Swiss monetary policy facts... and fiction

Swiss Finance Institute Evening Seminar, Geneva, 19.05.2015

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Based on his practical experience of making monetary policy in the last few years, the author attempts to dispel four Swiss monetary policy 'fictions' by contrasting them with established facts about Swiss monetary policy.

The first fiction is that, because of the so-called 'zero lower bound', nominal interest rates cannot become negative - obviously proven wrong by current developments. Of course, negative nominal rates do not represent a normal state of affairs. Rather, they mirror the exceptional circumstances faced by Switzerland, characterised by recurrent safe-haven demand for the Swiss franc and globally low interest rates. In this environment, imposing negative rates is a monetary policy necessity in order to re-establish a material interest rate differential vis-à-vis the major economies, and thus to reduce the incentive to invest in Swiss franc-denominated assets.

The second fiction is that an unlimited lengthening of a central bank's balance sheet is riskless. To address this fiction, three important facts - applicable both generally and to the current Swiss monetary policy situation - should be considered. First, a central bank balance sheet is never a target per se, but rather its size and composition simply mirror monetary policy decisions. Second, massive balance sheet expansions carry significant financial and economic risks. And third, policy measures involving a significant balance sheet expansion should be taken only as long as the benefits in terms of the broader policy objective justify the risks and cover the associated costs. The discontinuation of the minimum exchange rate is a case in point.

The third fiction is that central banks have unlimited power - nurtured by the perception that their independence renders them immune to democratic controls. While there are compelling reasons for the delegation of monetary policy power to an independent central bank, it is an important fact that the SNB's independence is far from unlimited, because of a well-developed system of checks and balances obliging the SNB to transparently account for its decisions.

The fourth fiction is that financial stability is an 'impossible dream'. While there are indisputable difficulties in fostering the stability of the financial system, this pessimism is unjustified if two main prerequisites are fulfilled in tandem. The first is to continuously strive to improve our knowledge about the key sources of financial instability. And the second is to recognise the fact that even with imperfect knowledge, financial stability is attainable if we muster, collectively, the political will to take precautionary measures commensurate to the extent of our ignorance.