Monetary policy in a climate of increased uncertainty

Thomas Jordan, Member of the Governing Board

SNB Money Market Event, Geneva, 01.11.2007

Uncertainty about the extent and distribution of losses from US „subprime” mortgages has resulted in a marked squeeze on financial markets. In particular, there is considerable uncertainty concerning the true valuation of securitised assets and structured products based on subprime mortgages. Demand for liquidity has surged. In certain instances, the crisis of confidence among financial market participants was so pronounced that some markets did not function at all. The „re-pricing of risk” has caused risk premia for most financial instruments to soar.

Risk premia are important for the Swiss National Bank (SNB) for two reasons. On the one hand, they act as economic signals and should therefore be as unbiased as possible in the way they reflect underlying risks. In addition, there are certain risks attached to extreme values of risk premia. Abrupt and uncontrolled corrections could lead to instability on financial markets and interfere with their smooth functioning. On the other hand, risk premia affect the restrictiveness of monetary policy. An increase in such premia tightens monetary policy. The SNB monetary policy concept, where the three-month Libor is at the centre of the implementation of monetary policy, takes systematic account of changes in risk premia.

In today’s environment, monetary policy is more than ever a form of risk management: it is about evaluating risks and avoiding major errors. There are at present significant uncertainties associated with the outlook for growth and inflation, partly because the impact of the financial crisis cannot yet be fully determined, Moreover, Switzerland still faces the particular risk of the exchange rate. However, robust economic activity and subdued inflation have placed the SNB in a good position and allow for a balanced approach in determining future monetary policy. In doing so, the SNB would not hesitate to take monetary policy action, should developments in the Swiss franc exchange rate threaten price stability.