Selected Issues

Abstract

Selected Issues

The Swiss Franc—Living in a Multipolar World1

A. Introduction

1. With Switzerland being a globally-integrated small open economy, major international currencies and their associated monetary policies likely provide important reference points for the Swiss franc and the operation of Swiss monetary policy. Nonetheless, the behavior of the Swiss franc relative to the US dollar and to the euro has shifted significantly during the past decade:

  • Before 2010, the franc was relatively stable against the euro (blue line), while its movements against the US dollar (red line) paralled those of the euro vis-a-vis the dollar (green line);

  • During 2010 to end-2011, the franc strengthened against both the euro and the US dollar;

  • Between end-2011 and early-2015, the SNB maintained an exchange rate floor for the Swiss franc against the euro, and hence both currencies moved together relative to the dollar; and

  • Since early-2015, following removal of the exchange rate floor and subsequent appreciation against both currencies (but more so relative to the euro, which weakened against the dollar), the franc has tended to depreciate somewhat against both currencies.

uA01fig01

Bilateral Exchange Rate

(Index – 1999 January = 100, increase = CHF appreciation & EUR appreciation against US dollar )

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: Bloomberg Finance L.P.; and IMF staff calculations.

2. This paper models the evolving behavior of the Swiss franc relative to the world’s major reserve currencies and considers possible reasons for the shifts. Economic fundamentals, including country-partners and currency of denomination of Swiss trade and finance, are likely to affect which currencies the franc co-moves with, although these factors tend to change only slowly. The behavior of the Swiss franc may have also been affected by the global financial crisis and its aftermath, as well as the shift in recent years from synchronized to divergent monetary policies by the major central banks. The extent of flexibility along the currency stability—monetary policy-independence continuum under the monetary trilemma will determine how closely the franc moves with its anchor currencies.2 To gain insights into these issues, this paper estimates the extent to which the Swiss franc comoved with the major currencies during the past two decades, as well as the extent of fixity of the franc relative to the estimated reserve currency “anchor baskets.” The estimated currency weights are then considered in the context of fundamental factors that might influence which currencies the Swiss franc comoves with, and the weights are used to calculate an effective foreign interest rate relevant for Switzerland.

B. Related Literature

3. Identifying reserve currency blocks and the de facto behavior of currencies is an ongoing pursuit. The gap between de jure and de facto exchange rate regimes has been extensively documented. Many countries, especially emerging markets, tend to maintain less-flexible arrangements than suggested by their official regimes, which has been attributed to fear of floating (Calvo and Reinhart, 2012). Tovar and Nor (2018) find that the international monetary system has transitioned from a bi-polar to a tri-polar one, with an increasing role for the renminbi. Ilzetzki and others (2019) find that despite the prediction of a more multipolar system, the US dollar remains the dominant global anchor currency (or reference currency in the case of more flexible arrangements). They also find the euro to be the only other major anchor currency, although its sphere of influence is limited to Europe, and only a few examples of dollar-euro baskets have existed. McCauley (2014) finds that the euro’s importance was growing prior to the GFC—with its sphere of influence extending to Australia, New Zealand, Canada and Latin America—but has since retreated alongside an increasing role for the dollar.

4. A related issue is how closely countries peg to the anchor currency (basket). The purported widespread adoption of inflation forecast targeting in recent decades was generally believed to have led to more flexible exchange rates. Bracke and Bunda (2011) find evidence of greater exchange rate flexibility among Central and Eastern European and CIS countries. On the other hand, while Ilzetzki and others (2019) find an increase in the number of intermediate managed-float and target-zone regimes, they conclude that the world remains heavily skewed toward less-flexible arrangements.

5. Available characterizations of Switzerland’s de facto exchange rate regime convey a mixed picture and may not apply to the most recent period. Prior to the floor with the euro, Bracke and Bunda (2011) conclude the franc was very flexible, with the euro playing only a limited anchor role. For the period since the floor, Ilzetzki and others (2019) characterize the franc as a de facto moving band linked to the euro within a relatively narrow range. This latter characterization therefore does not detect any recent influence of the dollar on the franc.

