Philipp M Hildebrand: Monetary policy in a global context
Speech by Mr Philipp M Hildebrand, Member of the Governing Board of the Swiss National Bank, at
the Swiss-American Chamber of Commerce, Zurich, 8 October 2003.
* * *
It is a special privilege to be able to give my first formal address as a central banker before the
distinguished audience of the Swiss-American chamber of commerce. I have always been very fond of
the Swiss-American friendship. It has been an integral part of my family's life for several decades.
More importantly, I am convinced it is an essential ingredient to the long-term vitality of the Swiss
economy. Like any friendship, it has had to endure difficult moments. The vibrancy of your association
is testimony to the fact that the cultural affinities and common interests between our two countries
provide a reliable foundation for extensive and mutually beneficial economic relations.
Let us strive to make this foundation as solid as the public service record of the Geneva-born Albert
Gallatin, whom Thomas Jefferson appointed as the fourth Secretary of the U.S. Treasury in 1801. To
this day, Gallatin remains not only the longest serving Treasury Secretary in the history of the United
States but the only Swiss-American to have occupied that most prestigious position in the then newly
established capital in Washington D.C.
My focus today will be on the long period of global disinflation following Paul Volcker's paradigmatic
shift of monetary policy in the United States. I will explore how the dramatic increase in international
competition during the last twenty years has affected price levels. I will then return closer to home and
attempt to illustrate how important segments of the Swiss economy have remained sheltered from
international competition through a web of regulatory hurdles. I will make the case that freeing up
these sectors would not only raise economic growth - something that is urgently needed in the effort
to alleviate the growing stress on our social programs - but also render monetary policy more effective
and provide it with more flexibility to focus not only on maintaining price stability but also on output
stabilization. Finally, I will conclude with a brief economic and monetary policy outlook for the United
States and Switzerland.
1. Great Inflation to Great Moderation
In the United States, the modern era of central banking began on October 6, 1979 when the Federal
Reserve, under the leadership of its newly appointed Chairman Paul Volcker announced its adoption
of monetary targets. Headline CPI inflation peaked at 15% at the beginning of 1980. Chairman Volcker
slowed the growth of money dramatically. Interest rates rose sharply with the banks' prime interest
rate exceeding 20%. The U.S. economy fell into a deep recession. Inflation began to recede steadily.
Remarkably, despite the vigorous recovery that followed after 1983, inflation remained relatively
subdued at 4%. It reached a temporary floor of 2.5% by mid-1992.
As we revisit this dramatic moment in monetary history, we need to remember that it occurred against
the backdrop of nearly 15 years of disillusion regarding the ability of activist "Keynesian" economic
policies to guarantee low inflation and full employment. From 1965 onwards, inflation had been on the
rise and unemployment surged in the 70's, following the first oil shock. In the beginning of the 80's, it
appeared that fiat money was inherently prone to cause periodic bouts of inflation and that there was
little one could do about it. (see annex for graph 1)
Since 1979, the global monetary environment has evolved dramatically. Achieving and maintaining
price stability has become the undisputed guiding principle of a vast majority of the world's central
banks. Price stability ensures the signalling power of prices, thus bolstering the efficiency of the
market mechanism. By preserving purchasing power, it facilitates long-term planning and induces
long-term investments. Price stability also prevents social injustices from emerging between debtors,
workers and retirees. Finally, price stability minimizes tax related distortions linked to the interaction of
inflation and the tax code.1
The determined focus of monetary policy on price stability has contributed to anchoring the public's
inflation expectations at low levels. The increasing scepticism of the 1960s and the 1970s about
monetary policy's ability to fight inflation has given way to confidence that prudent, consistent and
forward-looking monetary policy can contain the destructive forces of inflation.
