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Questions and answers on monetary policy strategy

What goals does the SNB pursue with its monetary policy?

In accordance with the Federal Constitution and the National Bank Act (NBA), the SNB has the mandate to conduct its monetary policy in such a way that money preserves its value and the Swiss economy can develop in an appropriate manner. The Constitution (art. 99) obliges the SNB, as an independent central bank, to conduct a monetary policy that serves the interests of the country as a whole. In addition, art. 5 NBA specifies that the SNB is to ensure price stability while taking due account of the development of the economy.

How can the SNB influence price stability?

The SNB maintains price stability by ensuring appropriate monetary conditions. This means keeping interest rates, the exchange rate, and the supply of money and credit aligned to the prevailing economic situation. Low interest rates promote the supply of money and credit to the economy, thereby increasing demand for goods and services. Over time, however, this may overly stretch production capacity, leading to a rise in the price level. At the same time, there is the danger of excesses on financial and real estate markets. Conversely, rising interest rates leads to a shortage in the supply of money and credit, thereby holding back aggregate demand. This leads to a fall in capacity utilisation and causes downward pressure on prices. Given Switzerland's strong integration in the global economy, the exchange rate has a direct impact on the price level and the utilisation of production capacity.

How does the SNB make its monetary policy decisions?

As a rule, the SNB conducts a monetary policy assessment every quarter (in March, June, September and December) and decides on the appropriate monetary policy course. If circumstances so require, such decisions can also be made at other times. The SNB informs the public of its monetary policy decisions and the reasoning behind them. For its monetary policy decisions, the SNB analyses and assesses the economic and monetary situation (in particular the inflation outlook) in Switzerland. Special attention is also paid to economic developments abroad which have a major impact on a country like Switzerland with its strong international integration. Based on this comprehensive analysis, the SNB draws up an inflation forecast and decides whether its monetary policy is to remain unchanged, be tightened or be relaxed. As a rule, monetary policy decisions are taken with regard to interest rates. But this is not always the case. If necessary, the SNB can also take non-interest rate related decisions, such as the introduction of the minimum exchange rate, which applied from 6 September 2011 to 15 January 2015. The SNB implements its decisions through its monetary policy instruments. The latest monetary policy decisions are available at Monetary policy for the current year.

What is the SNB's monetary policy strategy?

The SNB's monetary policy strategy refers to the way in which the SNB aims to fulfil its statutory mandate of ensuring price stability. The strategy, which has been in place since December 1999, consists of three elements: a definition of price stability, a conditional inflation forecast over the subsequent twelve quarters, and a target range for the reference interest rate, the three-month Swiss franc Libor (Questions and answers on monetary policy implementation).

How does the SNB define price stability?

The SNB defines price stability as a rise in the national consumer price index (CPI) of less than 2% per year. This is the first element of the monetary policy strategy. The CPI is calculated by the Swiss Federal Statistical Office (SFSO). Further information is available on the CPI website of the SFSO (www.bfs.admin.ch). Price stability refers to the overall average of price changes. Prices of individual goods can easily fluctuate more strongly. Deflation - in other words, a protracted decline in the overall price level - is also regarded as a breach of price stability.

Why is price stability so important?

Price stability is an important condition for growth and prosperity. It means that money retains its value over time and prices can optimally fulfil their informative function for decisions regarding the production and consumption of individual goods. By seeking to keep prices stable, the SNB creates an environment in which businesses can plan in a reliable way and fully exploit their production potential.

What happens if prices are not stable?

A sustained increase in the price level (inflation) and a sustained decrease in the price level (deflation) both hamper economic development. Inflation and deflation make decision-taking more difficult for manufacturers and consumers. They distort price signals, which can lead to the wrong use of the production factors labour and capital. In addition, they cause shifts in income and wealth and, as a rule, put the economically weak at a disadvantage.

Why does the SNB not define price stability as a CPI change of 0%, or a change in the range between -1% and 1%?

With its definition, the SNB takes into consideration the fact that inflation cannot be measured accurately. Measurement problems arise, for example, when the quality of goods and services improves. Such changes are not fully taken into account in the CPI calculation; as a result, measured inflation tends to be slightly overstated.

In its definition of price stability, why does the SNB take into account only consumer prices and not, for example, real estate or share prices?

