Open-Economy Macroeconomics

• Module 43: Capital Flows and the Balance of Payments
• Module 44: The Foreign Exchange Market
• Module 45: Exchange Rate Policy
• Module 46: Exchange Rates and Macroeconomic Policy

SWITZERLAND DOESN’T WANT YOUR MONEY

Parking your money in a Swiss bank is no way to get rich, given the low interest rates Swiss bankers offer. In fact, Swiss banks have even paid negative interest on deposits, charging customers for the service of keeping their funds.

But for generations, Swiss bank accounts have been seen as a way to stay rich, a safe place to store your wealth. In the troubled years that followed the 2008 financial crisis, the Swiss reputation for safety became especially important. European investors, in particular, poured money into Switzerland.

And the Swiss hated it—the result of the inflow of foreign funds was a surge in the value of the Swiss franc that wreaked havoc with Swiss exports.

At the beginning of 2008, one Swiss franc traded for about 0.6 euro. By mid-2011, the franc was trading for around 0.9 euro. That meant that Swiss exports, other things equal, had seen a 50% rise in their labor costs relative to competitors elsewhere in Europe.

Thanks to its reputation for quality, Switzerland has been remarkably successful over the years at selling goods to the world market, despite high labor costs. Nobody expects to get a bargain on Swiss watches or Swiss chocolate. But this was pushing matters to the breaking point.

So what was to be done? Starting in early 2009, the Swiss National Bank, Switzerland’s equivalent of the Federal Reserve, began selling francs on the foreign exchange market in an attempt to hold down the franc’s value. In return for these francs, it received other currencies, mainly dollars and euros, which it added to its reserves.

We’re talking about a lot of sales: over a period of 2½ years, the bank added $180 billion to its foreign exchange reserves, which was about a third of Switzerland’s GDP—the equivalent for the United States of selling $5 trillion dollars.

Yet even that wasn’t enough to stop the franc’s rise. In September 2011, as the franc seemed headed for a value of 1 euro or more, the Swiss National Bank announced that it would do whatever it took—sell an unlimited amount of francs—to keep the franc below a maximum of 0.833 euro per franc (that is, 1.2 francs per euro, which was the way the target was stated). That announcement finally seemed to stop the franc’s rise, at least at first.

What the extraordinary efforts of the Swiss National Bank illustrated was the importance of a dimension of macroeconomics that we haven’t emphasized so far—the fact that modern national economies are open economies that trade goods, services, and assets with the rest of the world. Open-economy macroeconomics is a branch of macroeconomics that deals with the relationships between national economies.

In this section we’ll learn about some of the key issues in open-economy macroeconomics: the determinants of a country’s balance of payments, the factors affecting exchange rates, the different forms of exchange rate policy adopted by various countries, and the relationship between exchange rates and macroeconomic policy.