Monetary policy strategy
Constitutional and legal mandate
Article 99 of the Federal Constitution entrusts the SNB, as an independent central bank, with the conduct of monetary policy in the interests of the country as a whole. The mandate is explained in detail in the National Bank Act (art. 5 para. 1), which requires the SNB to ensure price stability and, in so doing, to take due account of economic developments.
The SNB is thus charged with resolving in the best general interests any conflicts arising between the objective of price stability and business cycle considerations, giving priority to price stability. The requirement to act in the interests of the country as a whole also means that the SNB must gear its policy to the needs of the entire Swiss economy rather than the interests of individual regions or industries.
Significance of price stability
Price stability is an important prerequisite for growth and prosperity. Inflation and deflation, by contrast, impair economic activity. They complicate decision-making by consumers and producers, lead to misallocations of labour and capital, and result in a redistribution of income and wealth.
By seeking to keep prices stable, the SNB creates an environment in which the economy can fully exploit its production potential. The objective of the SNB's monetary policy is to ensure price stability in the medium and long term. Short-term price fluctuations, however, cannot be counteracted by monetary policy.
Appropriate monetary conditions
To ensure price stability, the SNB must maintain appropriate monetary conditions. These are determined by the interest rate level and exchange rates. If interest rates remain too low for an extended period, this will trigger an excess demand for goods and services. There is also a risk of inflated asset prices. Although such factors may boost the economy initially, bottlenecks occur over time and production capacity becomes stretched, causing a rise in the price level. Conversely, a high level of interest rates lowers aggregate demand. This has a dampening effect on the development of prices for goods and services. An appreciation of the Swiss franc also curbs inflation and economic activity.
Taking economic activity into account
The economy is subject to numerous domestic and foreign shocks. The resulting fluctuations in the business cycle generate pressures on prices which can be quite pronounced. Such fluctuations are unavoidable. Although monetary policy is essentially medium and long-term in nature, it can nevertheless help to limit these fluctuations.
The most common cause of inflationary or deflationary pressure is a mismatch of aggregate demand for goods and services with the economy's production capacity. Such situations can arise, for example, because of unexpected economic developments abroad or major fluctuations in exchange rates. Inflationary pressures increase when the economy is overheating, and they decrease when production capacity is not fully utilised. The SNB must gradually restore price stability by tightening monetary policy, in the first case, and easing it, in the latter. Consequently, monetary policy that is geared to price stability has a smoothing effect on aggregate demand and thus fosters steady economic growth.
The situation is more complex if price increases are triggered by shocks that increase companies' costs and cause these companies to reduce production. A sustained rise in oil prices is an example of such a shock. In such circumstances, monetary policy must, on the one hand, make sure that the higher production costs do not create an inflationary spiral. On the other hand, it must ensure that the companies affected by the increased production costs are not overburdened. A hasty restoration of price stability could have adverse effects on the economy and on employment.
The economic analyses underlying the monetary policy decisions are rendered more complex by a number of uncertainties. These uncertainties relate, in part, to the causes and likely duration of the shocks that affect economic performance. The transmission mechanisms, the time lags and the extent to which the instruments of monetary policy affect the business cycle and prices are also subject to uncertainties.
Monetary policy strategy
The SNB's monetary policy strategy sets out how the SNB implements its monetary policy mandate. It has been in place since 2000, and consists of three elements. The first element specifies what the SNB understands by price stability. The second element refers to the conditional inflation forecast as the main indicator for monetary policy and as a central instrument of communication. The third element describes how the SNB implements its monetary policy by influencing the interest rate level and the exchange rate.
Definition of price stability
The SNB equates price stability with a rise in the Swiss consumer price index (CPI) of less than 2% per annum. Deflation, i.e. a sustained decrease in the price level, also breaches the objective of price stability. With this definition, the SNB takes into consideration the fact that inflation cannot be steered with pinpoint accuracy, or measured precisely. 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.
The SNB reviews its monetary policy on a regular basis to ensure that it is appropriate for maintaining price stability. It publishes its conditional forecast for inflation over the next three years on a quarterly basis. The period of three years corresponds roughly to the time required for monetary policy stimuli to be transmitted to the economy. Forecasts over such a long horizon involve considerable uncertainties. However, by publishing a medium-term forecast, the SNB emphasises the need to adopt a forward-looking stance to react at an early stage to inflationary or deflationary threats.
The conditional inflation forecast serves as the main indicator for the monetary policy decision, but also plays an important role in communicating policy to the public. The forecast is based on a scenario for global economic developments and on the assumption that the SNB policy rate set when the forecast is published will remain constant over the entire three-year forecast period (which is why it is a conditional forecast). Thus, the forecast shows how prices would move, assuming the current scenario for global economic developments and an unchanged SNB policy rate. For this reason, it is not directly comparable with forecasts that factor in expected monetary policy decisions.
The SNB uses a number of different economic and statistical models to draw up the conditional inflation forecast. Besides the inflation forecast, it takes into consideration a large number of indicators of domestic and international economic and monetary developments, as well as of financial stability, for its monetary policy decisions. These indicators include movements in interest rates and exchange rates as well as growth in credit and monetary aggregates. Particular weight is also attached to information obtained from the discussions which the SNB's delegates for regional economic relations conduct with companies about their business outlook.
The SNB does not react mechanically to the conditional inflation forecast. For instance, if inflation temporarily exceeds the 2% ceiling as a result of one-off 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 deflationary pressures.
Implementation of monetary policy
To ensure price stability, the SNB maintains appropriate monetary conditions. These are determined by the interest rate level and exchange rates. The SNB sets the level of the SNB policy rate. In so doing, it seeks to keep the secured short-term Swiss franc money market rates close to the SNB policy rate. The most important secured short-term Swiss franc interest rate is SARON (Swiss Average Rate Overnight). If necessary, the SNB may also use additional monetary policy measures to influence the exchange rate or the interest rate level.
The SNB holds quarterly monetary policy assessments at which it reviews its monetary policy stance. If circumstances require, it will also adjust its monetary policy in between the regularly scheduled assessment dates.
Monetary policy instruments
The SNB has a range of instruments at its disposal for managing monetary conditions. These include repo transactions, purchasing foreign currency and setting an interest rate on sight deposits held at the SNB by banks and other financial market participants. Further information may be found under Monetary policy instruments.
Monetary policy decisions are taken on a quarterly basis (or more frequently, if necessary) by the SNB Governing Board, at its monetary policy assessment. The decision is announced in a press release. The members of the Governing Board also explain the monetary policy decision at a news conference.
The conditional inflation forecast is an important communication tool for explaining the monetary policy decision, since the assumption of an unchanged interest rate for the next three years means that changes in the forecast allow conclusions to be drawn about the future course of monetary policy. If forecast inflation indicates a deviation from the range of price stability, an adjustment in monetary policy could prove necessary in the future. Should inflation threaten to exceed 2% on a sustained basis, the SNB would envisage a tightening of its monetary policy. Conversely, it would consider a relaxation of policy if inflation showed signs of being too low in the medium term.
After the monetary policy assessment, details of the decision are published in the Quarterly Bulletin, along with further analyses of economic and monetary developments in Switzerland and abroad. The publication also contains the results of discussions conducted by the SNB's delegates for regional economic relations with company representatives. In addition to these communications at the monetary policy assessments, the SNB also explains its thoughts on monetary policy in its annual accountability report. Moreover, members of the Governing Board regularly give speeches on monetary policy topics.