C. Estimating the De Facto Swiss Franc Currency Regime

6. The two dimensions of exchange regimes—the anchor currency (basket) and the degree of exchange rate flexibility—should be identified simultaneously. This makes it possible to determine whether changes in the value of a country’s currency are due to co-movement with its anchor(s) or result from less-fixity around a central parity. Frankel and Wei (2008) and Frankel and Xie (2010) present an approach that synthesizes these steps into a single equation estimation model. Flexibility is determined by whether shocks to demand for a currency translate into the price of the currency (floating), the quantity of the currency (fixed) or some combination (intermediate regime).3 Identification of the anchor currency (basket) is obtained by regressing changes in the value of the currency on changes in the value of potential candidate anchors.

7. Following the models proposed by Frankel and Wei (2007, 2008) and Frankel and Xie (2010), the de facto Swiss franc regime is estimated by regressing changes in the Swiss franc on a weighted average of changes in leading reserve currencies. Each currency is valued in terms of the SDR,4 and enters as a percentage change to reduce the likelihood of nonstationarity while also allowing for the inclusion of a constant term to reflect a possible trend appreciation (or depreciation) in the level of the currency relative to its “basket”. Additionally, we include an exchange market pressure term, defined as the sum of the percentage change in the value of the currency and the percentage change in the stock of base money. The specification is as follows:

[Δlog CHFt – Δlog GBPt] =c + w1[Δlog EURt – Δlog GBPt] + w2[Δlog USDt – Δlog GBPt] + w3 [ΔlogJPYt – Δlog GBPt] + β BMP + ut where EMP = [Δlog CHFt + Δlog MBt]

CHF, USD, EUR, JPY and GBP denote the value of the currencies relative to the SDR. Monetary base is denominated in Swiss franc. The coefficients, wi, capture the weight of each currency in the de facto exchange rate basket, where their sum is constrained to unity.5 β measures the extent of de facto exchange rate flexibility, and multiplies a measure of exchange market pressure (EMP) defined as the percentage change in CHF relative to the SDR plus the percentage change in the SNB’s monetary base. When β is equal to zero, changes in EMP do not affect the value of the franc, implying a pegged regime, whereas a value of unity implies a pure float because MB does not change.6 The estimation is performed using ordinary least squares on monthly data for the period July 1999 to January 2019.

8. To capture possible changes in the exchange rate regime over time, the sample is split into four periods. Three breaks are assumed, resulting in four separate sub-periods:7

  • i. July 1999–December 2007, corresponding to the period prior to the GFC;

  • ii. January 2008–August 2011, corresponding to the GFC;

  • iii. September 2011–December 2014, corresponding to the period with the minimum exchange floor against the euro; and,

  • iv. January 2015–January 2019, corresponding to the period after the exchange floor.

9. The empirical model performs well overall, although fit (measured by R2) is relatively weak during the period of the GFC. The fit is especially strong for the most recent period (90 percent) and moderate for the first and third intervals (around 75 percent). Nonetheless, even when the overall fit is relatively weak, where the currency weights are of an economically-meaningful size, they are highly statistically significant.

Table 1.

Switzerland: Swiss Franc Exchange Regime Estimation Results

article image
Source: IMF staff calculations

10. Several notable empirical results are evident:

  • The euro has had a major weight in the estimated franc “basket” since the beginning of the sample period, while the role for the dollar has increased considerably in recent years. The weight of the euro rose from 70–75 percent prior to and during the GFC, and peaked at more than 90 percent during the period of the floor. The yen’s weight in the “basket” increased sharply to around one-third during the GFC. With sizable weights on the euro, dollar and the yen since the removal of the exchange rate floor, the franc can be characterized as a multipolar “basket.” The weight of the pound is relevant mainly during the time of the floor, which likely reflects identification issues owing to co-movement of the pound with the euro.8

  • The franc tracked the estimated currency “baskets” very closely prior to the GFC and during the floor (i.e., the coefficient on EMP is small), implying that idiosyncratic shocks to the franc were absorbed mostly through changes in monetary base.9 Since removing the floor, monetary policy has become considerably more flexible (the coefficient on EMP has risen from around zero to 57 percent).

