FX MONETARY POLICies
The SNB could be restricted by potential losses on its foreign exchange reserves. An unconditional expansion of the money supply could create inflation further down the line. SNB could create the wrong incentives to investors fleeing the EuroZone sovereign debt crisis.
sheet (due to recent FX losses) than three decades ago, that all this does not come completely without future risks. I see three different types of risks: potential losses, losing control on inflation and giving international investor the wrong type of incentives penalizing Swiss taxpayers.
Potential Losses
Te SNB could be restricted by potential losses on its foreign exchange reserves. By committing to an unconditional expansion of its balance sheet, it risks greater mark-to- market losses on its foreign exchange reserves. Indeed, the SNB posted a 10.8 billion loss on its reserves so far this year, with its equity capital and loan loss provisions dropping from a peak of more than 60 billion CHF in 2007 to 29 billion in June. Tere are ways around this, however.
First, the SNB could be recapitalized to bolster
its balance upcoming October sheet. Te 23rd election,
as well as greater political consensus on preventing further CHF strengthening, suggests there are fewer political constraints to recapitalizing the SNB compared to the beginning of the year. Second, the SNB could alter the accounting treatment on its balance sheet and avoid marking-to- market its foreign currency reserves. Tere are precedents for this. Te Federal Reserve does not mark its gold holdings to market, for instance. Alternatively, the SNB could move reserves off-balance sheet, similar to the Norges Bank petroleum fund, and establish a sovereign wealth fund. Finally, as obvious as it may seem, by setting a lower bound for the Swiss Franc, the SNB precludes any losses on its holdings by preventing Swiss Franc
26 FX TRADER MAGAZINE October - December 2011
strength.
Inflation risk Te second limitation of SNB policy is more important, and relates to the impact of current policy on inflation. Te SNB has de-facto subordinated its price stability mandate to an exchange rate target, even though it maintains a de-jure inflation mandate. An unconditional expansion of the money supply could create inflation further down the line. In the near- term this is arguably not a constraint. First, Switzerland does not face an inflationary problem, with recent downside surprises in the CPI numbers mainly originating from imported goods and confirming the downward pressure, which the exchange rate is exerting on the domestic price level. Second, the SNB could sterilize its monetary policy
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