Global inflation figures suggest that such confidence is largely justified. In the industrialized world,
inflation declined from 12% in 1980 to 1.4% in 2002.2 In the developing world, the decline of inflation
has been even more remarkable with yearly rates tumbling from an average of 31 percent in the early
1980s to currently under 6%.3
Along with a significant decline in inflation, volatility of economic growth has fallen everywhere. Both in
the U.S. as well as in Germany, the volatility of real GDP, averaged over four quarters, was about
30 percent less during the 1984 to 2002 period than it was between 1960 and 1983.4 The evidence
therefore confirms that monetary policy efforts to achieve and maintain price stability promote stability
in output and thereby help create economic conditions which are ultimately conducive to employment
creation. (see annex for table 1)
2. New Challenges for Monetary Policy
Not unlike successful athletes, central bankers must never be complacent in victory. It would therefore
be at best inappropriate and at worst irresponsible for the global central banking community to
consider its job done. There will be no "End of Central Banking". For one thing, there is no guarantee
that the elimination of inflation throughout much of the world economy is a permanent achievement.
Moreover, with the achievement of what constitutes for all practical purposes price stability across
many economies, a number of central banks discovered that with it came a new challenge: policy
could no longer be directed exclusively to push inflation lower but had to pay at least as much
attention to avoid inflation that could conceivably fall too low and thereby undermine the goal of price
stability by initiating deflationary tendencies. As has traditionally been the case, vigilance will therefore
continue to be the "Leitmotiv" for the world's central banks.
3. Global Competition and Disinflation
A number of factors have contributed to the striking disinflation since the 1970s.5 Good monetary
policy has undoubtedly made an important contribution of which many of today's leading central
bankers have every reason to be proud of. In many cases, a precondition for good monetary policy
was institutional independence. Politicians have therefore played an important role as well. They have
empowered central banks and freed them from political interference. Fiscal policy probably also
contributed somewhat to an improved global macroeconomic environment though the case is not
entirely convincing.6
Finally - and this is the point I would like to emphasize today - the global disinflation of the last twenty
years has been facilitated by dramatic structural changes in the global economy. These changes are
best encapsulated by what is loosely referred to as globalization. By globalization I mean the
2
In the United States, consumer price inflation fell from an average of 7.1% between 1970 and 1979 to an average of 2.5%
between 2000 and 2002. In Switzerland, consumer price inflation has declined from an average of 5% between 1970 and
1979 to an average of 1% between 2000 and 2003.
3
Kenneth Rogoff (2003): "Globalization and Global Disinflation". Paper prepared for the Federal Reserve Bank of Kansas
City Symposium "Monetary Policy and Uncertainty", Jackson Hole, August 28-30, 2003.
4
Stock, James H. and Mark W. Watson (2003): "Has the Business Cycle Changed? Evidence and Explanations". Paper
prepared for the Federal Reserve Bank of Kansas City Symposium "Monetary Policy and Uncertainty", Jackson Hole,
August 28-30, 2003.
5
For an excellent recent discussion with specific reference to the effects of globalization, see Kenneth Rogoff (2003).
6
In the industrialized countries, public debt increased until 1995 when it reached 75% of GDP. This was followed by seven
years of fiscal policy improvement, so that public debt decreased to 65% of GDP in 2002. More recently, fiscal balances are
deteriorating once again, in some countries dramatically so. The case of emerging economies is slightly different. There
government debt has been on the rise again since 1997.
BIS Review 44/2003
increasing speed, quantity and geographical spread of technological, commercial and financial
interaction throughout the world economy.7
These forces have sharply increased competition between economic agents throughout the global
economy. Deregulation has followed as an inevitable consequence of competitive pressures.
Particularly in the Anglo-Saxon countries, labour and product market reforms enhanced this structural
shift towards a global competitive trading and financial system. This increased flexibility in factor and
goods movements coupled with large scale technological innovations led to a boost in productivity
which is the ultimate underlying force of potential trend growth.
Though the long-term effects of these structural adjustments on the real economy are complex, there
is no doubt they have unleashed a powerful dampening effect on prices in many sectors of the
economy. Most of you who are present here today are actively engaged in running companies in a
global competitive environment. You need no sophisticated economic analysis to tell you that when
exposed to fierce global competition, monopoly rents and pricing power decline and prices therefore
come under downward pressure.
4. Switzerland: one Country - two Economies
As a small open economy, Switzerland is greatly affected by global cyclical let alone global structural
developments. Unfortunately, over the last twenty years, our economy only partly subjected itself to
the global market place. It has therefore developed along diverging paths.
