was monetizing tax receipts until the Swiss franc got to some level against the Euro...would not that work?
I wonder if the right way for the USA to fight a recession is a FICA tax holiday, compensated by the Fed buying bonds and putting the bonds into the Social Security and Medicare trust funds, to compensate for lost revenues.
Yes, heresy. But would it work? Is it only accounting conventions that proven such a solution?
Benjamin:
ReplyDeleteThe problem is that the demand for Swiss francs might fall. To avoid inflation in Switzerland, it will be necessary to reduce the quantity. Under your tax holiday plan, the way to reduce the quantity of Swiss currency would be to sell government bonds.
Now Switzerland has a large national debt on which it must pay interest.
Now I realize that you think moderately high inflation is a good thing. But this argument would apply even so. If the demand for Swiss francs falls off, then the result will be excessively high inflation.