Fritz Zurbrügg: Competitiveness of Swiss companies - the Swiss
National Bank's contribution
Speech by Mr Fritz Zurbrügg, Member of the Governing Board of the Swiss National Bank, at
the Swiss CFO Day, Zug, 13 January 2016.
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The charts can be found at the Swiss National Bank's website.
The speaker would like to thank Till Ebner, Rita Fleer and Adriel Jost for their valuable support in the preparation
of this speech. He also thanks Carlos Lenz for his helpful comments.
Ladies and Gentlemen
It is a great pleasure to be here at the Swiss CFO Day 2016. This year's topic - international
competitiveness - represents a key challenge for companies and politicians alike. In order for
companies to create growth and wealth in a globalised market, they are continually having to
maintain their position against international competitors. Local factors such as the educational
standard of the population, labour market flexibility and the tax burden clearly play their part.
The importance of monetary policy may be rather less obvious at first glance. However, as
was demonstrated on 15 January last year, when the Swiss National Bank discontinued its
minimum exchange rate of CHF 1.20 to the euro, monetary policy measures can influence
competitiveness.
The discontinuation triggered a sharp appreciation of the Swiss franc. On the one hand, this
appreciation put Switzerland's price competitiveness under severe pressure in the short term,
and I'm sure I don't need to go into detail on the practical repercussions for individual
companies in a forum such as this. The impact is still being felt at many of your organisations,
although Swiss firms have once again proved impressively flexible and resilient. On the other
hand, the decision last January was absolutely necessary, given that the euro lost considerable
ground against all major currencies as a result of the changed international environment.
Waiting any longer would have put the minimum exchange rate under permanent pressure.
The minimum exchange rate had become unsustainable. The costs associated with continuing
such a policy would thus no longer have been justified. Moreover, had we discontinued the
minimum exchange rate at a later date, the impact on the Swiss economy would have been
even greater. I am therefore convinced that the SNB's decision came at the right time. Without
this difficult step, we would have compromised our ability to fulfil our mandate of ensuring price
stability in the medium and long term.
It is precisely by fulfilling this mandate that the SNB contributes indirectly to Swiss
competitiveness in the long term. In my remarks today, I will first go into more detail about this
contribution. I will then discuss the difference between the short and long-term effects of a
strong currency on competitiveness. Finally, I will examine the role of the Swiss franc exchange
rate in our monetary policy deliberations.
Competitiveness and macroeconomic stability
In international comparisons of competitiveness, Switzerland is regularly among the leaders.
For example, it has headed the World Economic Forum's (WEF) Global Competitiveness Index
for years (cf. chart 1). So what are the factors behind Switzerland's high degree of
competitiveness? Let me make something clear right at the outset: competitiveness depends
first and foremost on companies and their ability to innovate (cf. chart 2). Innovation helps
companies to increase productivity, thereby lowering costs and prices. In addition, innovation
leads to higher quality and greater exclusivity of products or services, which in many cases
bestows price-setting power.
Switzerland is a case in point: its industries are highly competitive, precisely because our
country is among the world leaders in innovation, as a number of indicators have shown. If, for
example, we look at the number of registered patents relative to population size, Switzerland
is by far the most active of the OECD countries (cf. chart 3, left-hand panel). Innovation indices,
such as the Global Innovation Index and the Innovation Union Scoreboard, also place it right
at the top.1 A key factor behind this leading position is the level of investment in research and
development (cf. chart 3, right-hand panel), which is above average by international standards.
Firms that are innovative and willing to invest cannot develop and thrive in a vacuum. The
scope for development is largely dependent on a country's location-specific factors. The spider
diagrams used in the WEF Competitiveness Report show the main pillars underpinning the
competitiveness landscape (cf. chart 4). These include the level of education, the stability of
political institutions, legal certainty, labour market flexibility and the quality of infrastructure.
A further prerequisite for companies' ability to innovate is a stable macroeconomic environment
- in other words, a stability-oriented monetary policy and a sustainable financial policy. Price
stability and sound public finances make it easier for companies to plan, especially as regards
investment.
This is where the SNB comes in. According to the National Bank Act, it is responsible for
ensuring price stability, while taking due account of economic developments. By fulfilling this
mandate, the SNB makes a major contribution to a stable macroeconomic environment, and
hence indirectly to the competitiveness of the Swiss economy (cf. chart 5).2
From a historical perspective, the SNB has successfully fulfilled its monetary policy mandate.
Long-term average inflation is lower and less volatile in Switzerland than in most other
countries (cf. chart 6). As a result, the Swiss franc has lost less purchasing power over time
compared to other currencies.
The generally stable economic and political environment in Switzerland is one of the reasons
why the Swiss franc is popular with investors and has a tendency to strengthen. Thus, a
financial and monetary policy that successfully contributes to macroeconomic stability is both
a basis for competitiveness on the part of Swiss companies and a driver of Swiss franc strength
(cf. chart 7). This is especially the case in times of heightened uncertainty.
