Stability – the greatest Swiss virtue? | Economics in Plain English

Sep 06 2011

Stability – the greatest Swiss virtue?

BBC News – Swiss National Bank acts to weaken strong franc

The Swiss pride themselves on their long history of stable democracy, domestic tranquility and international neutrality. The stability of the Swiss state and the Swiss economy is heralded as one of its greatest virtues. But in the last few months, particularly in the first two weeks of August, instability has been more the norm in the Swiss economy due to the rapid appreciation of the Swiss currency, the franc, against the euro and the US dollar, which I blogged about here a couple of weeks ago.

Well, as of this morning, the franc’s ascent looks like it has reached its end, and the value of the franc is set to be pegged at 1.20 francs per euro (or 0.83 euros per franc), which is about 8% below what it was trading at this morning.

The Swiss National Bank (SNB) has set a minimum exchange rate of 1.20 francs to the euro, saying the current value of the franc is a threat to the economy.

The SNB said it would enforce the minimum rate by buying foreign currency in unlimited quantities.

The move had an immediate effect, with the euro rising from about 1.10 francs before the announcement to 1.21 francs.

In a statement, the SNB said: “The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

“The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20.

“The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.”

Against the franc, the euro climbed 9%, the dollar rose 7.7% and sterling gained 7.8% within minutes of the announcment.

NPR’s Planet Money reported on the story from Berlin here:

The instability resulting from the franc’s 30% rise in the value against other major currencies throughout the year is primarily the effect it has had on Swiss exporters. Foreign consumers, who actually buy about 50% of Switzerland’s output, have seen the prices of Swiss goods rise as the value of their own currencies has declined against the franc, reducing demand abroad for Swiss exports, forcing firms in the Swiss export sector to reduce their labor force and otherwise cut costs to compensate for the falling demand for their products. The threat of rising unemployment and falling demand for its output caused the Swiss National Bank and the Swiss government great concern, leading to today’s announcement.

The “deflationary development” mentioned by the SNB refers to a situation in the Swiss economy where the strong franc makes imports appear ever more attractive (and cheaper) to Swiss consumers, and Swiss goods increasingly less attractive to foreign consumers, reducing the demand for Swiss goods overall and forcing Swiss firms to lay off workers and lower their costs and prices to compensate for falling demand. Lower prices for goods and services in Switzerland reduces the incentives for firms to invest in new capital, thus reducing the demand for labor further, threatening to push the Swiss economy into a demand deficient recession. Deflation, defined as a persistent fall in the average price levels of a nation’s goods and services, can result in a downward spiral characterized by rising unemployment, falling demand, lower prices, and increased layoffs in the export sector, further exacerbating the unemployment problem.

The SNB’s decision to peg the franc to the euro will assure that foreign consumers of Swiss goods will not see their prices continue to rise, and Swiss consumers of foreign goods will not see them get any cheaper in coming months, hopefully bringing Swiss households who have recently enjoyed cheap imports back to the Swiss market to buy more Swiss-made goods and services.

Personally, I have mixed emotions about the franc’s peg with the euro. Of course, on one hand I have benefited greatly from the stronger franc, as an American working in Switzerland, earning swiss francs, the stronger currency has meant I can send the same amount of francs home as I always have, but it has translated into larger and larger quantities of dollars. Today, the dollar’s value has risen nearly 8%, meaning this month I will have a bit fewer dollars in my savings account in the United States as I would have before the peg.

As an employee in a Swiss firm, however, my continued employment depends on the continued demand for the service my school is providing, which is education to the children of multi-national corporations operating out of Switzerland. If the franc had continued to rise, the incentive for multi-nationals to locate their offices in Zurich would have become weaker over time, and more firms would have chosen to move their international employees to cities like Paris, London or Frankfurt, reducing demand for my school’s services and threating my own employment and income, just as those workers at other Swiss export firms’ jobs have been threatened in recent months.

