Speech
Embargo
14 July 2020, 3.30 pm
Small country - big challenges
Switzerland's monetary policy response to the coronavirus
pandemic
2020 IMF Michel Camdessus Central Banking Lecture
Thomas J. Jordan*
Chairman of the Governing Board
Swiss National Bank
Washington and Zurich, 14 July 2020
© Swiss National Bank, Zurich, 2020
Dear Madame Managing Director of the International Monetary Fund, Dear Kristalina, Ladies
and gentlemen
It gives me great pleasure to speak before you today - although for most of you only virtually,
unfortunately, due to the coronavirus pandemic.
Dear Kristalina, I'd like to thank you and the IMF very much for the invitation to give this
year's Michel Camdessus Central Banking Lecture. This is a great honour for me and for the
Swiss National Bank. I have had the privilege of meeting Michel Camdessus, and hold him in
high esteem as an impressive personality and a far-sighted decision-maker. Allow me also to
pay tribute to you, dear Kristalina, for your strong leadership of the IMF at this critical
juncture. The work of your institution is crucial for overcoming the current global crisis.
The coronavirus pandemic presents the world with enormous challenges. In my speech today,
I will focus on some of these challenges as they pertain to monetary policy in Switzerland. In
recent years, the Camdessus Lecture has been given by central bank governors of large
economies. These central banks shape global monetary policy. I, on the other hand, speak as
the central bank representative of a small open economy that conducts its monetary policy
against this global backdrop.
Pre-coronavirus: a difficult starting position for Swiss monetary policy
Even before the outbreak of the coronavirus pandemic, the monetary policy situation in
Switzerland was not easy. In January 2020 - in other words, even before the first coronavirus
cases were recorded in our country - inflation was just 0.2%. At the same time, the SNB
policy rate of -0.75% had already been at a historical low for five years. Not so long ago, we
could hardly have imagined negative nominal interest rates. Let me briefly explain how this
extraordinary situation came about.
Monetary policy challenges due to spillovers from abroad
As a small open economy, Switzerland is highly exposed to external disruptions. Exchange
rate movements in particular exert a major influence on inflation and economic activity in our
country.
A further characteristic of Switzerland is that the Swiss franc, as a safe-haven currency, tends
to appreciate when global risk sentiment deteriorates. In recent years, a number of crises -
notably the global financial crisis and the European sovereign debt crisis - have led to
appreciations of the franc. What does the strong influence of developments abroad on
inflation in our country mean for our monetary policy? It means that inflation can be
controlled with even less precision than in the large currency areas. It is not possible - or only
with disproportionate use of monetary policy instruments and correspondingly marked
sideeffects - to always fully offset spillovers from abroad. For this reason, a definition of price
stability that allows a certain flexibility in the monetary policy response is essential for
Switzerland. According to the SNB definition, price stability is considered to prevail when the
inflation rate is less than 2% but still positive. This has yielded good results.
In addition to the aforementioned crises, the international low interest rate environment has
also exerted upward pressure on the franc. The global decline in the level of interest rates over
recent decades is mainly due to structural factors - and thus to a decline in the equilibrium
rate of interest. No country can detach itself from this global development, and certainly not
Switzerland with its open capital market.
The global fall in interest rates increased the upward pressure on the franc. Historically,
nominal interest rates in Switzerland have been substantially below those abroad. Besides the
usually lower inflation rate in Switzerland, this also reflects our country's political stability
and the credibility of our institutions.
In response to the global financial crisis, the central banks in the major currency areas
lowered their policy rates close to zero. In Switzerland too, monetary policy easing was
necessary. However, there was less scope for interest rate cuts here than abroad due to the
already lower interest rate level. The global decline in interest rates therefore narrowed the
interest rate differential with other countries, which led to additional upward pressure on the
franc.
Following a series of appreciations, the Swiss franc was at times significantly overvalued.
This posed considerable challenges for companies in our country, and inflation declined
repeatedly into negative territory. Given this situation, how was the SNB able to conduct the
expansionary monetary policy required in this low-inflation environment? We carried out
substantial interventions in the foreign exchange market, and temporarily introduced a
minimum exchange rate against the euro. At the beginning of 2015, we then lowered our
policy rate below zero. This was done in order to at least partially restore the usual interest
rate differential with other countries and thus alleviate the upward pressure on the franc.