The CPI is based on a basket of goods that mirrors typical consumer behaviour in Switzerland, and is therefore a comprehensive and widely accepted reflection of developments in goods and service prices in Switzerland. Assets such as real estate and shares are not objects of consumption, but serve as a store of value, so they do not flow directly into an analysis of price stability. However, the SNB does take developments in assets markets into account for its monetary policy assessments, since these markets have an indirect influence on price stability and the development of the economy as a whole. And real estate price movements impact the CPI indirectly through rental prices.

Why does the SNB take the overall rate of inflation as a measure and not other inflation indicators such as core inflation, as several other central banks do?

Core inflation, which excludes certain categories of goods such as energy and food, and other inflation indicators can all be useful for assessing inflation trends. For the SNB, however, the overall rate of inflation is decisive because it is the relevant measure for the Swiss population.

What impact does the exchange rate have on price developments?

In an open economy such as Switzerland's with its high level of imports of preliminary products and consumer goods, exchange rate changes have an impact on import prices and therefore on the overall price level. This applies particularly in the case of strong exchange rate movements. Exchange rates enter into most of the SNB's analyses, as they can also have an impact on the monetary situation and influence economic developments.

How does the SNB monitor the maintenance of price stability?

In connection with its quarterly monetary policy assessments, the SNB publishes a conditional inflation forecast covering a three-year period - the second element of its monetary policy strategy. This forecast serves as the main indicator for the upcoming monetary policy decision, at which the SNB determines whether to tighten monetary policy, to relax it or to leave it unchanged. Furthermore, the conditional inflation forecast provides valuable guidance for the general public and is therefore a key element of the SNB's external communication.

Why does the SNB speak of a 'conditional' inflation forecast?

The SNB's inflation forecast is based on the assumption that the reference interest rate communicated at the time of publishing will remain unchanged over the next three years. This conditional forecast shows how the SNB expects consumer prices to move in the event that the reference interest rate does not change. For this reason, the SNB's conditional inflation forecast cannot be compared with forecasts by banks or research institutions. The latter, as a rule, factor anticipated interest rate developments - i.e. the SNB's reaction to economic and price movements - into their forecast calculations.

Why does the SNB produce an inflation forecast for a period of three years?

A time span of that length is certainly fraught with great uncertainty, but three years is approximately the period required for monetary policy measures to take effect on manufacturing and prices. With its three-year inflation forecast, the SNB thus takes account of the fact that the effects of monetary policy are lagged, and it therefore has to adopt a forward-looking stance in its monetary policy decisions and react at an early stage to threats of inflation or deflation.

When does the SNB adjust its monetary policy?

If the inflation forecast shows values that lie outside the price stability range, an adjustment to monetary policy may be necessary. Should inflation threaten to exceed 2% on a sustained basis, the SNB would consider tightening its monetary policy. Conversely, it would schedule a monetary relaxation if deflationary trends were identified.

Does the SNB automatically adjust its monetary policy when the inflation forecast is outside the price stability range?

The SNB does not react mechanically to the inflation forecast. In its monetary policy decisions, it also considers the general economic situation as well as possible risks that are not factored into the forecast models. If inflation temporarily exceeds the 2% ceiling as a result of exceptional factors, such as a sudden surge in oil prices or strong exchange rate fluctuations, monetary policy does not necessarily need to be adjusted. The same applies to short-lived negative inflation.

What indicators does the SNB base its inflation forecast on?

The SNB draws up its inflation forecast on the basis of various forecast models and numerous macroeconomic indicators, which it regularly explains and comments on in its report on the quarterly monetary policy assessment (published in the Quarterly Bulletin). For a country like Switzerland with its strong international integration, developments in the global economy play an important role. The SNB's inflation forecast is therefore based on assumptions concerning future global trends. It uses different scenarios relating to global economic developments in order to assess the risks for the forecast.

Has the SNB managed to maintain price stability over the past few years?

In 2008 annual inflation was 2.4%. The price level was down slightly in 2009 (-0.5%), 2012 (-0.7%), 2013 (-0.2%) and 2015 (-1.1%). In all other years since 1995, inflation remained within the bandwidth that the SNB equates with price stability, i.e. an annual increase in the consumer price index of less than 2%. Despite short periods of inflation outside the defined range, price stability has been maintained. If inflation temporarily exceeds the 2% ceiling or temporarily sinks below 0%, this may be the result of exceptional factors, such as a sudden change in oil prices or strong exchange rate fluctuations.