Competitiveness and the strong Swiss franc
But aren't these two consequences of a stability-oriented economic policy at odds with each
other? Or, to put it another way: does a strong franc really lead to a reduction in
competitiveness? It is essential to differentiate between the short and long-term impact of a
strong currency on competitiveness, and it is these differences which I will now examine in the
second part of my remarks.
In the short term, the answer is obvious: an appreciation makes Swiss companies less
competitive on prices than their foreign rivals (cf. chart 8). It becomes harder for them to sell
their products and services at a price that covers the costs involved. The increased pressure
on margins forces many companies to make adjustments. Without a doubt, these adjustments
are painful and require a high degree of innovative thinking, a willingness to take risks and
flexibility, from both employers and employees. If need be, companies may have to withdraw
from markets in which they are no longer competitive, or relocate part of their production - and
thus some jobs - to lower-cost countries, in order to keep pace with their foreign competitors.
Individual companies may even have to cease their activities in Switzerland altogether. A study
by the KOF research institute shows that, following a Swiss franc appreciation, the segment of
lower-skilled workers in particular sees employment numbers fall.3
However, the same study also points out that, despite pressure on margins, the remaining
companies will respond to the franc's appreciation by stepping up research and development,
improving product quality and increasing the number of highly skilled workers they employ.
Over time, these measures should lead the industries concerned to become more productive
overall. The majority of empirical studies for other countries confirm that, as a general rule,
strong competitive pressure increases an industry's productivity.4 Moreover, a number of
country studies indicate that an appreciation can have a positive impact on productivity.5 Often,
the relationship is reciprocal, with productivity gains themselves leading to a stronger currency.
Thus, in contrast to the short term, in the long term one cannot claim a contradiction between
an economy's competitiveness and a strong currency (cf. chart 9). The fact that Switzerland is
among the world leaders in competitiveness, despite the strong Swiss franc, confirms this
finding.
I'd like to illustrate the difference between the short and long-term consequences of a
stabilityoriented economic policy with a classroom metaphor. In most school classes, there is a
particularly enthusiastic pupil, the "swot". For swots, the immediate effect of good academic
achievement is negative, as they become excluded by the other pupils. Should they perform
less well, simply to avoid this unpleasant situation? In the short term, the result would be
positive, but in the long term they would probably regret it.
Switzerland as an economic centre faces a similar dilemma. The result of the successful
economic policy, and the associated stability, is that the Swiss franc has a tendency to
strengthen, demanding constant adjustment from companies and their workforces. So should
Switzerland throw its principles overboard and pursue an irresponsible financial and monetary
policy? This would automatically reduce the pressure to appreciate and to adjust. And in the
short term, that probably would bring some relief. However, in the medium and long term, such
a policy would certainly come at the huge cost of endangering the hitherto successful "Swiss
model".
The Swiss franc's role in SNB monetary policy strategy
What does this mean for monetary policy in practical terms? As a rule, monetary policy should
not focus on the short-term impact of a strong franc on price competitiveness. Therefore, a
monetary policy geared towards long-term macroeconomic stability does not normally involve
any fine-tuning of the exchange rate. Accordingly, the SNB's monetary policy strategy since
the 1970s has been based around a freely floating Swiss franc exchange rate that is not
actively managed by the National Bank.
This is not to say, however, that the SNB does not take the exchange rate into account in its
monetary policy deliberations - on the contrary: because Switzerland is so closely integrated
into the global economy, both appreciation and depreciation phases have far-reaching
consequences for economic and price developments in our country. As a result, exchange rate
movements have a major influence on our inflation forecasts. Thus, they also play an important
role in monetary policymaking.
The SNB thus takes the macroeconomic repercussions of exchange rate movements into
consideration. Under normal circumstances, we can respond by adjusting interest rates,
without intervening directly in the foreign exchange market. This approach has proved to be
useful and, in terms of our mandate, suited to the purpose. It allows the SNB to conduct a
monetary policy that is optimally tailored to the country's needs.
Despite the positive experience with flexible exchange rates, in certain situations it may be
necessary for the SNB to intervene in the foreign exchange market, in order to influence
exchange rate movements directly. This is the case when the interest rate as a tool proves
insufficient to ward off a threat to macroeconomic stability in Switzerland (cf. chart 10).
The difficult but crucial task of the SNB is to identify under which circumstances a Swiss franc
appreciation may lead to a destabilisation. A key element in this evaluation is the speed and
magnitude of the appreciation. A rapid and sharp appreciation can result in a substantial fall in
the price level in Switzerland. Such a price decline can also cause longer-term inflation
expectations to turn negative. Expectations of longer-term price declines can, in turn, lead to
inflation being persistently negative or - in the worst case - to a downward price spiral. This is
particularly a risk when the speed of an appreciation leaves companies virtually no time to
adjust, and the appreciation is thus combined with widespread upheaval in the real economy.
