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1 University of Fribourg, April 3, 2009 University of Fribourg, April 3, 2009 Swiss monetary policy principles Swiss monetary policy principles and reaction to the crisis University of Fribourg April 3, 2009 Florence Miguet, Economic

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Swiss monetary policy principles Swiss monetary policy principles and reaction to the crisis

University of Fribourg April 3, 2009 Florence Miguet, Economic Analysis

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Structure of the presentation

  • MANDATE OF THE SWISS NATIONAL BANK
  • PART I:
  • PART I:

SNB MONETARY POLICY STRATEGY

  • PART II:

REACTION TO THE CURRENT CRISIS

  • MORE QUESTIONS?
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Mandate of the Swiss National Bank

  • Federal Constitution (art. 99):

“As an independent central bank, the Swiss National Bank shall pursue a monetary policy serving the interests

  • f

the country as a whole”

  • Federal Act on the Swiss National Bank (art 5 al 1):
  • Federal Act on the Swiss National Bank (art. 5, al. 1):

“The SNB shall ensure price stability. In so doing, it shall take due account of the development of the economy”

  • Federal Act on the Swiss National Bank (art. 5, al. 2, lit. e):

“It shall contribute to the stability of the financial system”

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Mandate of the Swiss National Bank

  • Art.

6

  • f

the Act clarifies also what is meant by independence:

“In fulfilling its monetary tasks, the National Bank and the members

  • f the Bank’s bodies shall not be permitted to seek or accept

instructions either from the Federal Council or from the Federal instructions either from the Federal Council or from the Federal Assembly or any other body”

  • Art. 7 al. 2 of the Act specifies SNB’s duty for accountability

which is the counterpart of independence:

“The National Bank shall render account of the fulfilment of its tasks pursuant to article 5 to the Federal Assembly annually in the form of a pursuant to article 5 to the Federal Assembly annually in the form of a

  • report. It shall regularly elaborate on the economic situation as well as

its monetary policy to the competent committees of the Federal A bl ” Assembly”

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Part I SNB MONETARY POLICY STRATEGY

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Monetary policy strategy

Main goal: Maintaining price stability in the medium-term

  • 1975-1999: Monetary targeting

y g g

  • 2000 onwards: New monetary policy strategy

4 elements:

4 elements:

1)

An explicit definition of price stability

2)

A conditional inflation forecast as main guide for policy decisions

3)

A range for a short-term interest rate as operative target

4)

Repo operations as main instrument

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1) Price stability

  • Inflation rate of less than 2% y/y and not negative
  • Set in terms of headline CPI, not of CORE inflation index

,

  • The

definition

  • f

price stability takes into account measurement, substitution and quality adjustment bias

  • The definition of price stability delivers the nominal anchor

for the medium-term orientation of monetary policy

  • It is important for stabilizing inflation expectations
  • It is the benchmark for the accountability of the SNB
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2) Conditional inflation forecast

  • Forward-looking monetary policy: a conditional inflation

forecast is used as the main indicator for guiding monetary policy decisions

  • Inflation forecast is conditional on fixed interest rates and
  • n assumptions regarding the evolution of the world economy

and of oil prices I i i l t li d t b dj t d h th

  • In principle, monetary policy needs to be adjusted when there

is evidence of a sustained deviation of the projected inflation from the range compatible with price stability inflation from the range compatible with price stability

  • Monetary policy does not react mechanically to the inflation

forecast, the economic situation plays an important role

  • ecast, t e eco o

c s tuat o plays a po ta t ole

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How is the inflation forecast derived?

  • The SNB inflation forecast is put together as a broadly based

consensus forecast

  • Forecasts of different models and indicators are considered
  • The weighting of different model forecasts and various

indicators leads to a consensus forecast

  • The weights are not fixed; the weighting method depends on critical

analysis of models and indicators and on the specific economic analysis of models and indicators and on the specific economic situation

  • Quarterly publication of inflation forecast over a 3-year

horizon

  • Since monetary policy takes some time to influence inflation, the

forecast horizon used corresponds to the average lag of the forecast horizon used corresponds to the average lag of the transmission mechanism

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Models

NON-STRUCTURAL

  • 1. ARIMA and VAR - Autoregressive Integrated Moving Average, Vector Autoregression

SEMI-STRUCTURAL

2 SVAR St t l V t A t i

  • 2. SVAR - Structural Vector Autoregression
  • 3. SVEC – Structural Vector Error Correction

STRUCTURAL

  • 4. SEM - Simultaneous Equation Models
  • 4a. Small
  • 4. SEM Simultaneous Equation Models
  • 5. DSGE - Dynamic Stochastic General Equilibrium
  • 4b. Medium

y q

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Timing

  • Regular quarterly basis
  • Dates are known to the public (March, June, September and December)

Defining scenarios for the Reports and policy Meeting of Board Computing consensus international business cycle: Base scenario and suggestion to Board with policy decision inflation-forecast from model forecasts and i di t ase sce a o a d risk scenarios (Board approval) indicator information

T-4 weeks T-3 weeks T-1 week T

  • Extraordinary meetings in case of special circumstances...
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Current forecast

  • Point forecast: No fan chart !
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Interpretation of the forecast

