Question

There has been a growing concern, lately, about the on-going feud between the European Commission and the Italian government over the Italian budget deficit forecast for 2019. This has caused an increasing number of investors to convert their Euros into Swiss Francs.

a. Explain and show graphically what will be the consequence of these conversions on the value of the Swiss Franc (CHF) in terms of Euros, (i.e., on the EUR/CHF foreign exchange rate).

b. Suppose that the Swiss National Bank (SNB), the central bank, concerned for the country’s exporting companies, intervened in the foreign exchange market. How will the SNB intervene? (What exactly will it do)? Show graphically and explain the consequences of this intervention of the value of the Swiss Franc.

c. Explain the consequence of this FX intervention by the SNB on Switzerland’s monetary base.

d. Explain the consequence of this FX intervention of the level of the SNB’s international reserves. e. Explain and show graphically the consequence of the SNB intervention on the Swiss real interest rate.

Answer 1

Exporting businesses used to translate 0.88 EUR into 1 CHF beforehand. Now 0.95 CHF must be split for the same 1 CHF, which affects the exporting companies. CB usually comes to rescue exporters. OMO (Open Market Operations) is the most common method to reduce forex swings. In turn, the SNB will buy EUR out of the market and raise its Forex reserves.

The second option to depreciate SNB's currency (but last resort this option)

C.

The monetary base in Switzerland will grow (i.e. CHF cash circulating), as the SNB has printed and distributed massive CHFs to the market and raised EUR to build their foreign-exchange reserves.

D.

There will be an increment in international forex reserve.

E.

Swiss real interest rate (i.e. pure price without a element of inflation) will be that with SNB intervention. As the interest rate in Switzerland increases, global investors do not trade (i.e. carry trading from other countries is borrowed from low-interest countries and invests in high-interest countries).Historically as Switzerland had low interest rates, investors borrowed from Switzerland and invested in high-income countries as Australia and India. But interest rate growth does not lead to trades and so the demand for CHF decreases, which is the direct goal of SNB so that CHF does not enjoy much.