Governments that issue currency set the exchange rate of that currency if they so desire. They can easily devalue their currency as the Swiss National Bank did over the weekend. The SNB pegged the Swiss franc to the euro at 1.20. Literally, within minutes, the Swiss franc dropped 10% against the euro and it probably happened with nothing more than a statement from the SNB. On the flip side governments can make their currency dear by taxing heavily and issuing (spending) very little, a deflationary approach.
so in other words it's through fiscal policy that they set rates and not so much open market operations or monetary policy?
ReplyDeleteNote that the SNB not only announced the target rate but asserted that its stood ready to use an unlimited quantity to regulate desired price. They got it exactly right. The market through in the towel since they know that the cb has this ability and the SNB convinced the market it would use it as necessary. Same applies to setting the overnight rate, and it is how the cb can also control the yield curve if it wishes to do so.
ReplyDeleteYes, but with exchange rates or anything else which is not completely under the control of the government, it is easy to devalue as Switzerland just did, but harder to raise the foreign value of your currency. Not entirely comparable to domestic rate control. You may have to raid your buffer stock of foreign currency, or heavily tax / underspend / raise interest rates. The last three can seriously damage your economy, which is why they are so popular.
ReplyDeleteIt should be just as easy to raise the value as lower it: Heavy and highly punative taxation coupled with very low levels of domestic spending. Think Latvia? Estonia?
ReplyDeleteTom,
ReplyDeleteI may have asked you this before (if so, I'm sorry to have forgotten your answer), but what are your thoughts about Ravi Batra's plan to tackle the trade deficit ($600B this year) with Tsy and the Fed creating a dual exchange rate system?
http://www.businesswire.com/news/home/20050901005833/en/Dual-Exchange-Rate-Revive-American-Manufacturing-Economist
I guess the Swiss are going to run out of francs:
ReplyDeleteThe move "will work for a while, but the market will have more money in the end than the SNB," Rogers, who was the co-founder of the Quantum Fund with George Soros, told CNBC.com.
Where did George Soros get the Sterling to short the pound, was it from the British banks?
ReplyDeleteBFG
@ beowulf
ReplyDeleteI've seen that and I think it is a very interesting proposal. But I don't have the chops in this area to know how practical it is. Sounds good theoretically though.
A big problem is delinking foreign policy from domestic policy so that foreign policy doesn't constrain domestic policy space. The US has done that by going to an all volunteer forces supplemented with private contractors, along with ending the practice of pay-go for war, so that the public doesn't notice the effects of war very much. I see this proposal as acting along similar lines to restore employment.
The MMT solution of recognizing that the real terms of trade favor the US now and the problem of job loss can be correct with fiscal policy seems much more practical to me.
That is probably not going to happen politically, so Batra's proposal seems worth exploring as an alternative. But maybe there are risks or some other downside I don't see.
Thanks for your comments Tom. So far as I can tell, monetary policy is useless, fiscal policy is impossible so I'm afraid that leaves exchange rate policy.
ReplyDeleteI agree with that, beowulf. I wonder what the ramifications would be, though, if the US (as global leader) went to a dual exchange rate. I don't see any importune consequences, but that doesn't mean that there aren't any.
ReplyDeleteIt's not entirely true that they can set the exchange rate at whatever level they want.
ReplyDeleteObviously it is easy for a country to devalue its own currency, but only if the other countries let it do it. Otherwise it would just be a race to the bottom with too much money or debt issued for nothing.
It is much harder to revalue the currency. Although you can reduce the supply of the currency you have no control over the demand.
BFG:
ReplyDeleteEssentially, yes. The bank creates a British Pound denominated credit (a BP denominated loan, essentially) for Soros and he then Soros uses the proceeds to buy dollars, say. (All done with leverage.) Soros pays interest on the Pound loan, but there is no term (duration).
Mammoth,
ReplyDeleteYou DO have control over demand. Throw people in jail for not paying taxes. See how much demand that creates. ;)
No Mike, throwing people into jail only creates internal demand for the currency, which is not what determines exchange rates.
ReplyDeleteAnyway, there are several examples of overvalued currencies successfully attacked, and overvalued pegs that eventually gave in, and currencies were devalued.
But is there any case of an undervalued currency that was revalued under attack?
Mammoth:
ReplyDeleteIf the consolidated government's (Fiscal authority plus central bank) policy was to restrict the quantity of money, then interest rates would be high and real rates of inflation would likely be very low--two conditions that often result in a strong exchange rate.