  • A coefficient of close to zero on the constant term in each of the four periods implies that the franc does not display a trend with respect to its implied “baskets.”10 Nonetheless, the franc has appreciated relative to the SDR because reserve currencies which tended to appreciate (notably the yen) have a larger weight in the franc’s “basket” than in the SDR basket.

uA01fig02

Shares in the de Facto Swiss Franc Exchange Rate Basket

(Percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: IMF staff calculations

11. A synthetic Swiss franc reveals the extent of idiosyncratic market pressure on the currency since the onset of the GFC. A synthetic franc can be derived by cumulating up the time-varying “basket-weighted” changes in the reserve currencies, using the actual level of the CHF-SDR exchange rate at the beginning of each of the four intervals as the starting points. Comparing the synthetic with the actual value of the franc during 2010–11 indicates the large divergence of the franc from its reserve-currency linkages, which peaked at nearly 25 percent in August 2011. This provides a gauge of the extent of safe haven pressure exerted on the franc at that time. By contrast, appreciation pressures triggered by the realignment of monetary policies of major central banks (interest rate lift-off by the Federal Reserve and introduction of asset purchases and negative rates by the ECB) and exit of the franc from the euro floor around late 2014-early 2015 induced a smaller, but still substantial appreciation of the franc even as the synthetic franc was weakening.

uA01fig03

Actual and Synthetic CHF Against SDR

(Level, increase = CHF appreciation, synthetic CHFSDR rebased for actual values of 1999 June, 2007 December, 2011 August and 2014 December)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: IMF staff calculations.

D. Interpretation and Implications

12. The implied regimes align well with Switzerland’s de facto exchange rate arrangements and monetary policy frameworks. As documented in the IMF’s AREAER, the official exchange rate arrangement prior to and subsequent to the exchange rate floor is free floating, coupled with an “other” monetary policy framework. On a de facto basis, the regime was classified as a crawl-like arrangement during the period of the exchange rate floor, and was reclassified as floating after the floor was removed in 2015. According to the AREAER (2016), numerous countries moved to more flexible or less clearly defined exchange rate arrangements around that time due to heightened uncertainty in global economic and financial conditions.

13. The weights in the estimated exchange rate “basket” during the most recent period are now more aligned with the currency composition of the SDR basket. The change in the structure of the currency “basket”—which was previously dominated by the euro—has brought it closer to the SDR basket, although the weight on the euro and the yen are higher than in the SDR. The exchange rate weights are also relatively similar to the currency composition of the SNB’s reserves (see accompanying Selected Issues Paper).

uA01fig04

Currency Composition of Exchange Rate, Reserve and SDR Baskets 1/

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Source: IMF staff calculations.1/ January 2015-January 2019 for exchange rate basket, March 2019 for reserves, and March 2019 for SDR basket.

14. The implied currency weights and greater diversification of the “basket” accords well with Switzerland’s economic fundamentals:

  • A large weight on the euro is consistent with its important role in Swiss trade, although the dollar’s share in trade has risen. About two-thirds of Switzerland’s external trade is conducted with European countries, where the euro is likely the currency of invoicing and medium of exchange. The trade share with the US and the rest of the world, where the US dollar is likely to be important, has risen somewhat during the past decade, reaching around 30 percent. Swiss exports tend to be oriented to the quasi dollar-block region while imports are sourced mostly from Europe. This accords with Gopinath and others (2018), who report that 53 percent of Swiss imports are invoiced in euros, while 13 percent are invoiced in dollars. Beyond trade, the euro has added importance for Switzerland in view of its open labor market with the EU (see accompanying Selected Issues paper) and cross-border competition from EU firms.

