inflation, euro, foreign-exchangeThe Swiss National Bank is currently enforcing a cap of 1 EUR = 1.20 CHF, by promising to buy unlimited quantities of EUR at that rate. This was in response to large capital inflows seeking a “safe haven” causing substantial distortions in the exchange rate.
As I understand it this implies “printing” unlimited quantities of CHF. What effect will this policy have on inflation? Does the policy only counteract the effect of the capital inflows (Switzerland currently has a negative inflation rate), or does it create a significant risk of later inflation?
The SNB made the hypothesis that the Swiss Franc was highly overvalued and that part of this overvaluation was speculation (investors buying and holding the Swiss Franc because it should continue its rise). This overvaluation was hurting their exporting economy (prices became too high) and was threatening their labour market.
So, they introduced a cap that completely killed this buy-and-hold speculation and thus reduced the inflow of money to Swiss. By doing that, there is no further need to print money as there are no longer threats to their economy.
But, the problem is, that if they put a cap such that the Swiss Franc becomes too cheap, then there will be massive inflow of money, but this time it will not be to buy and hold the Swiss Franc, but to buy Swiss products. If that where to happen the SNB should stop its policy right away, else prices will increase very quickly (inflation) as the SNB prints money to match the demand from foreign firms to buy Swiss products.
We have to keep in mind that the reason behind having floating currencies is because the rate of exchange of currencies can adjust itself very quickly when the whole economy behind it can’t.
For example: Salaries are not adjusted of a daily basis and can remain too low while the inflation put the price higher, there exists contract that can fix prices of certain good a certain period, factories cannot be adjusted quickly to the new supply/demand, if money looses value to quickly then lending won’t be done on long period, etc….
So, if you want to assess the inflation risk, you can monitor the Foreign reserve of the Swiss Cenral Bank (I think that you can find this information on their website). If the reserve is increasing very quickly, then there is a risk of inflation.
Anyway, that’s my opinion and I can be wrong.
The answer is not clear. I guess that it will mainly depends on the behaviour of the economic actors. The key is probably commercial banking: if banks inject the new money faster that the country can match it with goods, then there will be an inflation.
Otherwise I think the effect will be relatively limited. But we must keep in mind that the swiss national bank promises to buy EUR with the “utmost determination”, and that we don’t know are deep will be the crisis on EUR.
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