Prices are regarded as stable when the change in prices for everyday items is barely perceptible from one day to the next. The SNB deems prices in Switzerland to be stable when the overall price level increases by less than 2% per year, and there is no incidence of negative inflation. Inflation or deflation is said to occur only when the general level of prices rises or falls substantially over a sustained period of time. The last 100 years have seen several inflationary phases, but only one conspicuously deflationary phase, namely during the 1930s.
The SNB monitors changes in the price level using the consumer price index (CPI). The CPI measures changes in the prices of a ‘basket’ of goods and services which the average Swiss household consumes.
Our perception of the value of 100 francs depends not just on how much we earn or possess, but also on how much we can purchase. This changes over time: In 1915, for example, 100 francs would buy over 500 kilogrammes of potatoes. Today, the same amount purchases just 40 kilogrammes, because the price of potatoes has increased pretty substantially. Many other goods and services have also become more expensive over the years. Identical items of shopping worth 100 francs today would have cost just 10 francs 100 years ago.
This state of affairs is due to the fact that prices in many economies – including Switzerland – have risen considerably over the last 100 years with a resulting decline in the value of money. However, this does not mean that we can afford less than we could 100 years ago, since, as the prices for things like food, clothing, accommodation and transport have risen, so too have wages.
In fact, generally speaking, wage growth has significantly outpaced price rises – which is why today we are able to afford far more and better products than consumers 100 years ago. This period has consequently seen substantial changes to both our needs and what is on offer. We are thus generally far better off today than we were in the past.
Excessive inflation and deflation are both extremely harmful. While an economy can absorb short-term deviations from price stability, sizeable and sustained fluctuations – whether up or down – are highly damaging. A substantial and unexpected rise in inflation leads to considerable uncertainty among companies and households, as well as a redistribution of wealth and income. As the value of money declines, consumers can afford less (i.e. their purchasing power is eroded) since wages and pensions are not always – or fully – adjusted for inflation, and then only with a time lag. Sustained deflation also has harmful consequences, since it has deleterious effects on economic performance.
The Constitution requires the SNB to pursue a monetary policy that serves the interests of the country as a whole. The National Bank Act describes this requirement in detail. It obliges the SNB to ensure price stability (i.e. to prevent both inflation and deflation), and in so doing to take due account of the economy’s development.
The law stipulates a clear hierarchy of objectives: the highest priority is accorded to ensuring price stability, while taking due account of economic developments occupies second place. These two objectives, however, go hand in glove. Of course the Swiss economy is also materially affected by global economic events, which the SNB cannot influence.
However, exactly controlling the price level and economic developments is beyond the power of the SNB and its monetary policy. Furthermore, the impact of monetary policy measures is initially mainly felt in the business cycle; only later does it feed through to prices. Monetary policy cannot, by itself, have a sustained influence on economic development and ensure a higher rate of growth. In the long term, monetary policy has no influence on economic development at all. But the maintenance of price stability does ensure favourable economic conditions. The power of monetary policy to influence economic activity is thus limited, and should not be overestimated.
If its inflation forecast indicates that prices will rise by more than 2% per year, the SNB increases the interest rate and restricts the supply of money and credit to the economy (and vice versa). This is how the SNB carries out its mandate.
The SNB’s monetary policy affects the economy in various ways. The sequence of events that changes in monetary policy trigger is known as the transmission mechanism. Monetary policy influences prices and economic activity via interest and exchange rates.
The monetary policy strategy outlines how, and with which instruments, the SNB achieves its objectives. It consists of three elements. First, on introducing this strategy, the SNB defined its mandate to ensure price stability in specific terms, namely that the general price level should not increase by more than 2% per year. Second, each quarter the SNB prepares an inflation forecast for the next three years. For this, it uses the SNB policy rate, which remains unchanged over the entire period. Based on this forecast, the SNB decides whether inflation is too high or low, or whether it falls within the realm of price stability. Third, based on this assessment, the SNB makes its interest rate decision, namely whether to raise or lower the SNB policy rate, or leave it unchanged.
The SNB conducts an in-depth monetary policy assessment in March, June, September and December. These assessments comprise an analysis of the economic situation in Switzerland and abroad, and the preparation of forecasts for future developments. Based on these assessments, the Governing Board makes its monetary policy decision. Should circumstances so require, the SNB may also take monetary policy measures at any time between these quarterly assessments – for example the introduction of the minimum exchange rate against the euro on 6 September 2011, and its discontinuation on 15 January 2015.
The SNB communicates monetary policy decisions through press releases. Furthermore, following the monetary policy assessments of June and December, it holds news conferences for journalists. News conferences are also held on an ad hoc basis as necessary.
Monetary policy decisions usually involve interest rate decisions, but not always – where necessary, the SNB also takes other monetary policy measures, e.g. the minimum exchange rate. While managing the interest rate level is generally enough to ensure price stability, in a small open economy like Switzerland’s, another major and fast-acting driver of prices is the exchange rate. Interest and exchange rates together therefore determine the monetary conditions of the economy. Through its monetary policy decisions, the SNB makes certain that these two elements are kept in check and that price stability is ensured.
In monetary policy terms, we have been living through exceptional times for some years now. The SNB has been compelled to resort to unconventional monetary policy measures, for example the introduction of the minimum exchange rate of CHF 1.20 per euro. Following the discontinuation of the minimum exchange rate on 15 January 2015, interest rate policy is again at the fore, but a return to normal is still a long way off. Concurrently with the discontinuation of the minimum exchange rate, the SNB lowered the interest rate further into negative territory. This has made investments in Swiss francs less attractive, thereby helping to weaken the currency over time. Furthermore, the SNB remains active on the foreign exchange market and will intervene as necessary.