  • A sizable weight on the dollar in the franc currency “basket” is consistent with Switzerland’s role as financial center. The dollar remains the dominant currency in international finance.11 About half of Switzerland’s FX-denominated private-sector foreign assets and liabilities are held in dollars, and a third are euros. A significant weight on the dollar and the euro therefore helps to limit currency risk in the context of financial dollarization and—to a lesser degree—financial euroization. The much-deeper spot and swap markets for the franc-dollar pair than for the franc-euro pair (as reported in the BIS Triennial Survey (2016)) also supports a sizable weight on the dollar in the currency “basket.”

  • Increased demand for safe assets during and since the GFC may have also affected the behavior of the franc vis-à-vis other currencies. To varying degrees, the US dollar, yen and the franc have in common the characteristic of a safe-haven currency. Jäggi and others (2016) find that negative surprises to the world economy cause the franc and the yen to appreciate, and that during the GFC, these currencies reacted more strongly to negative surprises than to positive ones. In line with this finding, one would expect that during risk-off episodes, demand for safe-haven currencies would tend to increase, causing them to co-move while appreciating against other currencies. These factors may explain the increased weight on the yen during the GFC.12 The shift in recent years to a more-diversified currency “basket” for the franc, with a greater role for the dollar and yen, may also reflect this common safe-asset characteristic.

  • Divergence of monetary policies by major central banks may have also contributed to a more diversified “basket.” Prior to and during the crisis, the monetary policy loosening cycles of the Federal Reserve and the ECB were relatively closely aligned. As a result, tracking only one of these currencies was not too dissimilar from tracking both. However, the more asynchronous policies in recent years would tend to discourage excessive concentration on any individual reference currency in favor of a more diversified “basket.”

uA01fig05

Exports and Imports by Region

(Percent – Europe EUR block; other regions – quasi-USD block)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: SNB; and IMF staff calculations.
uA01fig06

Foreign Assets and Liabilities

(Percent of total assets and liabilities)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: SNB; and IMF staff calculations.

15. The approach used in this paper identifies how the franc co-moves with the major reserve currencies, but is agnostic about the driving forces behind these moves. Is the franc’s behavior driven by markets, the result of policy or divine coincidence? McCauley (2014) observes that policy and market trading tend to align currencies into zones of shared movement. Relatively-deep markets for the Swiss franc and franc-denominated assets suggest that market trading plays an important role in moving the franc in the direction that market participants want it to go, implying that persistent divergence between policy and markets would be costly. Moreover, reverse causality, reflecting spillovers from policy actions by other central banks, is also likely to affect the behavior of the franc. Thus, in the absence of capital controls, and if policies are credible, whether markets or policies drive exchange rates is largely moot.

16. An effective foreign interest rate can shed light on the challenges facing a financially-globalized small economy in a multipolar world. Except for the yen, Swiss 3-month LIBOR was below comparable rates for the other major reserve currencies prior to the GFC. The negative differential between the Swiss interest rate and the effective foreign interest rate—defined as the time-varying “currency baskef’-weighted interest rates—averaged around one percentage point before the crisis.13 During the GFC, the effective interest differential was compressed as central banks converged simultaneously to the zero lower bound (ZLB). However, Switzerland not only faced the ZLB constraint earlier than other countries (because its initial rates were lower), it also faced a lower bound on the effective interest differential, and was thus squeezed from below and above. As a result, Switzerland experienced large inflows that appreciated the franc. To partly restore the historical differential, a negative policy rate was introduced at a rate below the ECB’s, helping to lessen the extent of appreciation pressure. The policy stances of the Federal Reserve and the ECB began to diverge around 2015. While the bilateral interest differential with the US widened, it remained compressed with the euro. This shift to asynchronous monetary policies by reference currencies—both of which are important for Switzerland’s real and financial sectors—likely contributed to the greater diversification of Switzerland’s “currency basket” in recent years.

uA01fig07

Interest Rate Differential With the CHF 3M Libor

(Percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: Bloomberg Finance L.P; and IMF staff calculations.
uA01fig08

Actual CHF 3 month Libor and Effective Foreign Interest Rate

(Percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A001

Sources: Bloomberg Finance L.P.; and IMF staff calculations

References

  • Berg, Kimberly A., and Nelson C. Mark. “Third-country effects on the exchange rate.” Journal of International Economics 96.2 (2015): 227243.

