Jean-Pierre Roth: Review of the Swiss economy: end-of-year media news
conference
Introductory remarks by Dr Jean-Pierre Roth, Vice-President of the Swiss National Bank, at the
End-of-year Media News Conference, Zurich, 7 December 2001
* * *
The Swiss National Bank has decided to lower the target range for the three-month Libor rate by
0.5 percentage points to 1.25%-2.25%. For the time being, the three-month Libor is to be kept in the
middle of the target range. Recently, the National Bank has adjusted its monetary policy twice already.
On 17 and 24 September 2001, we lowered the target range for the three-month Libor rate by
0.5 percentage points each. At the time, we acted in response to the decrease in inflationary
pressures and the undesirable development of the Swiss franc exchange rate. The economic outlook
has since continued to deteriorate around the globe. In Switzerland, there are no signs that price
stability might be jeopardised in the medium term. Due to this development, we are now in a position
to reduce rates again. Accordingly, since the beginning of 2001, we have lowered the target band for
the three-month Libor by a total of 1.75 percentage points, thus easing monetary policy considerably.
Assuming that the three-month Libor rate will remain stable at 1.75%, inflation is expected to hover
between 0.9% and 1.5% in the next three years. The National Bank projects real gross domestic
product to increase by 1.5% in 2001. For 2002 we anticipate a growth rate of around 1%.
In the following, I would like to describe the development of inflation over the past few months and
explain our latest inflation forecast in more detail. The dotted curve in the graph shows our inflation
forecast of June 2001. At the time, we expected inflation to climb slightly to 1.6% by mid-2002 and,
subsequently, to recede gradually towards 1.2% by the beginning of 2004. This forecast was based on
the assumption of a robust development of the world economy and a stable three-month Libor rate of
3.25%. We assumed at the time that the economic slowdown experienced in the United States and
Europe would be overcome as early as in the second half of 2001 and that the Swiss economy would
be able to perform according to its potential. The price of oil was expected to stand at approximately
USD 25 per barrel.
Our forecast of June overestimated the inflationary development of the last few months. Year-on-year
inflation, as measured by the national consumer price index, dropped to 1.0% in the third quarter 2001
from 1.5% in the second quarter. In October inflation amounted to 0.6%, and to 0.3% in November.
This sharp decrease can be mainly attributed to the marked fall in oil prices and prices of other foreign
goods. Moreover, upward price pressure on domestic goods also eased markedly in November after
still having been substantial until October.
The dashed curve in the graph shows our latest inflation forecast. The table contains the average
annual inflation rate according to the new forecast. Since our forecast of June 2001, the world
economy has moved towards recession. Short-term inflationary pressures have subsided
considerably. On the assumption that the three-month Libor rate will remain stable at 1.75% during the
next three years, inflation should amount to 0.9% in 2002, move up to 1.3% in 2003 and reach 1.5% in
2004. The fluctuations in the anticipated 2002 inflation rate are due to basis effects that do not reflect
the inflationary trend. Inflation is expected to remain within the range of price stability throughout the
forecasting period. From mid-2002 on, however, it will follow a slight upward trend through the rest of
the forecasting horizon. This slight rise in anticipated inflation is attributable to two factors. First, the
world economy will recover in due course. Second, Swiss monetary policy at a constantly low interest
rate - which is currently 1.5 percentage points lower than in the June 2001 forecast - will tend to have
an increasingly expansive effect as time passes. These two factors combined will cause inflation to
rise somewhat over time.
Our forecast is based on the assumption that the US economy will remain in recession until mid-2002
and will subsequently gradually return to its potential growth path. In Europe, the economy will
presumably stagnate until mid-2002 and pick up momentum afterwards. We expect the US dollar to
remain roughly at its current level vis-à-vis the euro. The forecast assumes that today's relatively low
oil prices will eventually climb back slightly.
At this point, I would like to briefly comment on the interpretation of our forecast. It is based on the
above-mentioned assumptions regarding the development of the world economy, and on the
three-month Libor remaining stable throughout the forecasting horizon. In other words, the forecast
shows the development of inflation on the condition that monetary policy is left unchanged. However,
monetary policy will certainly need to be adjusted during the forecasting period. The economic
environment changes continuously as new disruptions occur, and the National Bank responds to these
changes in order to meet its objective of maintaining price stability. Therefore, it is important to bear in
mind that the forecast is made for a three-year period but is valid for only six months at most, i.e. until
the publication of the next forecast. The relatively long forecasting period reflects the time lag with
which monetary policy measures impact on the price level. We publish our forecast in order to inform
the public of our assessment of the inflation outlook, at the time of the forecast, on the basis of an
unchanged monetary policy. The publication is a means of making our monetary policy decisions more
transparent and easier to understand.
