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Beggar-Thy-Neighbor Exchange Rates?

The Swiss National Bank's recent announcement that it was intervening on the foreign-exchange market with the aim of reversing the appreciation of the franc has been met not by protest at the prospect of competitive depreciations, but by silence. Does this indicate that all other central banks entertain the possibility of using that option?

GENEVA – When the Swiss National Bank (SNB) recently brought its interest rate down to 0.25%, it announced that it would engage in “quantitative easing,” following in the footsteps of the United States Federal Reserve and the Bank of England. More surprising was the simultaneous announcement that it was intervening on the foreign-exchange market with the aim of reversing the appreciation of the franc. Will this be the first salvo in a war of competitive devaluations?

Interest rates are traditionally low in Switzerland. Like most other central banks confronted with the recession, the SNB has reduced its policy interest rate all the way to the zero lower bound. Once there, traditional monetary policy becomes impotent, as the interest-rate tool is no longer usable.

This is why central banks are now searching for new instruments. Quantitative easing represents one such attempt. It remains to be seen whether it can effectively restore some monetary-policy influence. However, an important issue is rarely mentioned: in small, open economies – a description that applies to almost every country except the US – the main channel of monetary policy is the exchange rate.

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