Stability is a virtue the Swiss have always prided themselves on. Today’s announcement by the Swiss National Bank will bring greater stability to the Swiss economy, despite the disadvantages it brings to individuals who have enjoyed the benefits of a stronger franc in recent months.

The graph below explains how the SNB will enforce its currency peg against the euro:

Discussion Questions:

  1. How will the weaker Swiss franc help the Swiss economy?
  2. How will certain individuals in Switzerland be harmed by the weaker franc?
  3. How might the weaker franc affect demand for enrollmente at Zurich International School?
  4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
  5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate's Economics for the IB Diploma and REA's AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

16 responses so far

16 Responses to “Stability – the greatest Swiss virtue?”

  1. Best In Switzerland – SWITZERLANDon 04 Oct 2011 at 4:57 am

    […] Stability – the greatest Swiss virtue? | Economics in Plain English welkerswikinomics.com/blog/2011/…/stability-the-greatest-swiss-virt… […]

  2. kennyon 14 Nov 2011 at 8:43 am

    q1) the weaker swiss franc will increase the NX of the swiss economy. as exports become cheaper and that increased thus AD increased.

    Imports on the other hand will be more expensive due to weaker swiss franc. a decrease in imports and increase in exports increase NX –> increased AD and results in economic growth.

    q2) weaker swiss franc may mean decrease purchasing power. for production or merchandising industries that need to buy raw materials. it may result in higher production costs. and that cost must be translated to increase in selling prices . thus swiss goods may become more expensive and domestic users may elect to buy foreign imports instead.

    q3)it will affect the swiss internation enrollement schools as the weaker franc might result in some swiss teachers to move to greener pastures to teach for better contracts. when that occur the school loses in reputation, drop in international standings and results in a decrease in demand by international students.

    also if the international teachers are paid in USD. a weaker swiss franc means the school will have to pay more to its teachers . that result in the school making a loss. and that means the schoool cannot continue to upgrade infrastructure . and with all other countries schools improving. that result in a decrease in appeal to internatonal students . thus decrease demand for enrollement.

    q4) 1) one consequences would be that it might deplete the swiss foreign reserves as by promisign to pegged. should there be a speculative attack on the swiss franc. they need to create 'articial demand'' to maintain the pegged levels.

    2)no used of independent MP by the swiss central bank to smoothen short term fluctuations.

    q5)1) no usage of independent MP

  3. zhou sophieon 10 Nov 2012 at 7:39 pm

    1. How will the weaker Swiss franc help the Swiss economy?
    Weaker Swiss franc will increase export expenditure and decrease import expenditure by domestic consumers and investors. As a result, net export of the Swiss economy will increase as well as aggregate demand. Therefore, real output of the economy will increases.
    2. How will certain individuals in Switzerland be harmed by the weaker franc?
    Domestic consumers have to pay higher prices for imported goods and services.
    3. How might the weaker franc affect demand for enrollmente at Zurich International School?
    The demand enrollment at Zurich international school will increase due to cheaper tuition fees compare to other countries.
    4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    Firstly, the fluctuation of Swiss franc with Euro will decrease as a result it will reduce uncertainty about exchange rate for all the economic agents in the Swiss economy. Secondly, inflation will harm demand for exports and imports in Switzerland.
    5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    Under fixed exchange rate, government intervene the market through manipulating interest rate. If government assumes that exchange rate might increase (appreciate), they will increase interest rate, leading to deflation and unemployment. On the other hand, if government assumes that exchange rate might decrease (depreciate), they will decrease interest rate which will result in inflation. Therefore, fixed exchange rate can create unemployment or inflation. Moreover, for fixed exchange rate, government has to maintain high level of foreign exchange reserve. Furthermore, artificially low level of exchange rate might create international disagreement because low exchange rate will make the country’s export more competitive on world market which might be unfair to other countries.
    Floating exchange rate regime does not manipulate interest rate, therefore there might not be any inflationary or deflationary pressure due to changes in interest rate. Moreover, floating exchange rate adjust itself in order to keep the current account balance. If there is a current account surplus, then the demand for imports is high, resulting in decrease in exchange rate, vice versa. Finally, under floating exchange rate regime, government do not need to maintain a high level of foreign exchange reserve.