I will now make a few remarks about the development of the Swiss economy in the year now ending
and the coming year. The recessionary trends witnessed across the globe will not leave Switzerland
unscathed. Both this year and next, growth will be considerably slower than we predicted only a short
time ago. We expect the economy to go into virtual stagnation in the second half of 2001. Overall, the
economy will presumably grow by about 1.5% in 2001. In line with the development in the major
economic blocs, notably exports and capital spending have shrunk drastically, putting a major break
on economic growth. Although consumer confidence has been dented, consumption has so far turned
out to be a cornerstone of growth. The decline in construction investment is also clearly more
moderate than the fall in capital spending. We expect the economy to follow a path of muted growth
and to perform below its potential until the middle of next year. Only the second half of 2002 should
see the economy expanding in line with the development abroad. We project average growth of
approximately 1.0% for 2002. Unemployment is likely to climb in the months ahead.
We consider the current interest rate level and the existing monetary conditions to be adequate to
enable the economy to return to sustainable, non-inflationary growth. Our forecasts, however, are
fraught with uncertainties. In the aftermath of the terror attacks in the United States, these
uncertainties are now particularly substantial. Investment and consumption depend on whether market
participants have confidence in the quality and stability of the basic conditions. Depending on the
development of the political situation, the global economy may thus recover at a faster or slower pace
than we anticipated, and the exchange rates might be subject to major fluctuations. In this case, the
National Bank would have to review its monetary policy. In the short run, the price of oil will also have
a considerable influence on inflation. If it continues to erode, measured inflation might fall below zero
for a few months. Should this situation arise, it is important to bear in mind that it cannot be equated
with sustained - and thus economically dangerous - deflation. On the contrary, a low oil price level
would create a positive supply shock and, under the current circumstances, would impact favourably
on production. Inflation would be dampened temporarily. We also keep a close watch on the
development of the money supply M3 in order to assess the medium-term inflationary risks. Following
a phase of low, or even negative, growth rates, M3 is now expanding at a somewhat faster pace. So
far, however, there has been no excess supply of liquidity in the economy, and the money stock M3,
therefore, does not point towards inflationary risks at present.
Finally, I would like to make some closing remarks about the imminent introduction of euro notes and
coins. For about three years now, the euro has existed as deposit money. It has led to fixed exchange
rates and a uniform interest rate level in the euro area countries. The introduction of euro notes and
coins will have additional positive effects on the economic development in Europe, as it will be easier
to compare prices and confidence in the new currency will be strengthened. Moreover, the euro is to
be regarded positively not only with regard to the Swiss economy but also Swiss monetary policy. The
Swiss export sector will profit from lower transaction costs, and currency devaluations - as previously
implemented by some European countries in order to improve their competitiveness - will be a thing of
the past. Swiss monetary policy will benefit from the fact that a large economic bloc now exists in
Europe which pursues similar goals in terms of monetary policy. All in all, exchange rate fluctuations
between Switzerland and the EMU countries should thus remain below the levels seen before the
launch of the euro. Furthermore, the markets will realise in due course that there is no reason why the
Swiss franc, with regard to the role as a safe haven currency, should be assessed differently than the
euro. This realisation should reduce the risk of sharp appreciations.
As a result of the introduction of euro notes and coins, the euro will increasingly be used as a means
of payment in the tourism sector and the hotel and restaurant industry as well as in foreign trade, to
some degree simply as a substitute for the D-mark. Apart from very few viable exceptions, however,
employment and loan contracts will continue to be concluded in Swiss currency, and the large majority
of domestic payments, too, will be effected in Swiss francs in future. The euro will thus not emerge as
a parallel currency in Switzerland. The purview of Swiss monetary policy will remain unaffected by the
arrival of the euro. By retaining the Swiss franc, we are able to pursue an independent monetary policy
that is oriented to the needs of the Swiss economy, and to keep interest rates at a low level. In this
respect, the exchange rate is a key element for producing our inflation forecast and, therefore, for
determining our policy.
Inflation Forecast December 2001 with Libor at 1.75% 2001 2002 2003 2004
Annual average inflation in % 1.0 0.9 1.3 1.5