Our export sector has been fully exposed to the competitive forces of global economic and financial
integration. Many of you represent this sector. To remain competitive in the global market place, you
have had to innovate your production processes in a continuous attempt to increase your productivity.
In light of Switzerland's large current account surplus (50 billion CHF or 12% of GDP in 2002), you
have been additionally challenged by a real exchange rate which, over the last ten years, has on
average appreciated by 0.6%.8 For the most part, the Swiss export sector has risen to that challenge.
By contrast, the domestically oriented sectors of the Swiss economy have to a large extent remained
sheltered from the competitive forces of an increasingly open global economy by an intricate web of
regulatory measures which have prevented the product market from functioning according to market
principles. Examples are numerous: The electricity market remains regionally monopolized. As a
result, Swiss enterprises must bear higher electricity costs than their international competitors. In the
telecommunication market, the achieved results in the deregulated part of the sector have not been
matched on the still monopolized last mile. In the pharmaceutical and in the automotive sectors,
parallel imports are still impeded by patent law or tacit collusion rendered possible by weak
international cartel laws.
The detrimental effects of this economic bifurcation are clearly reflected in Switzerland's economic
statistics. As one would suspect, prices in the domestic sector are being kept artificially high, thus
undermining competitiveness. An analysis of longer-term price series demonstrates the diverging path
of prices between the export- and the domestic-oriented sectors of the economy. The export price
deflator rose much less than did the GDP deflator. (see annex for graph 2)
A similar picture emerges on the productivity side. While the export sector has continuously managed
to achieve high productivity growth rates, productivity has lagged behind dramatically in the domestic
sector of the economy. Since the domestic sector continues to represent the bulk of the Swiss
economy (approximately 60% of GDP), the poor performance of the domestically oriented sectors
undermines the growth potential of the Swiss economy.9 In light of the rapidly deteriorating
demographics and the pressure this will inevitably exert on our social services and programs, such a
shortfall in growth can have debilitating longer-term consequences. (see annex for graph 3)
With the post-bubble collapse in the equity markets, a heated political debate has emerged in
Switzerland as well as in many other countries about the sustainability of our retirement and social
welfare programs. Ideas, concepts and frameworks are being discussed by politicians and frequently
commented upon by the media. The fact that these difficult long-term problems which lie at the heart
of our social contract are being openly debated is a welcome development. However, short of
reneging on promises that are deeply embedded in our cultural and social fabric, the most meaningful
way to address these problems in the decades to come is to invigorate our economic growth
performance.
The challenge for our politicians is a formidable one. The political interests that defend the legislative
hurdles which distort the domestic sector of our economy and thus undermine our growth potential are
deeply entrenched. Never does this become more obvious than during a parliamentary electoral
campaign. Admittedly, painful short-term adjustment problems might emerge once the reform process
is initiated. Accelerating productivity growth rates can - in the short term - lead to a further reduction
in employment as uncompetitive industries are compelled to restructure. In the longer-term, however,
a rise in productivity is unquestionably beneficial. Ultimately, it will lead to higher growth rates. As the
time bomb of demographics continues to tick, it will become increasingly obvious that this process is
not a luxury our society can contemplate. It is a necessity!
5. Monetary Implications of Globalization
Let me now return to monetary policy. I have attempted to sketch out how after the "Great Inflation of
the 1970s", global financial and economic integration boosted competition, raised productivity growth
rates and ultimately helped bring about an extraordinary reduction in global inflation and along with it a
reduction in output volatility. As I have mentioned earlier, there is no doubt that good central banking
itself has made an important contribution. But ultimately central banks have also benefited from the
process. With inflation receding, many central banks have been able to focus increasingly on what
typically constitutes a subordinate element of their legislative mandate: stabilization of output. In other
words, a structural decline in the rate of inflation has increased the margins of manoeuvre for central
banks. This does not alter the fact that central banks have no ability to fine-tune the real economy.
Moreover, an important body of academic literature suggests that monetary policy has also become
more effective as markets shed regulatory impediments.10 Monetary policy is therefore not only one of
the forces behind the dramatic decline of inflation since the early 1980s. Perhaps more importantly, it
has been one of the main beneficiaries of the globalization process.
