The Swiss show the way on exchange rate targeting

Kaveh Pourvand, 24 September 2013

In his forthcoming Civitas publication, A Competitive Pound for a Stronger Economy, John Mills reiterates the case for an exchange rate target to boost British manufacturing and the economy as a whole. Some may object: is John’s case based purely on theoretical speculation? Is an exchange rate target the sort of issue that a select few economists are interested in without any application to the real world?

In response, one needs point only to Switzerland. The Swiss government control a national investment fund, called the Swiss National Bank, which had assets of $360 billion in June 2012. It is in effect a Swiss sovereign wealth fund, most of which is invested in the bond markets of other countries. This makes Switzerland one of the world’s largest hedge funds and gives it a lot of leverage in financial markets. The SNB reportedly holds eight per cent of German government bonds, enough to influence German interest rates.

Switzerland is, contrary to popular perception, one of the most industrialised countries in the world and the SNB is used to ensure that the Swiss Franc remains at a competitive rate for Swiss manufacturers. When the Swiss Franc started to appreciate in September 2011, the government set a target exchange rate of 1.20 Swiss Francs to one Euro and used the asset reserves of the SNB to defend that position. They have maintained this target since then and defended the Franc. Recently, the Franc has marginally exceeded the target rate to reach 1.23 against the Euro. However, broadly speaking the target has been met. As a result of these concerted efforts, Swiss manufacturing exports have stayed stable in the last two years.

The Swiss experience strongly suggests that concerted government action can maintain an exchange rate within a certain range. Of course, the Swiss can do this because they have substantial assets with which the government can intervene in the financial markets. If the UK was serious about an exchange rate target, it too would have to think about building up some sort of sovereign wealth fund. But this would imply a more active government role in financial markets than perhaps orthodoxy allows. The main obstacle to an exchange rate target may not be economic, so much as political.