Abstract
This paper compares the appreciation pressures on the currencies of Switzerland and Israel, documents the similarities and differences between their methods of interventions and discusses their consequences for the size of forex reserve accumulation and their management. Differences in methods of intervention and in the magnitude of reserve accumulation are discussed within the larger context of differences in the monetary policies of the Swiss National Bank and of the Bank of Israel. The paper examines the pros and cons of forex interventions by small open economies faced with large trading partners whose policy rates are at or below the zero lower bound and who engage in quantitative easing. Conventional views about costs of intervention and the related accounting methods used to quantify them are evaluated and institutional changes designed to ameliorate the tradeoff between leaning against appreciations and “excessive” reserve accumulation are considered.
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Notes
In particular, the SNB policy rate hit the zero lower bound as early as 2011 when the Israeli policy rate was still in the neighborhood of 3 %.
Further details appear in Figure 1 and the adjoining discussion in Ribon (2017). A relatively small amount of purchases designed to offset the potential impact of gas discovery on the exchange rate was preannounced during the second quarter of 2013 and consistently implemented thereafter. The average monthly intervention over months with non zero interventions during the variable intervention period was 830 millions $. This figure is substantially lower than the monthly intervention during the preannounced fixed intervention period.
Chronicle of monetary events, SNB 103rd Annual Report (2010), p. 196.
The paper uses the widespread convention that the notation EUR/CHF refers to the number of CHF needed to purchase one unit of the Euro (EUR). The currency in the numerator is known as the base currency and the one in the denominator as the countercurrency or quote currency. Or, in other words, EUR/CHF designates the number of units of domestic (Swiss in this case) currency per unit of foreign currency (Euro in this case).
Chronicle of monetary events, SNB 104th Annual Report (2011), p. 201.
The maximal monthly increase in forex reserves was 92 billion CHF. It occurred just prior to the enactment of the 1.2 floor against the Euro in September 2011. Interestingly part of this increase was reversed one month later. But even after this reversal the cummulative increase in forex reserves between August and October 2011 amounted to 73 billion Swiss Francs. By contrast the maximal monthly increase in forex reserves at the BOI was smaller by several orders of magnitudes. This maximum was around 4 billion $ and it occurred at the beginning of the transition to the discretionary intervention period. An important reason for this difference is the much stronger safe haven demand for the Swiss Franc relatively to such a demand for the Israeli Shekel.
This corresponds to the convention that specifies the USD/ILS rate as the number of ILS per USD and the EUR/CHF as the number of CHF per one EUR.
In spite of this, the cumulative rate of appreciation of the real effective exchange rate (not shown) of the Swiss Franc is somewhat smaller than that of the Israeli Shekel. As documented later this is due to the fact that Swiss inflation was generally lower than that of Israel over the sample period.
But decisions about interventions were not explicitly aimed at maintaining a particular crawling peg.
When Israeli intervention was renewed there was no tradeoff between preservation of competitiveness and “excessive” buildup of forex reserves since those reserves were initially too low. During this initial period intervention was particularly beneficial since it helped to preserve competitiveness on international market while replenishing forex reserves at a relatively low price of foreign exchange. It is argued later that, under appropriate reform of institutions, the “tradeoff” that emerged later can be largely mitigated.
Over the 2006–2016 period the correlation between the ratio of forex reserves to GDP and the ratio of the monetary base to GDP was 0.98 in Switzerland and 0.85 in Israel.
Actually the drop of the Swiss policy rate to 0.25 preceded similar drops in the policy rates of the US, the UK and Japan by one or two quarters. Details appear in Figure 1.1 of Bean et al. (2015).
As in Figure 2 the vertical light and dark black lines denote respectively the periods of relatively strong intervention in Israel and Switzerland.
The remaining four BVAR endogenous variables in addition to the USD/ILS rate are CPI inflation, an index of the rate of change in business sector product, the BOI interest rate and one year ahead inflationary expectations derived from the difference between the yields to maturity of non-indexed and indexed bonds. The paper also conducts a number of sensitivity tests the most important of which is designed to separate the effect of intervention from the panic that induced a rush to the USD following the collapse of Lehman Brothers in September 2008.
Interestingly, a higher level of accumulated reserves reduces the likelihood that the BOI will intervene.
One of many such statements is reported on page 214 of the 105th SNB Annual Report (2012).
Sight deposits at the SNB constitute a major component of the monetary base.
The ZLB need not be strictly at zero as demonstrated by the recent negative policy rates of the ECB and of Switzerland. But, there is little doubt that that there is a floor to how much policy rates can deep into the negative range without abolishing cash or introducing other substantial institutional changes. The floor is probably not far from the current −0.75 Swiss policy rate. Buiter (2009) and Rogoff (2016) propose institutional changes designed to abolish the ZLB constraint.
Besides Switzerland and Israel other small open economies such as South Korea, Sweden, the Czech Republic and Columbia engaged in direct foreign interventions in order to reduce the impact of negative rates cum QE operations in the US, the Euro area and Japan on their economies.
But in practice, due to a large balance of accumulated domestic currency losses, the BOI has not transferred any profits to the Treasury for quite a while. .
In a sense this is analogous to the “exorbitant privilege” enjoyed by the USD to this day. This privilege consists of the ability to collect seignorage revenues from the rest of the world and to issue international debt denominated in domestic currency (Eichengreen (2011)).
Further details appear in sections 5 and 10 of Cukierman and Melnick (2015).
The SNB started to invest in equities relatively early. In 2010 the fraction of reserves invested in stocks was already 11% (SNB 104th Annual Report (2011), p.67). This fraction was subsequently raised to around 20%. .
A recent comprehensive survey of evidence on the equity premium appears in discussion note 1/2016 of Norges Bank Investment Management.
Although the US base expansion was substantially larger in absolute terms than its Swiss counterpart it constituted only 23% of US GDP at its peak in 2014. In contrast the Swiss base was over 80% of GDP at the end of 2016.
Estimates by Laubach and Williams (2015) and Curdia (2015) imply that the natural rate has been negative during most of the GFC and that it is likely to be in the negative range more often than before the crisis in the future. Although, as argued in Cukierman (2016), there are reasons to believe that some of those estimates are biased downward the prediction that negative natural rates will be more likely to occur in the future appears reasonable.
Profits in terms of domestic currency have been reduced substantially over the last ten years due to appreciation of the Swiss Franc. This occurred in spite of the fact that returns in terms of forex were significantly larger on average. .
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Cukierman, A. Forex Intervention and Reserve Management in Switzerland and Israel since the Financial Crisis: Comparison and Policy Lessons. Open Econ Rev 30, 403–424 (2019). https://doi.org/10.1007/s11079-019-09522-0
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DOI: https://doi.org/10.1007/s11079-019-09522-0