  4. nvirani2on 14 Nov 2012 at 10:27 pm

    1. How will the weaker Swiss franc help the Swiss economy?
    A weaker Swiss franc will encourage more consumption of the franc. It will be more valuable and thus the prices of Swiss products can increase. There will be an increase in exports and a decrease in imports.
    2. How will certain individuals in Switzerland be harmed by the weaker franc?
    The consumer will be harmed as they will have to pay more for imported products.
    3. How might the weaker franc affect demand for enrollment at Zurich International School?
    As it is an international school, people from different countries will be encouraged to enroll their kids in the school due to the weaker franc. This means that when they exchange their money they will have more francs. The demand will thus increase as they will see the school as being less expensive.
    4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    One possible consequence is the excessive buying of other currencies as mentioned in the article. This could result in much debt for the country as they will be buying an unlimited amount of other currencies. A second possible consequence is the inflation of the country.
    5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    A disadvantage for fixed exchange rate includes the government being compelled to keep the exchange rate fixed. This is seen in the case of Switzerland where the government will not let the exchange rate with the euro be raised above 1.20. In addition, the country is compelled to maintain high levels of foreign reserves to keep confidence in the market high. Setting the fixed exchange rate is also difficult as finding the exact right level takes time. Lastly, it could create international disagreement. All these reasons can be countered by floating exchange rates; however, those have disadvantages of their own.

  5. simcajkaon 17 Nov 2012 at 10:47 pm

    1. How will the weaker Swiss franc help the Swiss economy?
    It will help Swiss’s balance of payments, and any trading deficit because exports will become cheaper, thus more demanded and therefore the Swiss’s aggregate demand will rise, causing production increase as a response and possibly inciting an economic growth.

    2. How will certain individuals in Switzerland be harmed by the weaker franc?
    The weaker franc will harm domestic producers who will now face higher prices of imports, and even less choice as importers become intimidated by fall of demand for their imports. Domestic producers who rely on imported resources in their production process may experience higher production costs due to the now more expensive imports.

    3. How might the weaker franc affect demand for enrollment at Zurich International School?
    Enrollment by international student will increase, because the fall in value will make the tuition for students cheaper for international families, therefore these families will be attracted to the school.

    4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    There is the possibility of inflation and it will generate speculations and might lead to the depletion of swiss foreign reserves.

    5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    Pegged exchange rates are sometimes considered to be less desirable because the government cannot use monetary policies to achieve domestic goals, and the government is also deprived of exchange rate polices. The use of expansionary fiscal policy is also restrained because the financing deficits may affect the money supply or interest rates. Also exchange rate adjustments are often abrupt and therefore potentially disruptive. Furthermore the central bank may maintain large foreign exchange reserves.
    Whereas floating exchange rates allow policy makers to use monetary policies to achieve domestic goals. Any trade imbalances are more likely to be automatically corrected, in theory. The exchange rate adjustments are much smoother and continuous. Also less speculation exists and there is less need for the central bank to keep foreign exchange reserves.

  6. simcajkaon 17 Nov 2012 at 10:55 pm

    reply to #zhou sophie

    Hi Sophie, I think your response is very insightful. In question 4 I liked that you mentioned the reduction of uncertainties for the economic agents in the Swiss economy, as that really cleared things up for me. I also found your answer to question 5 to be very detailed. I did not think about the possibilities of inflation and unemployment under fixed exchange rates but as it seems it is possible, so a very crucial and interesting point!

