Monetary policy using negative interest rates: a status report
Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank
Vereinigung Basler Ökonomen, Basel , 24.10.2016
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Since January 2015, the monetary policy of the Swiss National Bank (SNB) has been based on two elements: a willingness to intervene in the foreign exchange market as necessary and an interest rate of -0.75% on banks' sight deposits held at the SNB. It is not just short-term interest rates that are currently negative - longer-dated Confederation bonds and some corporate bonds are now also negative yielding.
Low interest rates are not confined to Switzerland, however. Interest rate levels, both nominal and inflation-adjusted, have been declining on a global basis for more than 20 years. Structural factors such as demographic trends, which have led to a higher supply of savings while demand for investment has fallen, are one reason for this development. Another reason for low interest rates is that monetary policy is very expansionary due to weak inflation and slow economic recovery.
In principle, taking a policy rate into negative territory has had a similar effect in Switzerland to cutting a policy rate in positive territory. Historically, Switzerland has always had lower interest rates than the euro area. During the global financial crisis, this interest rate differential narrowed and even turned negative with the introduction of negative interest by the European Central Bank in mid-2014. The SNB's negative interest policy has partially restored the interest rate differential to the euro area and has made the Swiss franc less attractive as an investment currency. Together with the SNB's willingness to intervene in the foreign exchange market, negative interest has reduced pressure on the Swiss franc despite occasional bouts of heightened market volatility. Financing costs for businesses and households have also fallen. This has caused companies to borrow more on the capital market. By contrast, growth in bank lending has not increased.
In the current environment, negative interest is necessary and appropriate for Switzerland. As a small open economy, it cannot decouple itself from globally low interest rates. Without negative interest, the Swiss franc would have appreciated even more strongly, unemployment would have risen, and growth would have collapsed, accompanied by even lower inflation.
However, the low interest rate environment also presents several challenges for monetary policy. The possibility of holding cash limits the scope for monetary policy action. Persistently low interest rates can also have an adverse impact on financial stability and diminish the effectiveness of monetary policy. These side-effects are one reason why negative interest, or expansionary monetary policy more generally, is no panacea. Structural reforms and adjustments in the real economy are necessary for a sustained economic recovery. Globally, structural measures can create the conditions for equilibrium interest rates to rise once more. This would allow central banks to embark on a gradual process of normalisation, and the potential adverse effects of persistently low interest rates would be contained.