Monetary policy through exchange rate pegs: The removal of the Swiss franc‐Euro floor and stock price reactions

• Published date: 01 December 2021
• Author: Gregor von Schweinitz,Lena Tonzer,Manuel Buchholz
• Date: 01 December 2021
• DOI: http://doi.org/10.1111/irfi.12332

ORIGINAL ARTICLE

Monetary policy through exchange rate pegs: The

removal of the Swiss franc-Euro floor and stock

price reactions

Gregor von Schweinitz

1,2

| Lena Tonzer

1,3

| Manuel Buchholz

1

1

Halle Institute for Economic Research (IWH)

‐Member of the Leibniz Association,

Macroeconomics/ Financial Markets

Department, Halle, Germany

2

Leipzig University, Institute for Theoretical

Economics, Leipzig, Germany

3

Martin-Luther-University Halle-Wittenberg,

Faculty of Law, Economics and Business,

Halle, Germany

Correspondence

Gregor von Schweinitz and Lena Tonzer, Halle

Institute for Economic Research (IWH) ‐

Member of the Leibniz Association, Halle,

Germany.

Email: gregorvon.schweinitz@iwh-halle.de

(G. S.) and lena.tonzer@iwh-halle.de (L. T.)

[Correction added on 15 December 2020,

after first online publication: Lena Tonzer was

designated as corresponding author]

The copyrightline for this article was changed

on 22 December 2020 after original online

publication.

Abstract

The Swiss National Bank abolished the exchange rate floor

versus the Euro in January 2015. Using a synthetic

matching framework, we analyze the impact of this unex-

pected (and therefore exogenous) policy change on the

stock market. The results reveal a significant level shift

(decline) in asset prices following the discontinuation of the

minimum exchange rate. As a novel finding in the literature,

we document that the exchange-rate elasticity of Swiss

asset prices is around −0.75. Differentiating between sec-

tors of the Swiss economy, we find that the industrial,

financial and consumer goods sectors are most strongly

affected by the abolition of the minimum exchange rate.

KEYWORDS

exchange rates, stock markets, synthetic matching, uncertainty

JEL CLASSIFICATION

Classification: C22; E50; F30; F41

1|INTRODUCTION

Small open economies implement monetary policy not only via interest rate setting but also by managing exchange

rates. Exchange rate movements in turn have implications for a country's competitiveness and future growth options.

For such economies, it is hence important to know in how far changes in the exchange rate target affect market par-

ticipants' assessment of future development as reflected in stock market prices. However, tracing these effects is

Received: 17 March 2019 Revised: 17 February 2020 Accepted: 28 July 2020

DOI: 10.1111/irfi.12332

This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial License, which permits use,

distribution and reproduction in any medium, provided the original work is properly cited and is not used for commercial purposes.

© 2020 The Authors. International Review of Finance published by John Wiley & Sons Australia, Ltd on behalf of International

Review of Finance Ltd. 2020

1382 International Review of Finance. 2021;21:1382–1406.wileyonlinelibrary.com/journal/irfi

challenging because causality between exchange rate fluctuations and stock market movements can run in both

directions (Granger, Huangb, & Yang, 2000; Hashimoto & Ito, 2004). We exploit the unexpected removal of the

exchange rate floor of the Swiss franc versus the Euro on January 15, 2015 to analyze the causal effect of the Swiss

National Bank's (SNB) policy change on stock markets. As a novelty in the literature, the causal stock market reaction

allows us to estimate an exchange-rate elasticity of asset prices of around −0.75.

With the start of the financial crisis, and even more so during the European sovereign debt crisis, Switzerland's

status as a safe haven caused an increase in demand for the Swiss franc. To stop the appreciation of the currency,

the SNB introduced an exchange rate floor in September 2011.

1

The floor was set at a minimum exchange rate of

1.2 Swiss franc per Euro. On the one hand, this ensured no further appreciation of the Swiss franc against the Euro.

On the other hand, monetary policy became less independent as it forced the SNB to accumulate high foreign cur-

rency reserves and to increase the amount of Swiss franc in the market. Following the depreciation of the Euro and

in the run-up to an announcement of further monetary expansion of the European Central Bank (ECB), the SNB sud-

denly discontinued the minimum exchange rate on January 15, 2015.

This step was accompanied by a reduction of its benchmark rate by 75 basispoints from 0% to −0.75%, in order

to ease possible negative consequences of the currency appreciation on the real economy. Hence, the SNB made

use of two different instruments to achieve its monetary policy objectives. As both policy decisions were taken

simultaneously, we cannot fully distinguish between them. Instead, we capture the effects of the overall change in

the monetary policy regime. However, it seems reasonable to assume that the relevant event affecting stock markets

was the removal of the exchange rate floor. In that respect, Bonadio, Fischer, and Sauré (2019) write that “The SNB's

decision to discontinue the floor took financial markets by storm.”For abbreviation purposes, we will talk about

exchange rates in the rest of the paper, always implying the combination of both policy tools.

The Swiss setting offers two useful features that help identifying the effect of the change in the SNB's policy on

stock markets. First, the removal of the minimum exchange rate was a surprise to markets and economically relevant

(Brunnermeier & James, 2015; Mirkov, Pozdeev, & Söderlind, 2016; Wyplosz, 2015). Second, it was driven by con-

cerns of the SNB about the independence of its monetary policy and not by stock market developments. This unex-

pected policy change thus offers an ideal instrument to evaluate reactions of stock market participants in response

to monetary policy regime changes (Ramey, 2016).

2

The key element of the regime change was the abolition of the exchange rate floor. Following the “current

account channel,”exchange rates can affect stock prices through the effect on the profitability of firms; exporting

firms will most likely lose given an appreciation, while those that (strongly) rely on imported inputs should benefit.

Therefore, the overall effect depends on the composition of importing versus exporting firms in the economy and

remains unclear ex ante. Bäurle and Steiner (2015) provide evidence in a structural dynamic factor model that the

negative effect through exports should dominate. We thus expect to find a significantly negative reaction of stock

markets to the abolition of the minimum exchange rate. Additionally, some sectors may be disproportionately hit

due to their larger exposure to exchange rate fluctuations.

In this paper, we employ synthetic matching to trace the effect of the abolition of the exchange rate floor on

stock markets because this technique is particularly well suited to analyze the effect of an unexpected policy change

on single entities in a relatively heterogeneous group (like countries). The idea of synthetic matching is to build a syn-

thetic counterfactual to Switzerland from a control group of OECD countries that have not been treated. The syn-

thetic counterfactual should be comparable to Switzerland in terms of its general economic environment and its

development of stock markets until January 14, 2015. The counterfactual is then used to construct stock market

developments after January 15, 2015 that would most likely have occurred in absence of the treatment (Abadie &

Gardeazabal, 2003; Chamon, Garcia, & Souza, 2017; El-Shagi, Lindner, & von Schweinitz, 2016).

Synthetic matching has been used in alternative contexts. For example, Abadie and Gardeazabal (2003) con-

struct a synthetic control group out of other Spanish regions to analyze the effects of terrorism in the Basque coun-

try. These authors find that GDP per capita declined around 10 percentage points due to terrorism. Abadie,

Diamond, and Hainmueller (2010) extend the method to study the effects of tobacco control in California. They

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