  7. mmecathumon 18 Nov 2012 at 7:14 pm

    1. How will the weaker Swiss franc help the Swiss economy?
    The weaker Swiss franc will aid the Swiss economy, as it will result in an increase in export expenditure and decrease import expenditure increasing Swiss’ net export. This pushes the AD curve to the right as it increases as well and in turn result in economic growth form rise in the economy’s real output.
    2. How will certain individuals in Switzerland be harmed by the weaker franc?
    The most directly affected individuals harmed by the weaker franc are the domestic producers as they are now incurred a higher production cost due to higher prices of imports and a more scarce amount of imports resulting in the decrease in choice and quantity of imported goods. Some may even lose their source of import and may have to stop production altogether until they find an alternative.
    3. How might the weaker franc affect demand for enrollments at Zurich International School?
    Being an international school, a weaker franc means that it is relatively cheaper to be enrolled in that school when compared to the value of other currencies as now the value of those currencies would be higher. As such, demand for enrollments would increase abiding the law of demand.
    4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    a) There would be less fluctuations between the Swiss franc and Euro
    b) Inflation affecting the demand for exports and imports

    5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    A pegged or fixed exchange rate are sometimes considered less desirable than floating exchange rates as it needs to uphold the fixed exchange rate, However, a country’s central bank or government is continuously buying or selling the domestic currency and this necessitates a great sum of reserves.

  8. mmecathumon 18 Nov 2012 at 7:23 pm

    Reply to #simcajka

    I especially liked your response to question five as it was in depth. You did not just “operate” on the disadvantages of fixed or pegged exchange rates but brought in the advantages of the alternative, the floating exchange rate to back up the claim of pegged or fixed exchange rates being often considered as less desirable than floating exchange rates. All in all, your response was very easy to understand.

  9. dnyanon 19 Nov 2012 at 7:48 pm

    1.How will the weaker Swiss franc help the Swiss economy?
    The weaker Swiss franc will make exports from Switzerland less expensive and hence more competitive; this will increase the employment in the export industries. An increase in net exports will increase aggregate demand, and possibly real output and economic growth.

    2.How will certain individuals in Switzerland be harmed by the weaker franc?
    Individuals who buy imported goods will be worse off as they are now more expensive. People who earn francs and send money to their family abroad will also be harmed as the weaker franc will mean that their family will receive less money than before.

    3.How might the weaker franc affect demand for enrollment at Zurich International School?
    The demand for enrollment at Zurich International School will increase as it is relatively less expensive for parents who are expats or diplomats and earn an income in the currency of their home country for example in US dollars.

    4.What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    There will be less uncertainty and fluctuations between the franc and the euro and so businesses can plan ahead on predicted prices and costs. Secondly, the Swiss National Bank must keep high levels of foreign currency in order to peg the currency to the euro.

    5.Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    Pegged or fixed exchange rates are sometimes considered less desirable because interest rates have to be manipulated to determine exchange rates. For example when the exchange rate is falling then interest rates need to be increased to increase demand for the currency. This could result in a decrease in demand and employment as the cost of borrowing increases, conflicting with the macro-economic aim of low levels of unemployment. Setting the level for a fixed exchange rate is also not simple as if it is set to high then exports will not be competitive but if it set artificially low like countries like China have been accused of then this may create international disagreement and tension.

  10. dnyanon 19 Nov 2012 at 8:04 pm

    @#kenny
    I find it an interesting aspect to answer question 3 in terms of the effect on the teachers and then how this will affect the demand for enrollment.

  11. katieedwardson 25 Nov 2012 at 2:30 am

    How will the weaker Swiss franc help the Swiss economy?

    A weaker franc will cause the demand of foreign consumers to increase, because they can purchase more of the Swiss franc for their currency, and therefore exports will boom for the Swiss economy. Producers will export more and import less.

    How will certain individuals in Switzerland be harmed by the weaker franc?

    Companies that rely on imports to supply to consumers will be harmed by a weaker Swiss franc because the imports will be more expensive to those using the weakened Swiss franc.

