And second, balance sheet effects can have material impacts – affecting the link between current account deficits and external debt burdens, as well as the external adjustment process itself. A corollary of financial globalisation has been the increased importance of market forces, rather than institutionalised inter government agreements, in providing incentives for policy makers within systemically important countries or regions to follow policies that are mutually consistent – notwithstanding the longevity of the Bretton Woods sisters (the IMF and the World Bank). The second important feature of today’s world is the rising economic importance of a group of Asian emerging market economies who heavily manage their exchange rates. As a result, the international monetary system has mutated into a ‘hybrid’ system in which some systemic countries float their exchange rates while others fix or manage them. One implication is that the pressure for adjustment to any given shock can be very asymmetric relative to a floating rate world. Thus, market driven exchange rate changes are likely to be concentrated on particular blocs rather than diffused across the system as a whole. As Obstfeld and Rogoff and others have pointed out, this is a situation which could create some difficult policy frictions. These have the potential to undermine free trade, and weaken world growth. The third feature is the continued dominance of the US dollar as both a reserve currency as well an anchor for those countries that choose to fix or manage their exchange rates. But nowadays countries have choices.
For one thing, while evidence suggests that quantitative easing in particular succeeded in lowering long-term borrowing rates, its effect on the real economy is less certain. 6 For another thing, such policies may have important side-effects: they may lead to additional risktaking in financial markets and thus contribute to financial instability, 7 and they can create spillover effects to the rest of the world – notably emerging markets, where capital flows in search of higher yield can fuel asset prices and currency movements. 8 A complete assessment of the positive and negative effects of these measures will thus have to wait until we have data on the full experience, that is, until the complete exit from these policies. An assessment of the effectiveness of the SNB’s minimum exchange rate is clearer: this measure has played a decisive role in addressing the imminent risk of deflationary developments and has thus been successful. Given the still weak economic environment, it remains the central tool to ensure that monetary conditions are appropriate and that the SNB’s primary objective of price stability is fulfilled. The period since the collapse of Lehman Brothers has also underlined the value of central banks being able to respond flexibly to unexpected circumstances. On 30 November, the Swiss electorate will vote on the so-called “gold initiative” (“Save our Swiss gold”, in full), which, paradoxically, would severely constrain the SNB’s room for manoeuvre in a future crisis. Let me digress for a few minutes to explain why the SNB is opposed to this initiative.