Forward Guidance: Should the SNB have shocked the world?

There has been a very public divergence in central bank practice this week.

For six months, the European Central Bank (ECB) has been slowly building towards an expected announcement implementing Quantitative Easing (QE) in the Eurozone. Carefully tailored releases and winks have unsubtly alerted the markets that QE was coming to Europe and that market actors better be prepared.

By contrast, the Swiss National Bank (SNB) shocked the markets with a surprise announcement that it would be both abandoning their 3 year-old currency peg to the Euro and cutting interest rates. The effects have been likened to a future “nuclear explosion” [Logutenkova & Vögel; 2014], with immediate impacts including a 41% increase in the Swiss Franc against the Euro and a 20% decrease in Credit Suisse’s stock price.

Whilst it is clear that the policies themselves are debatable, the issue to be discussed here is not centred on evaluating economy management strategies.

Rather this week has highlighted a broader question: what is the best style for central banks to take action? Should banks use a long lead-up time to corral market agents into calmly closing arbitrage opportunities and perhaps suffer a reduced impact of their actions? Or should they hide their planning and shock economies into a given direction and risk volatilit and credibility?

This piece shall first explore what is the currently recommended practice and critique it. Subsequently we will look into the merits of the alternatives and attempt to highlight the best approach.

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