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.
This channel is ignored for one good reason: exchange-rate policies are fundamentally of the beggar-thy-neighbor variety. Unconventional policies that aim at weakening the exchange rate are technically possible even at zero interest rates, and they are quite likely to be effective at the level of individual countries. Boosting competitiveness through exchange-rate depreciation may not succeed in raising exports in a situation where world trade is rapidly contracting, but it can cushion the blow by switching demand toward domestically produced goods and services.