The economy is subject to numerous domestic and foreign shocks. These cause fluctuations in the business cycle which generate pressures on prices that are more or less pronounced. Such fluctuations are inevitable. Although monetary policy is medium and long-term in nature, it can nevertheless help to limit these fluctuations. The SNB faces highly diverse situations.
The most common cause of inflationary or deflationary phases is when aggregate demand for goods and services does not move in line with the economy’s production capacity. Such situations can arise, for example, as a result of unforeseen developments in the international economy, major fluctuations in exchange rates, serious government budget problems or inappropriate money supply levels in the past. Inflationary pressures increase in phases of economic overheating and decrease when production capacity is not fully utilised. Thus, the National Bank must gradually restore price stability by tightening monetary policy in the first case and easing it in the latter. Consequently, monetary policy that is geared to price stability has a smoothing effect on aggregate demand and thus encourages steady economic development.
The situation is more complex when prices rise owing to shocks that increase firms’ costs and cause them to curb production. A continuous rise in the oil price is an example of such a shock. In these circumstances, monetary policy must, on the one hand, make sure that the higher production costs do not give rise to an inflationary spiral, while, on the other, ensuring that the companies affected by the shocks are not overburdened. An overhasty restoration of price stability might have adverse effects on the business cycle and employment.
