SEPTEMBER 7, 1982
Swiss Monetary Policies—The Case of a Smaller Country
AN ADDRESS BY Dr. F. Leutwiler, LL.D. PRESIDENT, SWISS NATIONAL BANK
CHAIRMAN The President,
Henry J. Stalder
Distinguished members and guests, ladies and gentlemen: What Mr. Clausen is for the World Bank, what Mr. Bouey is for the Bank of Canada, Dr. Leutwiler is for the Swiss National Bank, the central bank of Switzerland. It was founded in 1907 to amalgamate a variety of currencies into one national denominator. Its head office is in the Swiss capital, Berne, but the central administration is located in the Swiss banking centre, Zurich. It is a legal entity in the form of a shareholders' company with majority participation by the cantons of Switzerland. However, the bank has a goodly number of private shareholders. Its foremost mission is the protection of the national currency, the control of money, and currency politics. Out of the forty members of council, twenty-five are elected by the Federal Council, among them the President and his deputy. The other fifteen members are elected by the shareholders.
Although the SNB is not part of the IMF per se, only an observer, it is considered a monetary institute with an exemplary track record. Its conservatism, combined with a swift and smooth mobility reacting to most trends, has proved to be amazingly efficient. The gold reserves are the myth of journalists and are thriftily kept at a nominal book value around $40 per ounce. The Chairman and President, Dr. Leutwiler, is well known for his continuous battle against inflation in which he has been prominently successful. Once he was asked by a journalist why at times he was less successful, upon which he replied, "You can't have your cake and eat it too, which means you can't have a cheap currency to boost exports and at the very same time a strong currency to curb inflation." The international reputation today of the Swiss currency is to a great extent due to the achievement of one man, our guest of honour.
It should be particularly interesting to hear from Dr. Leutwiler on this 1982 IMF Conference for in 1978 (also at an IMF Conference), he signalled fundamental changes to occur in the Swiss franc-American dollar relationship when he addressed the Swiss American Society of New York.
After studies of economic and political sciences at the University of Zurich, he graduated in 1948 with a PH.D. on the thesis, "Wage Differentials." Four years later, he joined the Swiss National Bank as a research economist, to become subsequently secretary to the chairman of the Governing Board. He was promoted to manager in 1959 and joined the Governing Board in 1968. In 1974, he was nominated chairman of the Governing Board of the Swiss National Bank and member of the Board of Directors of the Bank for International Settlements. This year, he was elected chairman of the Board of Directors and President of the Bank for International Settlements. He also holds an honorary doctorate degree conferred on him by the University of Berne.
Not all the Swiss yodel, make chocolate, or repair watches--many are bankers and are very good at it. To them, Dr. Leutwiler is Mr. Switzerland.
Ladies and gentlemen, please welcome our guest of honour.
Mr. Chairman, ladies and gentlemen: In many countries, economic problems threaten to outgrow governments and central banks: high unemployment, high inflation rates, high interest rates, high budget deficits, and high balance of payments deficits are characteristic of disorderly economic conditions. Worse than that: in most places there are few hopeful signs for a quick change for the better.
Comparatively speaking, Switzerland seems to be in a happy state. Among the problems just mentioned, some are totally unknown to us while others are only relevant to a degree which is, by foreign standards, not disturbing.
First of all, up to now, Switzerland has stayed clear of any serious unemployment problem. Yet, in 1974-75 our country was struck by a deep recession. Measured in GNP terms, it was even one of the sharpest downturns experienced by any industrial country. However, the considerable loss of jobs was to a large extent absorbed by the reduction of the foreign worker population. We were blamed, therefore, for taking things too lightly by simply exporting unemployment. Statistically speaking, this criticism might seem to be well grounded: between 1973 and 1977 the number of foreign workers fell by almost two hundred and fifty thousand or around 30 per cent. However, no foreign workers who had the right to an abode in Switzerland were sent home. Instead, work permits for seasonal workers and borderers were simply not renewed. Moreover, many foreign workers returned to their home countries voluntarily.
Since 1977, the number of foreign workers has increased again; today it amounts to 706,000, or 23 per cent of the total labour force. This percentage is higher than in any other industrial country.
Today, Switzerland is once again in a recession. Nevertheless, the unemployment figure is still very low, at 11,000, or 0.4 per cent of the labour force. Unlike during the seventies, the number of foreign workers is not decreasing; should a marked worsening of the labour market conditions take place today, there would be no scope for a large reduction. Up to now the main consequence of the recession has been an increase in part-time work, which, however, is by no means alarming and has not yet led to any social hardship. In Switzerland, the social climate is therefore still favourable. In our country, strikes have been exceptional phenomena anyway. Needless to say, the political situation is quiet, too; the Swiss government's stability has always been proverbial. This, of course, makes easier a solution to economic problems and keeps political pressure away from the Central Bank. We can do our jobs in a much less disturbed environment than many of our colleagues abroad and we do not have to care so much as to the direction the political winds are blowing.
