A Square Peg in a Round Euro
Of the Swiss National Bank's decision to abandon its euro peg, Thomas Jordan, the bank's leader, drily noted that "If you decide to exit such a policy, you have to take the markets by surprise." And boy, markets couldn't have been more surprised if he'd hired Russian currency traders to jump out of a cake in their birthday suits.
But this surprise has not been met with shouts of wild glee. Many eastern European homeowners suddenly have to repay their mortgages in now-much-more-expensive Swiss francs. Currency markets are in turmoil, banks are losing millions, and foreign exchange trading houses are flirting with insolvency. Paul Krugman, among other economists, says that it is abandoning its commitment to fight deflation, losing institutional credibility with markets, and in the process making it harder for other central banks to make credible commitments.
All this is true. And yet, currency pegs are very hard to commit to. It's not that the peg was a bad idea -- back when the euro crisis was in full swing, it was probably the best way to keep scared global money from swamping Switzerland's currency and destroying many of its export industries. The problem with pegs is that they're hard to maintain and also hard to let go of without ... well, a lot of financial chaos. With trouble in Russia and the European Central Bank trying to stimulate its lackluster economies with a round of quantitative easing, the peg was about to make life even more difficult for the SNB -- and it apparently decided that financial chaos was preferable to the alternative.
From an economist's perspective, this seems like the wrong decision, not just because of the chaos, but because, as Krugman notes, this is going to be hell on the exporters. But as Tyler Cowen points out, the SNB is not privileged to make its decisions in the rarefied air of a university office. It doesn't just need to think about maintaining institutional credibility with markets; it also needs to think about preserving the institution's political capital, protecting the bank from meddling politicians who might take away the bank's independence, and start doing things even less in line with modern macroeconomic best practices:
Bureaucrats hoard and indeed extend institutional capital because they know how important it is to maintain the quality of significant institutions, such as central banks. Without such capital, semi-independent central banks would soon cease to exist, to the detriment of us all. Outside academics, however, rarely can see the importance of this factor, because they have less experience running political institutions. When smart central bankers -- which yes includes the Swiss -- are apparently doing the wrong thing, it is because they are seeing more variables of the problem than we are. They either cannot do “the right thing,” or doing that would be too costly in terms of the country’s longer-term institutional prospects.
Maybe this hoarding is foolish in the current situation -- central banks, and indeed government agencies in general, are often excessively obsessed with preserving their prerogatives at the expense of their mission. But that, too, is a real-world constraint on the possibilities of policy: You go to your financial war with the central bankers you have, not the game-theoretically-optimized super-robots who might do a better job.
I've written this before, but my general observation in writing about financial crises is that the technocratically obvious solution is very rarely the politically feasible one. And yet commentators tend to ignore this. They ask, over and over, why the bureaucrats are trying some half-baked, eighth-best solution rather than this clearly superior policy I have right here, with the implication that the bureaucrats must be venal, or mad, or perhaps both, with a soupcon of sheer pigheaded stupidity thrown in for good measure. Sometimes this is true. But often what you have is smart, competent people doing what they must, rather than what they would like to do in a better world.
Of course, that's not going to make Polish homeowners or bankrupt currency traders feel any better about things.
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