What constitutes sound money?
Thomas Jordan, Chairman of the Governing Board
Economic Conference, Progress Foundation, Zurich, 08.10.2020
History shows that sound money is a fragile accomplishment. Money is sound when its value is stable and it is thus able to perform its functions as a medium of exchange, a unit of account and a store of value. Sound money creates security and trust, which in turn promotes social harmony and cohesion.
The Swiss franc's value has never been as stable as in the past twenty years. Nevertheless, the financial crisis and central banks' reactions to it have increased concerns about money. The monetary base has expanded significantly and interest rates are at record low levels. In the past, such phenomena have often presaged currency depreciation.
There are two types of money in circulation in the Swiss monetary system today: central bank money - banknotes and banks' sight deposits at the SNB - and bank deposits.
These days, central bank money is paper money, which means the issuing of money is completely flexible. If a central bank applies this flexibility appropriately, it can keep the value of money stable and limit the damage to the economy in the event of a crisis. However, paper money has often proved to be decidedly bad - with disastrous consequences. The flexibility must not be misused to print money for the purposes of solving political problems. Central bank money is sound when the paper money system is supported by three mainstays: a central bank mandate focused on price stability, the independence of the central bank, and solid state finances. Central bank money that retains its value is a prerequisite for sound bank deposits. Furthermore, banks must be solvent and liquid at all times and structure their business models accordingly. In Switzerland, central bank money and bank deposits are sound money. The marked expansion in the monetary base in recent years does not pose a threat to currency stability because the SNB has simply reacted to rising demand for Swiss francs. Had it not acted, price levels would have dropped significantly, the Swiss franc would have appreciated even more, and economic activity would have declined.
Even amid the coronavirus crisis, the responsibilities for monetary policy and for fiscal policy must be clearly separated to ensure that central banks remain independent. Excessive government debt could force a central bank to focus its monetary policy on its impact with regard to public finances rather than on price stability. This would negatively affect the soundness of money. In Switzerland, the coronavirus crisis has led to mounting calls for the SNB to make additional profit distributions. However, the size of any distribution depends on the earnings potential of its investments, and a central bank must maintain a sufficient level of equity to cover the risks in its balance sheet. Safeguarding the three mainstays of a sound paper money system today is essential to ensure that the advantages of its flexibility can be used in the national interests going forward.