    • Search Google Scholar
    • Export Citation
  • Bracke, Thierry, and Irina Bunda. “Exchange rate anchoring-Is there still a de facto US dollar standard?” (2011). Working Paper Series, No 1353, ECB.

    • Search Google Scholar
    • Export Citation
  • Calvo, Guillermo A., and Carmen M. Reinhart. “Fear of floating.” The Quarterly Journal of Economics 117.2 (2002): 379408.

  • Deutsche Bundesbank Monthly Report July 2012, “The euro as an anchor currency and core of a currency bloc.” Deutsche Bundesbank.

  • Engel, Charles. “Exchange rates, interest rates, and the risk premium.” American Economic Review 106.2 (2016): 43674.

  • European Central Bank, July, 2017, “The international role of the euro.” ECB.

  • Frankel, Jeffrey A. Is Japan creating a yen bloc in East Asia and the Pacific? No. w4050. National bureau of economic research, 1992.

  • Frankel, Jeffrey, Eduardo Fajnzylber, Sergio Schmukler, and Luis Servén, 2001, “Verifying Exchange Rate Regimes,” Journal of Development Economics, Vol. 66, No. 2, December: 351386.

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey, Sergio Schmukler, and Luis Servén. Verifiability and the vanishing intermediate exchange rate regime. No. w7901. National Bureau of Economic Research, 2000.

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey, Sergio Schmukler and Luis Servén, 2000, “Verifiability and the Vanishing Intermediate Exchange Rate Regime,” Brookings Trade Forum 2000, edited by Susan Collins and Dani Rodrik (Brookings Institution, Washington, DC).

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey A., and Shang-Jin Wei. “Yen bloc or dollar bloc? Exchange rate policies of the East Asian economies.” Macroeconomic Linkage: Savings, Exchange Rates, and Capital Flows, NBER-EASE Volume 3. University of Chicago Press, 1994. 295333.

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey, and Shang-Jin Wei, 1995, “Emerging Currency Blocs,” The International Monetary System: Its Institutions and its Future, Hans Genberg, ed., Springer, Berlin, 111143.

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey A., and Shang-Jin Wei. “Assessing China’s exchange rate regime.” Economic Policy 22.51 (2007): 576627.

  • Frankel, Jeffrey, and Daniel Xie. “Estimation of de facto flexibility parameter and basket weights in evolving exchange rate regimes.” American Economic Review 100.2 (2010): 56872.

    • Search Google Scholar
    • Export Citation
  • Ghosh, Atish R., Mahvash Saeed Qureshi, and Charalambos G. Tsangarides. Friedman redux: External adjustment and exchange rate flexibility. No. 14–146. International Monetary Fund, 2014.

    • Search Google Scholar
    • Export Citation
  • Gopinath, Gita, et al. “Dominant Currency Paradigm.” NBER Working Paper 22943 (2018).

  • Gourinchas, Pierre-Olivier, Helene Rey, and Nicolas Govillot. Exorbitant privilege and exorbitant duty. No. 10-E-20. Institute for Monetary and Economic Studies, Bank of Japan, 2010.

    • Search Google Scholar
    • Export Citation
  • Ilzetzki, Ethan, Carmen M. Reinhart, and Kenneth S. Rogoff. “Exchange Arrangements Entering the Twenty-First Century: Which Anchor will Hold?The Quarterly Journal of Economics 134.2 (2019): 599646.

    • Search Google Scholar
    • Export Citation
  • Jäggi, Adrian, Martin Schlegel, and Attilio Zanetti. “Macroeconomic surprises, market environment and safe-haven currencies.” No. 2016–15. Swiss National Bank, 2016.

    • Search Google Scholar
    • Export Citation
  • McCauley, Robert N., and Tracy Chan. “Currency movements drive reserve composition.” BIS Quarterly Review December (2014).

  • Ranaldo, Angelo, and Paul Söderlind. “Safe haven currencies.” Review of finance 14.3 (2010): 385407.

