Customize Consent Preferences

We use cookies to help you navigate efficiently and perform certain functions. You will find detailed information about all cookies under each consent category below.

The cookies that are categorized as "Necessary" are stored on your browser as they are essential for enabling the basic functionalities of the site. ... 

Always Active

Necessary cookies are required to enable the basic features of this site, such as providing secure log-in or adjusting your consent preferences. These cookies do not store any personally identifiable data.

No cookies to display.

Functional cookies help perform certain functionalities like sharing the content of the website on social media platforms, collecting feedback, and other third-party features.

No cookies to display.

Analytical cookies are used to understand how visitors interact with the website. These cookies help provide information on metrics such as the number of visitors, bounce rate, traffic source, etc.

No cookies to display.

Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors.

No cookies to display.

Advertisement cookies are used to provide visitors with customized advertisements based on the pages you visited previously and to analyze the effectiveness of the ad campaigns.

No cookies to display.

Loading...
Most Recent Stories

Central Banks Don’t Need Financial Capital, but do Need Political Capital

In the wake of the SNB exchange rate shocker I think we’re learning a very important lesson – Central Banks are politically constrained. I think the most plausible reason for the exchange rate shocker is an explanation that has been relayed to me from many people in Europe – that the SNB acted because they were concerned about mark to market losses potentially undermining their balance sheet in the case that they were forced to follow the ECB along with QE.

While the SNB can’t go bankrupt in a currency it can produce, this could have weighed heavily on Swiss politics as the country views its monetary credibility as being above all else. Politically, this was a risky policy to continue as politicians might have felt that, at some point, they were going to have to “bail out” a Central Bank that was just digging a deeper and deeper hole. The SNB was clearly being forward looking here and took measures into their own hands before they had to even confront such an environment.

In reality we are constrained by the laws and institutional structures that allow certain entities to operate in certain ways. This is why it’s so important to understand the monetary system as it exists, as opposed to how politicians and economic theorists want it to exist. Of course, a Central Bank can’t become insolvent in a currency it can produce. That’s an obvious fact. But the fact that a Central Bank doesn’t need financial capital is only useful up to a certain point. After all, the Central Bank is a product of a certain country’s laws and it answers to the same politicians who created it and allow it to operate.

What the SNB experience is teaching us is the very real political constraint that controls so much of what government institutions can and can’t do. In this case the SNB clearly thought that following the ECB into the QE rabbit hole was a risk that could undermine their political capital. How rational is all of this? Not very in my view, but politics trumps reality in this case.