When monetary policies diverge, it becomes difficult to maintain a pegged exchange rate. Consider the case of the Swiss franc and the euro. In January 2015, Switzerland shocked the foreign exchange market by terminating a crucial part of its effort to hold down the value of its franc against the euro, concluding that the strategy was too risky and costly given the substantial forces that were pushing the franc in the opposite direction. How did this come about? During the height of the European debt crisis in 2011, investors and savers dumped the depreciating euro in favor of the Swiss franc, which was viewed as a safe haven. As investors and savers purchased francs with euros on the open market, the franc's exchange value rapidly appreciated against the euro. Swiss monetary authorities saw that the rise in the value of the franc was causing problems for Swiss exporting companies, which suddenly found that their exports were becoming less competitive in foreign markets. So, the monetary authorities took action to try to keep the euro from depreciating against the franc (the franc from appreciating against the euro): They set an exchange rate floor of 1.2 francs per euro. To defend this floor, the central bank of Switzerland purchased euros with francs on the open market as the euro approached the floor. Although this policy initially seemed to work, by January 2015, the Swiss monetary authorities realized that intervening in the foreign exchange market to stabilize the euro was becoming very difficult. Why? The European Central Bank announced that it was about to implement an expansionary monetary policy (quantitative easing)
that would reduce interest rates so as to pump prime the weak economies of the euro zone. However, falling interest rates would result in net investment outflows for the euro zone countries, which would place further downward pressure on the euro's exchange value against the franc. This would require the Swiss central bank to purchase sizable quantities of euros to defend the exchange rate floor. Viewing this action to be too costly, the Swiss monetary authorities abandoned their effort to defend the exchange rate floor. The move came as a complete surprise as the monetary authorities gave no prior warning about the policy.
Switzerland's move to abandon the exchange rate floor sent the euro plummeting a stunning 30 percent against the franc before it recovered somewhat. This ended more than three years of stability in Swiss foreign exchange markets. As the franc skyrocketed against the euro, the competitiveness of Swiss exporters declined, at least for those exports going to the eurozone. The January 2015 appreciation in the Swiss franc was the biggest move in the modern history of developed market currencies. It jolted money managers, central bankers, and corporate treasurers around the world. It also resulted in sizable losses for many foreign exchange market traders, who borrow heavily to fund risky bets.

What do you think? Why is it difficult to maintain pegged exchange rates when monetary policies diverge among nations?