    How might the weaker franc affect demand for enrollmente at Zurich International School?

    The demand for enrollment will increase because the tuition will be of a lower value with the weakened franc. International students will be interested in enrolling to obtain the same education as before, but for a cheaper price.

    What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?

    They’ll have to purchase a supply of euros so that they can keep the exchange rate equal, and by needing to supply more francs for euros, the National Bank could cause inflation in the supply of francs.
    A pegged exchange rate also makes the National Bank responsible for controlling the exchange rate in the future, and keeping it steady if they promise to enforce the pegged rate.

    Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?

    They are sometimes considered less desirable because inflation and deflation come from the national bank’s regulation of currency. Fixed exchange rates are controlled by government/bank power, whereas floating exchange rates would be more desirable to the people whose actions influence the foreign exchange rate.

  12. katieedwardson 25 Nov 2012 at 2:32 am

    @ dnyan

    Your response in #2 is interesting because I hadn’t considered the people who support their families from abroad being hurt. Differences in the exchange rate in a household use of currency impacts a lot more of the consumer population than central banks often account for.

  13. NadiyaSon 30 Nov 2012 at 2:42 am

    How will the weaker Swiss franc help the Swiss economy?
    A weaker franc will mean that the demand of foreign consumers increases. When the Swiss franc gets weaker, other currencies can buy more of the Swiss franc. Therefore the amount of exports demanded from Switzerland will rise, and as we remember, exports are injections into a macro economy. More exports and less imports is beneficial to an economy.
    How will certain individuals in Switzerland be harmed by the weaker franc?
    Not all companies export products (exports in this case are beneficial), some firms import products from other countries, to sell to Swiss consumers. However if the Swiss franc weakens, then the firms will have to pay more money for the same amount of products as they bought before. If the Swiss franc weakens, those who import products are at a disadvantage.
    How might the weaker franc affect demand for enrollment at Zurich International School?
    With a weaker franc, the cost for international students will decrease because their currencies are worth more than the franc, and if the cost for enrollment decreases, this means that the demand will rise.
    What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
    A promise would mean the Bank is now responsible for controlling the exchange rate which might lead to some problems.
    In order to enforce a pegged exchange rate, the Swiss Bank will need to purchase a supply of euros to maintain the exchange rate. If more francs are needed to keep the rate balanced, the Bank might cause inflation due to the increasing supply of francs.
    Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?
    Floating exchange rates change with the level of economic activity by the people, thus they are able to fluctuate accordingly, however fixed exchange rates are controlled by the government and or bank (and at times it is hard to battle the natural fluctuations).

  14. NadiyaSon 30 Nov 2012 at 2:47 am

    @kenny
    Your response to question three was really interesting. I hadn’t thought about the effects on the teachers the weaker franc would have. Although I wonder if the effect of the weaker franc would be enough to make the professors leave their jobs. Even with a weaker franc, the pay and school is still a good one, I guess it is a question of the extent to which the weakening franc would have an impact on the teachers…

  15. avonwendorffon 19 Nov 2013 at 1:12 am

    Hi # kenny,

    I liked your point about international teachers. I would like that they are paid in francs, and thus they get relatively less money compared to where they may spend the money during the summer at their homes.

  16. cbowieon 12 May 2014 at 1:52 am

    1.A weaker currency value is able to rise AD through the rise in exports and lowering of imports, thus should be beneficial in terms of economic growth.
    2.Relatively, imports will become more expensive, thus those who rely on cheaper imports may be harmed.
    3.By depending on foreign workers for employment, the school may be adversely affected by the weaker currency value
    4.By promising to peg the currency value, national reserves may be depleted trying to keep a stable value. Also, excessive currency reserves can trigger inflation.
    5.By allowing a currency to float, you are able to grasp a more true determination of its value. Also, as mentioned before, a pegged currency may deplete national resources or possible trigger inflation.