Over the past few years, David Beckworth and I have stressed the importance of the concept of monetary equilibrium. When actual money balances differ from desired money balances, this causes fluctuations in spending and as a result nominal income. This is significant because in the short run, such fluctuations also have real effects. The implication is that increases in the demand for money should be offset with increases in the supply of money from the central bank.
This morning the Wall Street Journal editorial board embraced this concept (for Switzerland):
The Swiss National Bank’s announcement Tuesday that it would buy “unlimited quantities” of euros to keep the franc-euro exchange rate above 1.20 is a dramatic and helpful move amid the continuing euro crisis.
Switzerland is a small economy, but since 2008 its franc has become the shelter currency of choice for skittish investors. With debt crises on both sides of the Atlantic and Japan on its sixth prime minister in five years, Switzerland looks like the last sane man in the room.
But such popularity has driven up the purchasing power of the franc abroad while making Swiss exports more expensive. Exporters in particular have been howling about the franc’s appreciation. The Swiss central bank clearly had these pressures in mind in deciding to impose the exchange-rate ceiling.
But throwing a bone to exporters is not the most important reason for the central bank to intervene. Central banks are the monopoly suppliers of the commodity known as money. When a currency like the Swiss franc appreciates rapidly, the market is sending a signal that not enough francs are being printed to meet demand.
The modern central banker’s weapon of choice for combatting a currency’s rapid rise in value is a “sterilized” intervention—in which a bank sells its currency against another, but then sells bonds or other instruments so the amount of money in circulation doesn’t change. This may have a psychological effect on speculators but does nothing to change the supply-demand imbalance.
The Swiss National Bank, by contrast, seems to be buying euros with francs without offsetting the purchases elsewhere. In other words, it seems prepared at last to meet the increased demand with additional supply. This need not be inflationary for Switzerland. Should demand for francs recede in the future, the central bank can easily mop up the additional money it’s creating now by selling the foreign-exchange it’s currently buying to keep the franc steady.