Furthermore, the fulfilment of our tasks as central bankers is made easier by the fact that the Swiss current account does not cause us any serious problems. After years of considerable surpluses we had, in 1980, a small deficit. Yet in 1981 this gave way again to a surplus that might well be repeated this year. Problems of external debts are thus unknown to us; on the contrary, year after year, interest and dividend receipts on our foreign investments make a considerable contribution toward covering the traditional trade balance deficit.
As for the Swiss interest rates, they also present themselves in a favourable light compared to international standards. Today, for all maturities, they are lower than in any other industrial country. The often-heard complaints about excessively high interest rates are explained by the fact that in the past the Swiss were particularly lucky in this respect. Of course, we also feel the influence of the high American interest rates, but we are less "coupled" to them than other countries.
These considerations lead me naturally to discuss the Swiss National Bank's monetary policy. The results of this policy are, of course, reflected in the inflation, exchange, and interest rates. However, it is mainly through our ability to stabilize the price level that the efficiency of our monetary policy should be judged.
The Swiss National Bank has only been able to conduct a monetary policy deserving this name since January 1973, when it abandoned fixed exchange rates. Before this time, it was practically impossible to control the quantity of money: its evolution was essentially a function of the Swiss National Bank's intervention to support the dollar on the exchange market.
Formally, the current approach to Swiss monetary policy was inaugurated in 1975, when the National Bank, for the first time, fixed a target for the money supply.
In the following, I would like to explain briefly how we have managed the money supply in the last few years, the successes we had, and the disappointments we were confronted with. I shall also give a short overview of how we have tried to deal with the strong exchange rate fluctuations characteristic of the Swiss franc.
The Swiss National Bank was among the first central banks that decided to adopt a money stock target. However, the decision to adopt a target for M1 in 1975 was not the outcome of a sophisticated piece of research work, it simply reflected the casual observation that there had been in the early seventies a fairly close relationship between MI and the consumer price index and that growth rates of M1 had fluctuated around 3 per cent during periods of stable prices. As a result of these observations, the Swiss National Bank strove to lower the growth rate of MI to a long-range average of roughly 3 per cent. Such a policy was considered a necessary condition for achieving and maintaining an inflation-free environment. It should be emphasized, however, that the policy of well-controlled, stable monetary growth was never viewed as a policy which should be adhered to rigidly month after month, or even year after year. Rather, it was considered a medium- to long-term strategy, allowing for short-run flexibility, especially in view of exchange rate developments.
The Swiss National Bank usually determines the annual money-stock target at the end of a calendar year. The size of the target depends upon the expected and desired economic growth for the year to come and on the assumption about next year's income velocity. The quantitative setting of the target is always a compromise between empirical findings, theoretical ideas, and, last but not least, political considerations. Before the Governing Board of the Bank makes its final decision on the target, the government is informed about our intentions. However, it must be emphasized that the responsibility for defining a money-stock target rests solely with the Governing Board.
During the first three years this approach produced satisfactory results. The actual growth in MI was relatively low and conformed fairly closely to the targets set by the Swiss National Bank.
The situation changed drastically in 1978, when Ml grew by no less than 16.2 per cent, while the target amounted to only 5 per cent. This huge discrepancy, however, was not due to erroneous control procedures, but reflected a shift in monetary policy in response to a strong appreciation of the Swiss franc.
Toward the end of 1977, Swiss monetary policy became increasingly bedevilled by exchange rate problems, owing to a strong appreciation of the Swiss franc in both nominal and real terms. By the spring and summer of 1978 this upvaluation had become large enough to open up the prospect of a drastic slump in economic activity. In order to avert a recession, the Swiss National Bank, at the beginning of October 1978, reluctantly decided to replace temporarily the target for MI by an exchangerate target in the form of a floor on the Swiss-franc price of the Deutschmark. On November 1, the Swiss National Bank's efforts to push down the value of the Swiss franc were supplemented by a program of foreign-exchange-market interventions launched jointly by the central banks of the United States, Germany, Japan, and Switzerland.
The Swiss National Bank took a calculated risk when it switched temporarily to an exchange rate target. It was clearly aware of the possibility that the explosion in the money stock might jeopardize its anti-inflationary monetary policy. Through a policy of tightly controlling the money stock it had managed to reduce the inflation rate from over 10 per cent in 1974 to less than 1 per cent in 1978. The Swiss National Bank was not sure whether the switch to an exchange rate target would be consistent with price stability. However, despite the pre-eminence of price stability as an objective of Swiss monetary policy, the Swiss National Bank in 1978 could not be oblivious to the employment situation. In an effort to forestall a serious recession, it was prepared to accept a substantial increase in the money stock.
