What can the National Bank do for the economy?

Jean-Pierre Roth, Chairman of the Governing Board

Zürcher Volkswirtschaftliche Gesellschaft, Zurich, 10 April 2002, 10.04.2002

From the realisation that monetary policy can have a long-term impact only on the development of the price level, and not on the real growth of the economy, follows that price stability must be the primary goal. The National Bank defines price stability as annual inflation of less than 2%, measured by the national consumer price index. If the National Bank succeeds in keeping price stability within this range, it makes it easier for companies and households to anchor their inflation expectations, and it protects the national economy from the costs of inflation.

In its inflation forecast, the National Bank takes the exchange rate into account. Since the exchange rate influences the course of inflation, and the National Bank sets the short-term interest rate in such a manner as to keep forecast inflation within the target range in the medium term, the exchange rate also has a bearing on the monetary policy of the National Bank. Moreover, the National Bank reserves the right to shift the interest rate within the target range in times of exchange rate fluctuations. It made use of this flexibility in the week before Easter when it lowered the repo rate, thus initiating a downward shift of the three-month Libor rate to the lower end of the interest rate target range, which was confirmed at the Bank's assessment of the situation on 21 March 2002 (1.25%-2.25%).

However, the possibilities of the National Bank to influence the exchange rate are limited. It can bring about a sustained change in the nominal exchange rate only if it changes the markets' expectations about its monetary policy stance. These expectations are ultimately determined by the National Bank's goal to keep medium-term inflation below 2%. Should the National Bank want to lower the nominal exchange rate sustainedly, it would thus have to abandon this goal and introduce an expansionary monetary policy, which would boost inflation expectations.