Monetary policy strategy
Constitutional and legal mandate
Article 99 of the Swiss Federal Constitution entrusts the SNB, as an independent central bank, with the conduct of monetary policy in the interest of the country as a whole. The mandate is explained in detail in the National Bank Act (art. 5 para. 1 NBA), 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 interest any conflicts that may occur between the mandate of price stability on the one hand and business cycle considerations on the other, giving priority to price stability. The requirement to act in the interest of the country as a whole also means that the SNB must tailor its policy to the needs of the entire Swiss economy rather than the claims of individual regions or industries.
Significance of price stability
Price stability is an important condition for growth and prosperity. Inflation and deflation, by contrast, hamper economic development. They complicate decision making by consumers and producers, cause labour and capital to be misallocated, and lead to 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 productive capacity. The objective of monetary policy is to achieve price stability in the medium and long run. However, it cannot eliminate all short-term price fluctuations.
Appropriate monetary conditions
To secure price stability, the SNB must set appropriate monetary conditions. 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, an interest rate level which is too high lowers aggregate demand. This has a dampening effect on the prices of goods and services.
Taking economic activity into account
The economy is subject to numerous domestic and foreign shocks. The resulting business cycle fluctuations generate pressures on prices, which can be quite pronounced. Such fluctuations are unavoidable. Even though monetary policy is geared toward the medium and long term, it can still help contain certain short-run fluctuations that arise from various types of shocks.
The most common cause of inflationary or deflationary pressure is when aggregate demand for goods and services does not move in line with the economy’s productive 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 a pass-through of the higher production costs does 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 which monetary policy decisions are based on are rendered more complex by a number of unavoidable 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 it consists of three elements: a definition of price stability, a medium-term inflation forecast, and – at the operational level – a target range for a reference interest rate, which is the three-month Swiss franc Libor (London Interbank Offered Rate).
Definition of price stability
The SNB equates price stability with a rise in the national consumer price index (CPI) of less than 2% per annum. The objective of price stability is also breached by deflation – i.e., a protracted decline in the price level. In this definition, the SNB takes account of the fact that inflation cannot be managed with pinpoint accuracy; neither can it be measured accurately. Measurement issues arise, for instance, when the quality of goods and services improves over time. The CPI calculation methods do not fully adjust for changes of this kind; as a result, measured inflation tends to overstate actual inflation to a small degree.
The SNB reviews its monetary policy stance 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 changes in monetary policy to be transmitted to the economy. Forecasts over such a long horizon naturally involve considerable uncertainties. Nevertheless, by publishing a medium-term forecast, the SNB emphasises the need to adopt a forward-looking stance and to react at an early stage to any inflationary or deflationary threats.
Whereas the conditional inflation forecast serves as a main indicator for the monetary policy decision, it also plays an important role in communicating policy to the public. The forecast is based on a scenario for future global economic developments and on the assumption that the policy rate published along with the forecast will remain constant over the entire three-year forecast period (which is why it is conditional). The forecast thus projects how prices would develop given the SNB’s current scenario for global economic developments and with monetary policy in Switzerland remaining unchanged. For this reason, this forecast is not directly comparable with other forecasts which incorporate expectations that monetary policy will change over time.
The SNB uses a number of economic and statistical models to make conditional inflation forecasts. In addition to employing model-based inflation forecasts, it also takes into consideration several indicators of domestic and international economic and monetary developments as well as of financial stability in 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 on their business outlook.
The SNB does not respond in a mechanical fashion to its conditional inflation forecast. For instance, if inflation exceeds the 2% ceiling as a result of one-off factors such as a sudden surge in oil prices or strong exchange rate fluctuations, the stance of monetary policy would not necessarily need to be adjusted. The same applies to short-lived deflationary pressure.
Libor target range
The SNB implements its monetary policy by setting a target range for the three-month Swiss franc Libor. The Libor is a reference interest rate in the interbank market for unsecured loans. It is a trimmed mean of the rates charged by 11 leading banks and is published daily by the ICE Benchmark Administration. The SNB regularly publishes its target range, which generally extends over 1 percentage point. As a rule, it aims to keep the Libor in the middle of the target range.
The SNB holds quarterly monetary policy assessments at which it reviews its monetary policy stance. If required by circumstances, it can also adjust the three-month Libor target range in between the regularly scheduled assessment dates.
Against the backdrop of international reform efforts on benchmark interest rates for financial contracts, the UK’s Financial Conduct Authority announced in July 2017 that it would no longer compel banks to contribute to the Libor panel after 2021. The continued availability of the Libor is thus uncertain. The SNB will provide advance information on any adjustments that may be necessary for its monetary policy strategy. The changes will have no impact on its monetary policy objectives.
Set of monetary policy instruments
The SNB has a range of instruments at its disposal for managing monetary conditions, including repo transactions, purchasing foreign currency and setting an interest rate on sight deposits held by banks and other financial market participants at the SNB. 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 decisions are announced in press releases following the conclusion of each meeting. In addition, following the June and December monetary policy assessment meetings, a press conference is held at which the members of the Governing Board explain the monetary policy decision.
The SNB’s conditional inflation forecast is an important communications tool for explaining monetary policy decisions. Due to the assumption of an unchanged policy interest rate for the next three years, its development allows people to draw inferences about the future course of monetary policy. For instance, if inflation is forecast to lie outside the range of price stability, an adjustment to the monetary policy stance could prove necessary: Should inflation be projected to exceed 2% on a sustained basis, the SNB would envisage a tightening of its monetary policy stance. Conversely, it would consider relaxing monetary policy if there were signs of inflation being too low in the medium run.
After each monetary policy assessment round, the SNB publishes details of its decision 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 with private sector representatives conducted by the SNB’s delegates for regional economic relations. Apart from these quarterly communications related to the monetary policy assessment meetings, the SNB also explains its deliberations on monetary policy in its annual accountability report. In addition, members of the Governing Board regularly give speeches on monetary policy topics.