Briefly explain the main economic rationale behind the Swiss National Bank’s (SNB) decision to intervene in the foreign exchange market in response to such a strong demand for franc.

Macroeconomics: theory and applications

Question 1

Using an appropriate version of the IS/LM/BP model, demonstrate which of the curves in the model would shift in response to the fall in the world interest rates (iw). Also, show how this would affect Switzerland’s BP position: you must clearly explain if it is a BP surplus or a BP deficit. (15 Marks)

Question 2

Briefly explain the main economic rationale behind the Swiss National Bank’s (SNB) decision to intervene in the foreign exchange market in response to such a strong demand for franc. (15 Marks)

Question 3

The IS/LM/FE model predicts that the BP disequilibrium (i.e. BP≠0) in Question 1 should eventually disappear and BP must return to zero (BP=0). Explain the underlying transmission mechanism that ensures this adjustment when:

SNB decides to peg the national currency as explained in the introduction, and
(15 Marks)
SNB decides not to intervene, i.e. it allows the value of franc to be determined by market forces.
(15 Marks)

Question 4

In addition to the two scenarios in Question 3, what other policy options are available for the Swiss authorities if they want to achieve BP=0? Discuss the pros and cons of each approach.
(15 Marks)

Question 5

Explain why SBN abandoned its policy in 2015 and why the franc/Euro exchange rate fell so sharply as a result.
(10 Marks)

Some economists argue SNB’s intervention in the exchange market was successful while others disagree about the success of the intervention policy. Critically discuss both sides of the arguments.
(15