Monetary policy report 1996

A more expansionary monetary policy than announced...

The unexpected economic downturn induced the National Bank to pursue a more expansionary monetary policy in 1996 than announced at the end of 1995. We endeavoured to provide the economy with sufficient monetary leeway for a rapid cyclical recovery and to counteract deflationary pressures emanating from the strength of the Swiss franc. At the end of 1995, we had expected the seasonally-adjusted monetary base to grow by more than 1% but considered it unlikely to reach the medium-term target path by the end of the year. In actual fact, between the fourth quarter of 1995 and the fourth quarter of 1996 the monetary base rose by 5%, thereby already exceeding the target path in summer.

...necessary due to the economic situation

Our initial assumption, at the end of 1995, had been that the Swiss economy would revive and real gross domestic product would grow by 1.8% until the fourth quarter of 1996. At the same time, we had anticipated an inflation rate of approximately 1.5% during this period. Towards mid-year, however, it became increasingly evident that there would be no economic recovery. Consequently the danger of a steady decline in prices grew. We were thus led to expand the monetary base more markedly than originally planned. This enabled us to keep money market rates more or less at the low level attained at the beginning of 1996. The low interest rates acted as a corrective to the excessive rise of the Swiss franc in the foreign exchange market.

Marked decline in savings deposit rates

The vigorous expansion of the monetary base does not simply reflect the monetary policy pursued in 1996. In the wake of a distinct relaxation of monetary policy in spring 1995, savings deposit rates fell more steeply than expected at the end of 1995 and the beginning of 1996. Banknote circulation reacts to changes in monetary policy with a time lag of several months since it is influenced less markedly by money market than by savings deposit rates. The latter only adjust to changed money market rates after some delay.

Shift in demand for banks' sight deposits at the National Bank

Another reason for the strong expansion of the monetary base in 1996 is to be seen in the liquidity behaviour of various banks, which increased their sight deposit holdings at the National Bank and reduced their postal cheque account balances. Like cash and postal cheque account balances, these sight deposits help to meet statutory liquidity requirements. In contrast to sight deposits, however, postal cheque account balances do not form part of the monetary base. In order not to tighten our monetary policy course unintentionally, we adjusted the supply of base money by some Sfr 400 million on account of the higher demand for these sight deposits. Our stance was therefore not quite as expansionary as the growth of the monetary base seems to suggest.

Interest rate rise in mid-1996 not consistent with monetary policy

As a result of the expansionary monetary policy money market rates, which had already been declining steadily since spring 1995, fell to below 2% at the beginning of 1996. In the second quarter they moved up again. At first we took this as a sign of the anticipated economic recovery. Then, for the first time after a long period, the Swiss franc started to weaken in the foreign exchange market, which normally leads to a certain amount of interest rate tension. In addition, distortions in the money market as a result of the already mentioned changes in the banks' liquidity behaviour made themselves felt. We counteracted interest rate tension by providing the money market with ample liquidity. At the end of September, we decreased the discount rate from 1.5% to 1%, thus underlining our willingness to keep money market rates at a low level.

Strong growth of the broadly defined monetary aggregates

The development of the broadly defined monetary aggregates, which react promptly and vigorously to interest rate changes, confirmed the picture presented by the monetary base. Already beginning in spring 1995, the decline in money market rates had led to a massive expansion of sight and savings deposit liabilities in the banking system to the detriment of time deposits. This development was interrupted by a temporary rise in interest rates in spring 1996. Nevertheless, all the broadly defined aggregates rose vigorously: in 1996 the money stock M1 exceeded the previous year's level by 11.9% on average, the money stock M2 expanded by approximately 12.2%, while the money stock M3 increased by 7.2%.