Barry Eichengreen and Beatrice Weder di Mauro write:\u00a0 Around the world, central banks’ balance sheets are becoming an increasingly serious concern \u2013 most notably for monetary policymakers themselves. When the Swiss National Bank (SNB) abandoned its exchange-rate peg\u00a0 causing the franc to soar by a nosebleed-inducing 20%, it seemed to be acting out of fear that it would suffer balance-sheet losses if it kept purchasing euros and other foreign currencies.<\/p>\n
Similarly, critics of the decision to embark on quantitative easing in the eurozone worry that the European Central Bank is dangerously exposed to losses on the southern eurozone members’ government bonds. This prompted the ECB Council to leave 80% of those bond purchases on the balance sheets of national central banks, where they will be the responsibility of national governments.<\/p>\n
Central banks are not profit-oriented businesses. Rather, they are agencies for pursuing the public good. Their first responsibility is hitting their inflation target. Their second responsibility is to help close the output gap. Their third responsibility is to ensure financial stability. Balance-sheet considerations rank, at best, a distant fourth on the list of worthy monetary-policy goals.<\/p>\n
Equally important, central banks have limited tools with which to pursue these objectives. Indeed, a clear understanding of their priorities has often led central banks to incur losses when doing so is the price of avoiding deflation or preventing the exchange rate from becoming dangerously overvalued. The Chilean, Czech, and Israeli central banks, for example, have operated with negative net capital for extended periods without damaging their policies.<\/p>\n
It is hard to fathom what the SNB was thinking. The sharp appreciation of the franc threatens to plunge the Swiss economy into deflation and recession. The risk of balance-sheet losses for the SNB, with its euro-heavy portfolio, may be greater now that the ECB has embarked on quantitative easing. But this is no justification for abandoning its mandate to pursue price and financial stability.<\/p>\n
Last year, the SNB was dragged into the highly charged debate surrounding a referendum on a \u201cgold initiative” that would have required it to increase its gold reserves to 20%, and limited its ability to conduct monetary policy. One rationale for the initiative was to bullet-proof the SNB’s balance sheet against losses. This goal was especially dear to the cantons, the states of the Swiss Confederation, which rely on transfers from the SNB for a significant share of their budgets.<\/p>\n
The \u201cgold initiative” was voted down, but the political debate was traumatic. In January, with the accelerating depreciation of the euro, the debate flared up again. The fear was that the SNB’s balance-sheet losses might anger cantonal leaders to such a degree that the central bank’s independence would be threatened.<\/p>\n
Whether true or not, the political salience of the issue underscores the dangers of an arrangement that precludes the SNB from focusing fully on economic and price stability. The obvious solution is not to abandon the franc’s euro peg, but to change the cantonal financing mechanism.\u00a0 And, to those who are concerned for the SNB’s independence, one might ask a fundamental question: What is independence for if not to ignore those who complain that the central bank is insufficiently profit-oriented?<\/p>\n
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