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Switzerland Punished For Its Sound Fiscal Policies?

August 8, 2011

With the world’s two largest economies and currencies facing debt crises, investors have been flocking to the safety of the Swiss Franc.  Switzerland has a history of low inflation (0.7 percent in 2010), small government debt (38 percent in 2010), and a AAA bond rating, making it an ideal place to invest if you are worried about the dollar or the euro.  However, the result of this demand for Swiss Francs is that the price has risen (also known as the exchange rate).  As the figure below shows, the value of the franc has increased against both the dollar and the euro.  In fact the franc has risen by more than 30 percent against both the euro and the dollar since January 1, 2011.

Unfortunately for Switzerland, the increasing value of the Swiss Franc is not necessarily welcomed news.  The BBC reported this morning that the Swiss government held an emergency meeting today to deal with the rising Swiss Franc.  Switzerland is a very open economy, as its 2010 exports and imports were worth about 140 percent of the country’s GDP.  Its main export partners are its European neighbors and the US, but the increasing Swiss Franc could reduce exports, hurting many Swiss firms.  In addition, imports from the Eurozone and the US will be cheaper, which would also harm Swiss firms that must compete with imports from its neighbors.

There is not much that Switzerland can do to make its currency less attractive to investors, as hurting its finances to preserve the value of the franc.  The only real tool Switzerland has is to reduce interest rates, which it did last week.  However, with a current rate of 0.5 percent, Switzerland really cannot go much lower.  As a result, Swiss manufacturers are in essence being punished for maintaining fiscal discipline and having a stable currency that people want.

Update (8/10):  The Swiss Central Bank announced today that it would increase the supply of francs in an effort to reduce the increasing value of its currency.  However, as the BBC reported today, the Swiss have very little control over their monetary policy at the moment, given the size of the global financial markets and reasons why investors are flocking to the franc.

This post was updated on August 10, as the chart was unfortunately mislabeled on the original posting. It was suppose to indicate how much it costs to buy a Swiss franc in dollars and euros (i.e. currently$1.38 = Sfr. 1) instead of the other way around. This has since been corrected.

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