These destabilisation risks are all the more severe if the global economy is in crisis. An
international economic crisis often heralds an inflow of domestic and foreign capital to the
Swiss franc, which has acquired a reputation as a safe haven on account of its historical
behaviour. In other words, in uncertain times, the franc is seen as an anchor of stability, and is
therefore much in demand. The currency can thus experience a strong short-term appreciation
as a result. At the same time, a weak global economy can put pressure on sales volumes for
the Swiss export industry. This increases the risk that production capacities cannot be fully
utilised, that unemployment will rise sharply, and that the Swiss economy as a whole will slide
into crisis.
If an appreciation threatens macroeconomic stability in Switzerland through these channels,
this has consequences for monetary policy. When conventional instruments reach their limits,
the SNB has to resort to other tools in order to fulfil its mandate (cf. chart 11). First and foremost
among these are foreign exchange market interventions. Since 2009, the SNB has, as you
know, used this tool in a number of ways, purchasing foreign currency amounting to nearly
CHF 500 billion. Between September 2011 and January 2015, for example, the SNB used this
tool to enforce a minimum exchange rate against the euro.
In this regard, I feel it is important to stress that considerable risks accompany on such
interventions. First, market interventions aimed at preventing an appreciation expand the
SNB's balance sheet. When there is a fixed exchange rate target, one might even have to
expect an uncontrolled expansion of the balance sheet. This is attached to a number of
imponderables.6 In addition to major financial risks, it should be noted that, as the balance
sheet grows, it will become increasingly difficult to reduce excess liquidity during a subsequent
normalisation of monetary policy, and to fulfil the monetary policy mandate - of ensuring price
stability - sustainably.
Second, it is important to bear the following in mind: pegging the franc partially or fully to
another currency would mean that the SNB would have to adopt the monetary policy of the
currency area concerned. However, it could no longer be guaranteed that this monetary policy
would always be optimally tailored to the needs of the Swiss economy.
Thus, the benefits of an active exchange rate policy need to be properly weighed against the
costs for the economy as a whole. But there is no one-size-fits-all method of determining the
need to intervene in the foreign exchange market, or the best way to do so. The points to
consider will differ depending on the situation.
Current SNB monetary policy
In that regard, I would like to briefly describe the SNB's current thinking. At its most recent
monetary policy assessment about a month ago, the SNB published its new inflation forecast.
The forecast shows that, assuming an unchanged interest rate policy, inflation will rise
gradually over the coming quarters, and will exceed 1.0% in 2018 (cf. chart 12). So the forecast
suggests that current monetary policy is appropriate. For this reason, in December the SNB
decided to continue its expansionary policy. This is based on two elements: first, an interest
rate of -0.75% on sight deposits at the SNB combined with a target range for the three-month
Libor of between -1.25% and -0.25%; second, the SNB's willingness to influence exchange
rate developments if necessary.
The negative interest rate and the willingness to intervene on the foreign exchange market
serve to make investments in Swiss francs less attractive, and thereby reduce the pressure on
our currency. These measures demonstrate that business as usual is still a long way off. During
the crises of the last few years, recurring safe-haven flows of both domestic and foreign capital
have led to severe upward pressure on the Swiss franc. Despite weakening somewhat over
recent months, the franc is still considerably overvalued, as chart 13 illustrates. The blue curve
shows changes in the inflation-adjusted, trade-weighted Swiss franc exchange rate. The yellow
bars mark deviations from the long-term average, which is currently around 15%. At the same
time, the global economic recovery is still not firmly bedded in. Our current monetary policy is
tailored to these circumstances. It counters the risk of an undesirable appreciation and, in turn,
the associated risks to price and economic developments.
Conclusion
Ladies and gentlemen, following the discontinuation of the minimum exchange rate of
CHF 1.20 to the euro almost a year ago, Swiss competitiveness came under pressure in the
short term. Yet Switzerland's position among the leaders in major international rankings clearly
shows that, over the long term, exchange rate developments are only one factor shaping
competitiveness. A more decisive role is played by the existence of a strong network of
location-specific factors which have been established, nurtured and honed over several
decades. By fulfilling its price stability mandate, the SNB contributes substantially to
perpetuating one of these factors - macroeconomic stability.
In this regard, a monetary policy geared towards flexible exchange rates has, in principle, stood
Switzerland in good stead over the last 40 years. Under certain conditions, however, the SNB
is prepared to intervene directly in the foreign exchange market. This applies especially in the
prevailing environment. Whether, and to what extent, foreign exchange market intervention is
called for requires careful deliberation, and consideration of the international environment.
Prior to the discontinuation of the minimum exchange rate, international developments had
caused the euro to lose considerable ground against all major currencies; the minimum rate
had thus become unsustainable. We appreciate that the exchange rate situation since then
has presented you all with a huge challenge. Our decision was inevitable, however, to
guarantee the SNB's continuing ability to conduct an effective monetary policy. Ultimately, the
resulting increase in flexibility means that the SNB can better contribute to keeping Switzerland
on the road to competitive success.