  • Reinhart, Carmen M., and Kenneth S. Rogoff. “The modern history of exchange rate arrangements: a reinterpretation.” the Quarterly Journal of economics 119.1 (2004): 148.

    • Search Google Scholar
    • Export Citation
  • Reynard, Samuel, 2008, “What Drives the Swiss Franc?” No. 2008–14. Swiss National Bank.

  • Tovar, Camilo E., and Tania Mohd Nor. “Reserve currency blocs: a changing international monetary system?” (2018), IMF Working Paper No. 18/20.

    • Search Google Scholar
    • Export Citation
1

Prepared by Apostolos Apostolou (EUR) and Tryggvi Gudmundsson (MCM). The paper benefited from comments and suggestions from Christian Grisse and colleagues from the Swiss National Bank.

2

The term “anchor currency” should be interpreted in an observational sense as the franc was never pegged on a de jure basis.

3

Demand shocks are measured using exchange market pressure. See Country Report No. 18/174.

4

If the currency follows a peg, identification of the basket will be precise (an R2 of 100 percent), irrespective of the choice of numeraire. Alternatives to the SDR, including the Australian and New Zealand dollars, were tested as numeraires, and resulted in similar estimation outcomes.

5

This condition is imposed by subtracting the percentage change in the pound-SDR exchange rate from the left side of the equation and the percentage change in the pound-SDR weighted by the remaining currency weights from the right-hand side of the equation. The weight on the pound can be recovered as the difference between unity and sum of the other currency weights.

6

If the regime is a peg (to the anchor currency or basket), then the value of the currency—the first term in the EMP variable—does not change in response to a demand shock for the currency, which instead will be absorbed by a change in monetary base—the second term in the EMP variable. To ensure that the change in the value of the EMP variable does not affect the dependent variable—as would be the case under a peg—then β must be close to zero. In the case of a pure float, a shock to demand for the currency would be absorbed in the exchange rate—the first term in the EMP variable—with no change in monetary base—the second term. To ensure the EMP variable moves with the dependent variable, β must be close to unity.

7

The Bai-Perron test for break points identified only two significant breakpoints: May 2010 and September 2014. However, residuals for the two years prior to the first of these breakpoints—coinciding with the onset of the GFC— had a systematically-positive mean, suggesting that the behavior of the franc had already changed during these two years. We therefore impose an earlier first break as well as an additional break corresponding to the period of the floor.

8

A negative weight on the dollar during the floor implies that the franc was moving in the opposite direction to the dollar because the euro and the dollar were diverging.

9

During the GFC, the coefficient on EMP—though small—is insignificant. During this time, the franc both appreciated and monetary base grew strongly.

10

The coefficients are not significant during the first three periods, and only marginally so during the most recent period.

11

Gourinchas and Rey (2017).

12

McCauley (2014) finds instances of a negative currency weight on the yen, which tends to move inversely to the dollar, reflecting carry trade behavior.

13

Adjusted for expected exchange rate changes, this negative interest differential can be considered the return discount investors are willing to forego in order to hold franc-denominated fixed income assets.

Switzerland: Selected Issues
Author: International Monetary Fund. European Dept.
  • View in gallery

    Bilateral Exchange Rate

    (Index – 1999 January = 100, increase = CHF appreciation & EUR appreciation against US dollar )

  • View in gallery

    Shares in the de Facto Swiss Franc Exchange Rate Basket

    (Percent)

  • View in gallery

    Actual and Synthetic CHF Against SDR

    (Level, increase = CHF appreciation, synthetic CHFSDR rebased for actual values of 1999 June, 2007 December, 2011 August and 2014 December)

  • View in gallery

    Currency Composition of Exchange Rate, Reserve and SDR Baskets 1/

  • View in gallery

    Exports and Imports by Region

    (Percent – Europe EUR block; other regions – quasi-USD block)

  • View in gallery

    Foreign Assets and Liabilities

    (Percent of total assets and liabilities)

  • View in gallery

    Interest Rate Differential With the CHF 3M Libor

    (Percent)

  • View in gallery

    Actual CHF 3 month Libor and Effective Foreign Interest Rate

    (Percent)