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Monetary Policy without Central Bank Money: A Swiss Perspective

Conference on the Future of Monetary Policy, sponsored by the World Bank, Washington D.C., 11 July 2000, 11.07.2000

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At the beginning of 2000, the Swiss National Bank (SNB) modified its approach to monetary policy. It abandoned monetary targeting in favor of an approach based on an inflation forecast. The proximate cause of the switch to a new policy framework lay in instabilities in the demand for base money, the SNB's intermediate target variable up to the end of 1999. However, this difficulty alone need not have prompted the SNB to abandon monetary targeting as money demand – in general – has been quite stable in Switzerland. In particular, the demand for M3 has behaved in a reasonably stable manner. The switch to a new framework was motivated by a more fundamental problem arising from monetary targeting. While the monetary base served as an effective long-run policy anchor, it was not well suited for deciding how the SNB should respond to unexpected shocks, notably exchange rate and cyclical shocks. A policy approach based on an inflation forecast is likely to help the SNB to react better to such shocks.

The new policy framework comprises three elements: (1) The SNB defines price stability, the main ultimate objective of Swiss monetary policy, as a CPI inflation rate of less than two percent per year. The SNB does not specify a precise floor to the range of price stability, but it is unwilling to tolerate sustained deflation. Nor does it treat its definition of price stability as an inflation target because it is prepared, if necessary, to tolerate temporary deviations in the inflation rate from the range of price stability. (2) In principle, the SNB bases its policy decisions on a forecast of inflation three years ahead. It publishes its forecast twice a year, i.e. in June and December. The SNB may also have to adjust monetary policy at a time at which it does not publish a new forecast. To this end, it identifies major monetary policy indicators entering into its inflation forecast. In the longer run, inflation is largely explained by the growth in the monetary aggregates, especially in M3. In the short run, it is the cyclical state of the economy and the exchange rate mattering the most. Thus, if necessary, the SNB may also adjust monetary policy with reference to these indicators. (3) The SNB frames its policy decisions as an operational target band for the three-month Libor rate of interest for Swiss francs, with the width of the band amounting to one percentage point.