This insight has tremendous significance for Switzerland where, as I have attempted to show, much of
the non-tradable sector of our economy remains tied up in a structural straight jacket. Eliminating this
straight jacket or at least unbuttoning it would have wide-ranging positive effects on the Swiss
economy. If our legislative authorities rise to that challenge, they are likely to replicate the
competitionboosting effect that the forces of globalization have exerted on the external sector in the domestically
oriented sectors of our economy. Higher productivity growth rates would ultimately lead to higher
growth rates and thus reverse a worrying trend of declining relative growth dynamics in Switzerland in
comparison with other OECD countries.11
Such productivity driven growth dynamics should lead to lower prices across a sizeable part of our
economy. Obviously, this statement needs to be qualified. he Swiss economy will always remain
vulnerable to developments abroad. A significant demand or supply shock to the global economy
could reverse the beneficial impact on domestic prices of further domestic liberalization. For example,
widespread protectionist measures rolling back the achievements of globalization or widespread
geopolitical conflict and uncertainty would certainly threaten the broad achievements with regard to
price stability. Nonetheless, breaking up the rigidities impeding competition in the domestically
oriented sectors of our economy has every chance of rendering monetary policy not only more
effective but also more flexible in its ability to focus its efforts beyond the primary mandate of
maintaining price stability.
6. Economic and Monetary Policy Outlook
Let me now turn to a brief assessment of current economic conditions in the United States as well as
here in Switzerland and conclude with a few comments regarding the outlook for Swiss monetary
policy.
Recent U.S. economic data confirms that GDP growth has accelerated rapidly in the second half of
2003. Third quarter U.S. GDP growth will be close to 6%. For the fourth quarter, most market
participants expect GDP growth to slow to a still robust 4%. This would imply a U.S. growth rate of
approximately 3.5% for 2003. Substantial monetary and fiscal stimulus as well as strengthening
financial conditions has supported the growth dynamic in the second half of 2003 in the United States.
Expectations of moderating growth going forward are linked to the fact that stimulus from fiscal policy
is set to shrink. The contribution to consumer spending from this year's tax cuts is set to decline
gradually during 2004. In addition, further substantial increases in the defence budget are unlikely in
the coming year, thus dampening the relative contribution to GDP from defence spending during 2004.
The most worrying missing component of the U.S. recovery has been the absence of job creation
which has led many market participants and media representatives to make reference to a "jobless
recovery", or even a "jobloss recovery". With the September employment report which was released
last week, we now have at least some evidence that labor markets in the U.S. are improving
somewhat. Provided these numbers get confirmed in the months to come, it would add weight to the
hypothesis that early at cyclical turning points, official payroll numbers underestimate the actual
number of jobs created. At such times, the household survey statistics might be a more accurate
gauge of labour market conditions.12 At least for now, the latest employment data has strengthened
market expectations of a sustained recovery.
On the business spending side, we have also seen some encouraging signs of a pick up in spending
on capital equipment though it would appear that, so far, much of this demand is for replacement
purposes rather than expansion. However, business inventories in the United States have fallen to low
levels. Rising inventories should therefore contribute to production increases in the months to come.
Without confirmation that a pick up in inventory spending and an expansion of the labour force
complete the traditional pattern of a recovery cycle, market concerns about the sustainability of the
U.S. expansion are bound to persist. Moreover, financial markets will continue to follow carefully the
growing twin deficit in the U.S. and the potential risk it represents to global exchange rate stability.
Finally, persistently high oil prices may add another element of caution with regard to the sustainability
of the currently impressive growth dynamic in the United States.
On the monetary side, Federal Reserve officials have repeatedly pointed out that despite firm
consumer growth and gradually firming spending, there remains much slack in the U.S. economy. As it
stated in its release of September 16, the Federal Open Market Committee therefore believes that
pricing power and increases in core consumer prices remain muted. Or, as Federal Reserve Governor
Don Kohn stated a few days ago, "it will be a while before we can be sure that a self-sustaining
expansion is underway of sufficient strength and persistence to put the economy back on a path
toward full employment."13
Switzerland will undoubtedly benefit from the improved outlook in the United States. Unfortunately,
apart from the lack of internal growth dynamic I discussed previously, Switzerland's growth
prospective is further curtailed by economic developments in the rest of Europe where there is
currently little evidence of a robust and sustainable upswing in economic activity. This is reflected in
the fact that despite more favourable exchange rate conditions, Swiss exports during the second
quarter declined again. While consumer spending had a stabilizing effect, investment also continued
to decline.
