The initials “SNB” for the Switzerland’s central bank, the “Swiss National Bank” are about to become just as familiar as the initials ECB for the European Central Bank. Today, the SNB announced it would cut interest rates for banks that keep large amounts of money at the SNB to -.25%. Yes – a negative interest rate.
The SNB’s negative interest rate surprise is bigger news than it seems. Switzerland has strong reasons to turn to new monetary policy tools. The lackluster economic growth Switzerland has had since the Financial Crisis in late 2008–visible in the graph of Switzerland’s real GDP in the chart above–has brought inflation down until now it hovers around zero, as shown in the graph below:
The Swiss economy is heavily dependent on exports to the eurozone, which hasn’t fared well lately. And the Swiss economy has had troubles of its own. This past September, BBC News ran the headline “Swiss economy fails to grow as EU stagnates,” accompanied by this quotation from Maxime Botteron Credit Suisse’s Maxime Botterton:
The trend in exports is not a big surprise. Trade data so far already pointed to a rather weak contribution of exports. What is a bit more surprising is the weak investment spending, especially in the construction sector.
Let me explain why the slowness of Swiss exports matters: Thomas Jordan, the head of the SNB, said during Thursday’s press conference that asset markets have been spooked by the fall of the Russian ruble and are looking for a safe haven. Switzerland has a long history of being just such a safe haven: during times of crisis, money flows in. So the ruble crisis is putting upward pressure on how many euros it costs to buy a Swiss franc, because more investors are trying to buy francs. A more expensive Swiss franc will make Swiss exports even more expensive, making it even harder to sell things produced in Switzerland to the rest of the world. The SNB is determined, therefore, to do whatever it takes to keep the Swiss franc from ever costing more than .833 euros.
The main tool the central bank has had for preventing the Swiss franc from appreciating is buying up enough foreign assets with Swiss francs to guarantee there are enough Swiss francs available in the world for anyone to buy one for .833 euros. The trouble with relying on that approach alone is that Switzerland winds up with a lot of foreign assets that are less safe than Swiss assets would be (especially when the effect of possible future exchange rate changes on those foreign assets are taken into account).
The world is used to positive interest rates: a borrower pays a lender for the use of money. Negative interest rates mean that the lender has to pay the borrower to keep money safe. Negative interest rates are a way for Switzerland to get paid for the safety it provides in a financially dangerous world. Then, if Switzerland ends up with risky foreign assets while foreigners end up with safe Swiss assets, at least Switzerland is getting paid for the difference between the safe assets it provides and the riskier assets it is buying.
The most remarkable thing SNB chief Thomas Jordan added to his initial remarks was the statement that despite already having a -.25% interest rate compared to the ECB’s higher -.2% rate, the SNB is prepared to go even further. As James Shotter and Alice Ross reported in the Financial Times
Mr Jordan said the SNB was prepared to take further steps to protect the minimum exchange rate if needed, including pushing rates deeper into negative territory and lowering the threshold above which the negative rates were charged.
The other hint that the SNB is prepared to go further was in its statement that its band for the Libor interest rate now goes all the way down to -.75 %.
A good question to ask now would be: Why is the SNB confident that it can go down to deeper negative rates? Most central banks are afraid that if they cut their target rates or interest rates on reserves too far into negative territory, people will start piling up paper currency, which may be inconvenient to store, but otherwise pays an interest rate of 0%, which might start looking very good, compared to, say -.75%.
The answer, which most observers don’t realize, is that the SNB can actually inflict a negative interest rate on paper currency as well. In a principle that the underappreciated polymath (art and cultural historian, Biblical scholar and monetary theorist) Robert Eisler groped towards back in 1932, there’s an easy way to exact a negative interest rate: Charge customers an exchange rate between paper currency and money in the bank. More recent economists, notably Willem Buiter (now Chief Economist of Citigroup) further elaborated on this idea.
On July 15, 2014, I gave a presentation at the SNB explaining how to use a fee on paper currency deposited at the SNB by private banks to generate a negative interest rate on paper currency. This was a variant on Robert Eisler’s approach. To generate a negative paper currency interest rate, the paper currency deposit fee has to gradually increase in size. But as soon as interest rates are positive again, the paper currency deposit fee can gradually shrink in size until it finally disappears, and things go back to the way things work now. So the SNB has the idea of a paper currency deposit fee to implement negative interest rates on paper currency in its back pocket.
There is a world of difference between a central bank that cuts some of its interest rates, but keeps its paper currency interest rate at zero and a central bank that cuts all of its interest rates, including the paper currency interest rate. If a central bank cuts all of its interest rates, including that paper rate, negative interest rates are a much fiercer animal.
As a professor who teaches for a living, I care most about whether students learn things in the end. But I can’t help but notice the difference between quick learners and slow learners. When it comes to how to do negative interest rates right, the people at the SNB are some of the quickest learners I’ve seen.
The bottom line is that no one should underestimate the Swiss National Bank when it says that it will do whatever it takes to keep its exchange rate at .833 euros per Swiss franc – even if it requires boldly cutting its interest rates to a depth no central bank has gone to before.