Earlier today the central bank of Switzerland showed that there’s a lot that can be done through the communications channel of monetary policy by simply stating that they will not allow the Swiss franc’s price in Euros to rise above a certain level, and promised to engage in “unlimited” printing of money and purchasing of foreign currency to hit the exchange rate peg. Naturally, this immediately moved currency markets because when someone with the ability to create arbitrary quantities of Swiss francs at zero cost speaks of his determination to reduce the price of Swiss francs, you listen closely.
I continue to be fascinated by the fact that lots of issues in monetary policy that are controversial when you talk about “monetary policy” become uncontroversial when the subject switches to exchange rates. Everybody knows that currency depreciation expands aggregate demand. This is what the Swiss are talking about. This is what Americans are talking about when they complain about Chinese “currency manipulation.” And everyone agrees that a determined central bank can achieve whatever exchange rate goals it sets. So despite the apparent disagreement over whether or not a determined central bank can boost aggregate demand, everyone in fact seems to agree that it can—but only if we agree to talk about exchange rates rather than “aggregate demand.”
Even better slash stranger, the Swiss move has rekindled newspaper articles making hazy reference to “currency wars.” The reference here seems to be to competitive devaluations. The ECB tries to reduce the value of the euro vis-a-vis the dollar, yen, and pound. But then the Fed responds in kind. And then the Bank of Japan responds in kind. Meanwhile, Switzerland, Sweden, Canada, and Australia scramble to avoid giant negative demand shocks. What’s not clear to me is what this has in common with a “war.” Unlike in a war, nobody gets shot, nobody dies, and nothing is destroyed. What happens is that countries experience a higher inflation rate, unless they don’t want to experience a higher inflation in which case they simply fail to participate in the “war.” At the end of the “war” countries that are experiencing below-capacity output are making more stuff, and countries that are already producing at near their current capacity end up with more stuff. Basically, everybody wins. It has basically nothing in common with a war and a great deal in common with internationally coordinated action to produce adequate demand and correct global imbalances. The difference is that it’s not actually coordinated, so things get a bit chaotic. But compared to what’s been happening for the past 36 months a currency war would be a boon to the world.