Inflation V: The Independent SNB Strikes Back

When I posted the blog “Inflation IV: A Phenomenon That’s Not Neutral, Rather Harmful in Reality” on LinkedIn, I announced that it was almost as exciting as Star Wars Episode IV. This blog examines the redistributive effects of inflation in an economy. In a commentary, I was suggested to devote Episode V to the means of fighting inflation. Like Star Wars Episode V “The Empire Strikes Back,” this blog could be titled, “Episode V: The Independent SNB Strikes Back.” The idea is excellent and I like to keep it.

Let’s go back to the 1980s. The Swiss economy was booming, the real estate market overheated and unemployment was very low. The SNB then pursued a money supply target, a concept influenced by the so-called monetarist1

In 1987, three events took place that led to a spike in inflation in Switzerland in the following years. First, stock markets worldwide collapsed in October 1987, prompting central banks to inject liquidity into the markets to calm things down. In other countries, she traded with homeopathic doses). Second, the SNB introduced a new clearing system that year that reduced the need for base money for commercial banks. The banks could provide more credit and they did. Third, the SNB introduced new liquidity requirements for banks, which also had an expansive effect. The management of the National Bank probably underestimated the expansive effect of these three events.

With the economy already running at full capacity, inflation rose above 6%, which is high for Switzerland. The central bank leaders were shocked and raised interest rates vigorously to halt price movements. This resulted in a recession. Inflation has certainly fallen, but at the cost of rising unemployment. Many companies went bankrupt. Property owners could no longer pay their debts. Banks were faced with high losses on their credit transactions. Within a few years, almost half of the regional banks, two cantonal banks and the Swiss Volksbank lost their independence. Since then, new regulations have reduced the likelihood of such a chain reaction: higher capital requirements for loans, a countercyclical capital buffer or greater bank funding.

But imagine if inflation in Switzerland exceeds 6% next year and Swiss politicians can decide how to proceed. Would the Federal Council or Parliament allow the three-month interest rate to rise above 9% as it did in the 1990s? Many homeowners with a mortgage would ask that interest rates not rise too quickly. Craftsmen fear a cessation of activities in the construction sector. The unions would demand a generous adjustment of wages to inflation, prolonging the inflation phase. The left would argue in favor of launching state stimulus programs, which are actually easier to fund when interest rates are low. The right along with the left could demand that the copious interest income of the central bank be redistributed to the people, preferably in the AVS, etc. In short, in such chaos monetary policy could not act and not or too late respond to rising inflation.

Fortunately, the SNB is (and hopefully for a long time to come) largely independent of politics. It can perform a “counter-attack”: If inflation really rose, it could do the following:

  1. Sell ​​foreign securities
    The sale of government bonds and foreign stocks that the central bank has amassed in recent years to hold the Swiss franc would primarily see the franc be withdrawn from circulation. An important side effect of inflation would be a controlled appreciation of the franc, which would curb inflationary inflation and dampen general price increases.
  2. Increase the interest
    Once the European Central Bank (ECB) tightened, raising interest rates in Switzerland would no longer risk triggering a sharp revaluation of the franc. Then the SNB could raise interest rates in Switzerland – albeit with some delay. This would dampen inflation.
  3. Re-enter SNB vouchers
    If the ECB waits too long to raise interest rates, the SNB can use its accounts again. They work as follows: the SNB issues interest-bearing securities itself. Buyers of these vouchers pay in Swiss Francs. This reduces the money supply.

One thing is clear: hardly anyone would welcome a restrictive policy, even if a return to price stability is necessary and in everyone’s long-term interest. The export economy would suffer from a strong franc, property owners would face financial difficulties, government revenues would fall, rents would rise and unemployment would rise. And because all of this is so unpopular, the SNB should essentially be able to act without being influenced by politics. Only an independent central bank strikes back at the right time – but, unlike the Star Wars saga, in the service of good.

1After the high inflation phase that many countries went through in the 1960s and 1970s, an intense debate began about the best way to manage inflation in the long term. Nobel laureate Milton Friedman put it this way: “Inflation is always and everywhere a monetary phenomenon.” Shortages can lead to temporary price increases, but sustained inflation would be due solely to this: monetary policy injected too much money into the system. Anna Schwartz, an eminent scientist, and Milton Friedman in their famous work “A Monetary History of the United States, 1867-1960” demonstrate that the money supply has a profound influence on the economy. The response of the so-called monetarist, including the Swiss Karl Brunner, was that central banks should conduct rules-based monetary policies. They proposed that the money supply increases at the same rate as an economy’s long-term production potential. However, the relationship between the money supply and price developments has not been sufficiently stable. Rules-based policies gave way to inflation targeting. At that time, however, people also became aware of the importance of the central bank’s independence from political circles. Empirical research has shown that independent central banks tend to have lower inflation than policy decisions should follow.


Episode I: Beware of Monetary Illusions: The Franc Isn’t As Strong As It Was In 2015

Episode II: Four Explanations of Record Inflation in the US

Episode III: “This Time It’s Different”, Really?

Episode IV: A Phenomenon That Isn’t Neutral, But Rather Harmful In Reality

Episode V: The Independent SNB Strikes Back

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