Experience with the negative interest rate in Switzerland
The SNB was one of the first central banks to lower its monetary policy rate significantly into
negative territory. Let me therefore say a few words about our experience with the negative
interest rate, which has now lasted a good five years. On the whole, negative interest has
proved its worth for Switzerland. The transmission of negative interest to the economy in this
country occurs primarily through its impact on the exchange rate. Negative interest has passed
through to money and capital market rates, and thus eased upward pressure on the Swiss
franc. This has helped to ensure more appropriate monetary conditions for the economy. It is
less clear to what extent the negative interest rate also has an effect via the credit channel.
However, we introduced negative interest not because of its effect on the demand for credit,
but because of its influence on the exchange rate.
In Switzerland, the negative interest rate has thus had the intended impact. But there have also
been side-effects. Negative interest poses a challenge for banks, pension funds, insurance
companies and savers. It may also have negative consequences for financial stability if the
search for yield leads to excessive risk taking. The decision to impose negative interest
therefore requires, like all monetary policy decisions, a cost-benefit analysis. While the
benefits of negative interest in relation to the exchange rate occur immediately, possible
sideeffects only become apparent over time. With regard to financial stability, our experience
shows that macroprudential measures - in particular the countercyclical capital buffer - help
to limit the undesirable impact of negative interest. In order to further reduce the side-effects
on the banking system, we also grant the banks a considerable exemption threshold. Negative
interest is thus charged on only a portion of their sight deposits at the SNB.
Ladies and gentlemen, even though we still have scope for further interest rate cuts, the fact
remains that one cannot lower interest rates indefinitely. For this reason, interventions in the
foreign exchange market, in which we buy foreign currencies and sell Swiss francs, also play
a central role in our policy mix.
Foreign exchange market intervention as a monetary policy instrument
Since the global financial crisis, the central banks of many large economies have implemented
extensive securities purchase programmes (known as quantitative easing, or QE). By contrast,
the SNB has intervened in the foreign exchange market. This has several reasons. First, the
capital market in Switzerland is relatively small, which naturally limits the size of a QE
programme. Second, the capital market in Switzerland plays only a subordinate role in the
transmission of monetary policy, as comparatively few, large companies use it to finance
themselves. And third, in Switzerland the upward pressure on the franc was the main reason
for the at times very low inflation. Against this backdrop, for us, foreign exchange market
interventions were and still are the most direct and thus the most effective instrument besides
the negative interest rate.
When deciding on whether to intervene, it is vital - just as with negative interest rates - that a
continuous cost-benefit analysis takes place. On the one hand, there is the benefit of
preventing an excessive appreciation of the Swiss franc and thereby stabilising price and
economic developments. On the other hand, foreign exchange market interventions expand
the SNB's balance sheet and have caused our investments in foreign currencies to rise
sharply. Therefore, they increase financial risks in the longer term. The responsibility to
manage our assets in the best possible way, and so limit the risk of potential loss, has thus also
increased. For this reason, we invest a significant proportion of our assets in stocks in order to
improve the risk/return profile of our investments.
Our experience shows that foreign exchange market interventions and the negative interest
rate are essential for a small open economy with a safe-haven currency in a global low interest
rate environment. The combination of these two monetary policy instruments is more
effective and results in fewer undesirable side-effects overall than concentrating on just one of
them.
Challenges for monetary policy in times of the coronavirus pandemic
Ladies and gentlemen, a strong franc, low inflation and negative interest rates - this was the
monetary policy environment in Switzerland at the beginning of the year. And then came
coronavirus.
The pandemic and the restrictions imposed in many countries to contain the virus brought
parts of the economy to a temporary standstill. Not only coronavirus, but also the economic
downturn spread unusually quickly across the entire world. In the first quarter of this year, the
Swiss economy experienced the sharpest downturn since the oil crisis in the 1970s.
Furthermore, the second quarter is likely to be considerably worse. Inflation has declined once
again and has fallen clearly into negative territory.