Since the Swiss National Bank did not know when it would be able to return to a policy of controlling money growth, it abstained from fixing a money-stock target for 1979. In the spring of that year, however, the turmoil in the foreign exchange market had subsided sufficiently to allow the Swiss National Bank gradually to syphon off the excess base money accumulated during the preceding months. At the end of 1979, the Swiss National Bank was ready once again to announce a moneystock target. Although the events of 1978 did not shatter its belief in the usefulness of such a target, the Swiss National Bank nonetheless decided to reassess the policy approach it had followed since 1975. After it had investigated the relative merits of targeting various monetary aggregates, it came to the conclusion that MI was no longer an optimal target variable. Instead it chose to target directly the monetary base. The main reason why the Swiss National Bank opted for a monetary-base target was that, unlike MI, it could directly control the monetary base.
As we had feared, the sharp increase in the money stock at the end of 1978 ushered in a new period of inflation. Due to the restrictive policy course pursued since early 1979, however, inflation did not get out of hand. In my opinion, there is a good chance that we will be able to restore price stability in Switzerland in the not too distant future. As a matter of fact, we have loosened somewhat our restrictive monetary policy since the beginning of this year. In view of the present recession, it would be unwise to adopt an overly restrictive policy course. A very tight monetary policy would likely strengthen the Swiss franc to an extent that would cause difficulties for our exporting industries.
Compared to what the public must swallow in other countries, the current Swiss inflation rate of 6 per cent is relatively low. But for us, it is definitely too high. It would have been easy for us to push down the inflation rate more quickly by tightening monetary policy, but by doing so we would have amplified the recession. We have no intention whatsoever of implementing such a monetary policy. Although our policy is aimed at price stability, we believe that the central bank cannot be oblivious to the employment situation. Monetary policy cannot be pursued in a dogmatic fashion. After all, its fundamental purpose is to create and maintain a healthy economic environment. Price stability is not an end in itself, but a crucial precondition for the central bank being able to achieve this fundamental aim.
Although the Swiss National Bank handles its monetary policy in a flexible manner, we do not alter the course of our monetary policy after every minor change in exchange and interest rate conditions. The experience of the Swiss National Bank during the past years has confirmed to a large extent the monetarist's position for a non-activist monetary policy. We had to realize that the short-run relationships between monetary actions, interest rates, exchange rates, and nominal GNP are much more subtle and complex than standard models lead us to believe. Recognizing that lags are variable and hard to predict, the Swiss National Bank is sceptical, to say the least, about its ability to control in the short run interest rates, exchange rates, or monetary aggregates (except the monetary base). Therefore, we have become more and more convinced that the pursuit of a medium-term target for the monetary base is an optimal strategy. Short-term money-stock targets are not regarded as a helpful device for the market. In many cases, they even confuse market participants and do not help the investors in any way.
What is needed today is to convince the markets that the
monetary authority will permanently lower the growth rate of the monetary aggregates. However, given the rather low credibility of most central banks today, neither monetary targets nor the best monetary control procedure will be enough to convince the market participants. A central bank should simply lower the monetary aggregate growth rates. It is nevertheless clear that such a policy should be implemented gradually and with care in order to minimize the short-run negative effects on the level of employment. The safest way to lower these growth rates over time is to reduce the monetary base growth rate. Though not always true in the very short run, the correlation between the monetary base and other monetary aggregates is so close that a central bank should never fail, by lowering the growth rate of the base, to reduce the growth rates of monetary aggregates. A monetary base approach can, therefore, lower the uncertainty about the long-term trend of the monetary policy. This might be regarded as a small contribution. By considering the frequent failure of central banks to bring monetary growth under control, it would represent a big step forward towards a more stable and non-inflationary economic growth.
Being Canadian, you know of course that a small, open economy cannot pursue an economic policy independently of the international environment. Clearly, stability begins at home; but Switzerland is not an island in the middle of nowhere; it is exposed to many outside influences. We do business all over the world; we harbour an international finance centre and the Swiss franc is an international reserve currency. Therefore, and more than any other country, we are dependent upon others. We are thus still a long way from an ideal independent state and there is little chance that we shall ever reach it. This, however, does not release us from the burden of pursuing in economic policy the way we think to be right, even if this way is difficult and tortuous.
The appreciation of the audience was expressed by William M. Karn, a Past President of The Empire Club of Canada.