While the Swiss economy therefore remains weak, it is set to strengthen somewhat into the fourth
quarter of 2003 and the first quarter of 2004. Improved corporate expectations, a pick up in residential
construction and strengthened financial conditions suggest that the trough of this cycle was reached
during the second quarter of 2003. Provided the growth momentum in the U.S. sustains itself, exports
should rise gradually, followed by an increase in equipment investment. Given considerable margin of
slack in resource utilization, an improvement in the labour market can only be expected in the course
of 2004.
As we have indicated in our quarterly monetary policy assessment on September 18, the Swiss
National Bank will continue to support the economy by conducting an accommodating monetary
policy. Low interest rates - we continue to target our 3-month libor rate at 0.25% - are designed to
keep Swiss franc investments unattractive. Despite a rapid expansion in our monetary aggregates
which we monitor closely, price stability is currently not threatened.
A rapid expansion of monetary aggregates does not automatically lead to higher inflation. In
Switzerland, commentators often compare the current environment to the one in 1988, when money
supply expansion rates were similar to what we observe today and inflation eventually rose to 6% by
1991. While understandable, the comparison is flawed. For one thing, current interest rates are
significantly lower than they were at the time, thus reducing the opportunity cost of holding money to
virtually zero. More importantly, the monetary expansion between 1986 and 1988 occurred against the
backdrop of an unemployment rate of around 1%. A careful examination of the data of that period
reveals that the margins of slack in resource utilization were rapidly declining at the time. Moreover,
credit expanded dramatically during the late 1980s, thus providing a direct channel for the excess
liquidity to find its way into excess demand.
The current economic environment is a different one. Still adjusting from a historically unique
speculative financial bubble, we currently observe an unemployment rate of close to 4% which
markets expect to rise further in the months to come. In addition, virtually any measure of slack in
resource utilization suggests that our current output gap is somewhere between 1.5% and 3%, thus
indicating that it would take at least a year of significant above-trend growth before a balance would be
reached between aggregate demand and potential supply.
In conclusion, let me repeat what we have said after our last quarterly monetary policy assessment. In
light of the underlying weakness of economic conditions in Switzerland, the risks pertaining to the
sustainability of the welcome upswing in the United States and the benign global and domestic
inflation outlook, we conduct our monetary policy with the aim of preventing a premature shift to a
more restrictive monetary policy stance which could endanger the fragile upswing underway in
Switzerland. Given the openness of our economy, exchange rate developments greatly affect
monetary conditions in Switzerland. It therefore follows that our commitment to an expansionary
monetary policy includes a firm commitment to fight against an unwelcome tightening of monetary
conditions in the event of a marked appreciation of the Swiss franc.
Graph 1
Global Price Development
[%]
Consumer prices, unadjusted, change in % versus previous year
30
World
25
Japan
USA
20
Switzerland
Germany
15
10
5
0
-5
1957 1967 1977 1987 1997
Source: Datastream.
Table 1
Standard Deviation of Four-Quarter Growth or Real GDP per Capita
1960-1983 1984-2002
USA 2.7 1.7
Germany 2.5 1.5
Japan 3.7 2.2
United Kingdom 2.4 1.7
Source : Stock and Watson, 2003
Graph 2
Swiss Price Deflators
220
200
180
160
GDP deflator
140
Export price deflator
120
100
1973 1978 1983 1988 1993 1998 2003
Graph 3
Labor Productivity 1870 - 1998
GDP per hour worked (in 1990 international USD per hour)
35
Switzerland
30
USA
25
Germany
20
Western Europe
(12)
15
10
5
0
1870 1913 1950 1973 1990 1998
Source: A. Maddison (2001): "The World Economy - A Millenial Perspective". Paris: OECD.