What is the task of monetary policy in Switzerland in this situation? As always, the aim is to
ensure appropriate monetary conditions. In this specific case, it is also about providing banks
with the necessary liquidity so that they can supply the economy with credit. Many companies
have experienced severe sales losses due to the restrictions imposed on their business
activities and the lack of demand for their products. While revenues have fallen away, a large
part of the costs continue to be incurred. These companies therefore need swift access to
financial resources, to bridge the loss of revenue.
In the current situation, however, the line between liquidity and solvency problems is blurred
for many companies. To ensure that banks do not hesitate in granting new loans, the Swiss
government set up a programme through which it provides guarantees for corporate loans.
With a minimum of red tape, companies are able to apply for such guaranteed loans from their
account-holding bank. Following a brief check, the loans are approved and paid out. In this
way, even small companies with no existing credit relations can obtain bridging loans quickly
and at very favourable conditions - with an interest rate of 0% for amounts of up to half a
million francs. Within the first week after the start of the programme, every tenth Swiss
company had received such a loan. This figure has since risen to a good 20% of all companies
in Switzerland.
The SNB is offering the banks a new facility for refinancing the loans guaranteed by the
government at our current policy rate of -0.75%. The SNB COVID-19 refinancing facility
increases the banks' liquidity and their capacity to grant credit on favourable terms. Getting a
loan programme aimed at mitigating the economic consequences of the coronavirus pandemic
up and running so quickly depended on close cooperation between the government, central
bank and private sector.
Not only has the coronavirus pandemic presented Swiss monetary policy with new
challenges, but it has also exacerbated the long-standing problem of upward pressure on the
franc. Two drivers have been decisive here recently. First, the monetary policy easing by the
major central banks through purchases of securities and interest rate cuts pushed down foreign
yields. As a result, the interest rate differential with Switzerland narrowed once again. And
second, the high level of uncertainty about the economic outlook led to a flight to safe-haven
currencies such as the Swiss franc. Our combination of negative interest and foreign exchange
market interventions thus remains more necessary than ever. In recent months, we have
intervened more strongly on the foreign exchange market in order to alleviate the upward
pressure on the franc.
Conclusion and outlook
Ladies and gentlemen, I hope that I have been able to give you an insight into the special
situation in which Switzerland finds itself as a small open economy.
Our experience underlines how exposed small countries are to international developments.
Spillovers from abroad require continuous adjustments to our monetary policy, and
sometimes difficult decisions taking into account comprehensive cost-benefit analyses. In an
environment of low interest rates worldwide, we were forced to find new instruments to
ensure appropriate monetary conditions. Negative interest and foreign exchange market
interventions have served us well. However, the Swiss experience also shows that monetary
policy in small open economies cannot always fully absorb disruptions from abroad. Our
definition of price stability, which allows a certain flexibility in the monetary policy response,
is therefore essential for our country.
Monetary and fiscal policy in Switzerland have complemented each other well to cushion the
economic consequences of the coronavirus pandemic. However, the experience with
coronavirus in particular also illustrates the importance of a clear division of roles between
monetary and fiscal policy. Monetary policy is not a panacea. It must not take fiscal and
structural policy decisions. Responsibility for these policy areas must remain with the
government, even in the event of a crisis such as the coronavirus pandemic.
Finally, I would like to say a few words about the outlook. The economic recovery will take
time. Expansionary monetary and fiscal policy is therefore still necessary. Meanwhile, even
for countries like Switzerland - which entered the crisis with low levels of public debt - the
sharp rise in new borrowing will be an issue for years to come. In the longer term, inflation
could rise again due to the global increase in public debt. The challenge will then lie in
identifying the right time and the right pace for monetary policy normalisation in order to
ensure price stability.
It is uncertain whether and to what extent coronavirus will lead to permanent structural
changes in the economy. The creativity and adaptability of companies will be crucial for
economic recovery. Structural policies can play an important role in fostering
entrepreneurship through good framework conditions, thereby increasing potential growth.
This is the best way back to sustainable growth and sustainable long-term public debt. Both
are a prerequisite for broad-based prosperity and social stability.
Thank you for your attention.