  • Although the forecast horizon extends over the subsequent 3

years, the individual forecast itself is valid for 3 months at most

  • The published forecast is conditional on the level of interest

rate as it is set after the policy decision

  • If inflation at the end of the forecast horizon is within the range of

price stability and displays no sustained trend the published price stability and displays no sustained trend, the published forecast offers no hint as to the likely changes in the interest rate

  • ver the following 3 months

H bli h d f h h i d d

  • However, a published forecast that shows a sustained trend or a rate

that departs from price stability at the end of the forecast horizon signals future interest rate changes, although the timing will remain unspecified

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SNB strategy vs. inflation targeting

  • The definition of price stability:
  • Should be valid for an extended period of time
  • Should not be changed for political reasons
  • The SNB is happy with any non-negative value under 2%
  • There is no defined time horizon for reaching price stability
  • The SNB is free to choose the time horizon to restore price stability

after an inflationary shock after an inflationary shock

  • The time horizon will depend on circumstances and the stance of the

economy

  • The inflation forecast is not used as an intermediate target

but rather as the main indicator

i i ll d i i i h h

  • No commitment to react systematically to deviations with the

forecast

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3) Target range for the 3M-Libor

  • A target range for the 3M-Libor (London Interbank Offered

rate) represents the operational target (≠ BoE, Fed, ECB)

  • The 3M-Libor is a significant short-term interest rate for

Switzerland (e.g. mortgages rates)

  • Computed in London by the British Banker’s Association as an average
  • f data provided by 12 banks (3 highest + lowest rates excluded)
  • If not limited by technical factors the target range is 100
  • If not limited by technical factors, the target range is 100

basis points wide

  • The region within the range that is being aimed at (centre
  • The region within the range that is being aimed at (centre,

upper, or lower part) is announced together with the target range itself g

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Why a target range on a 3-month rate?

  • For a small open economy like Switzerland, the target range
  • f the 3M-Libor allows to absorb small exchange rate shocks

without intervention of the SNB which could be considered as a change in the course of monetary policy

  • A 3-month rate cannot be fixed precisely by the central bank
  • Market expectations and risk premium exert also an influence

A target range allows to ensure a certain flexibility

  • A target range allows to ensure a certain flexibility
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Monetary policy decisions since 2000

January 2000: 1.75% 03.02.2000 +50bp 2.25% 23.03.2000 +75bp 3.00% 15.06.2000 +50bp 3.50% 22 03 2001 25bp 3 25% 22.03.2001

  • 25bp

3.25% 17.09.2001

  • 50bp

2.75% 24.09.2001

  • 50bp

2.25% 07.12.2001

  • 50bp

1.75% 02.05.2002

  • 50bp

1.25% 26.07.2002

  • 50bp

0.75% 06.03.2003

  • 50bp

0.25% 17.06.2004 +25bp 0.50% 16.09.2004 +25bp 0.75% 15.12.2005 +25bp 1.00% p 16.03.2006 +25bp 1.25% 15.06.2006 +25bp 1.50% 14.09.2006 +25bp 1.75% 14.12.2006 +25bp 2.00% 15 03 2007 +25bp 2 25% 15.03.2007 +25bp 2.25% 14.06.2007 +25bp 2.50% 13.09.2007 +25bp 2.75% 08.10.2008

  • 25bp

2.50% 06.11.2008

  • 50bp

2.00% 20.11.2008 -100bp 1.00% 11.12.2008

  • 50bp

0.50% 12.03.2008

  • 25bp

0.25%

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4) Repo operations

  • Repo

(Repurchase Agreement)

  • perations

are the key instrument of the SNB to manage the money supply

  • Daily

auctions allow the SNB to steer the 3M-Libor (maturity: overnight to 3-weeks, exceptionally 3-, 6- or 12- months)

  • The SNB sets the repo rate and the rate of allocation

Banks have to provide a collateral (security)

  • Banks have to provide a collateral (security)
  • Other instruments:
  • Intraday liquidity is supplied free of charge
  • Intraday liquidity is supplied free of charge
  • Liquidity-shortage facility (50 bp above the overnight rate)
  • Foreign exchange swaps
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4) Repo operations

CHF

C i l

Today

C

SNB

Commercial bank

Collateral

T

CHF + repo rate

SNB

Commercial

Term SNB

Co e c al bank

Collateral + dividend

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Timing of the transmission mechanism

Instrument

(Repo rate, liquidity)

Financial markets Immediate Financial markets

(Libor, Asset prices, Exchange rates)

Immediate Aggregate demand

(Consumption, Investment, Exports- O )

4-8 quarters

Imports Output gap)

Prices and inflation 6-12 quarters

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Communication and transparency

  • Communication and transparency are important aspects of

the strategy

  • The press release “Monetary policy assessment” is published

after the board meetings and explains briefly the policy decision

  • The “Quarterly Bulletin” provides a detailed review of the

i i l i di t hi h f d d th l t li d i i principal indicators which founded the last policy decision

  • Articles on the monetary policy strategy and on the forecasting models

are also published in the Quarterly Bulletin are also published in the Quarterly Bulletin

  • Members of the board and senior staff explain Swiss monetary

policy in speeches p y p

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Recent performance

Oil price effects

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Recent performance

  • No problem of credibility at the time the new monetary policy

strategy was introduced (in 2000)

  • Prices were stable in Switzerland between 1994 and 2007, i.e.

during 13 years

  • Average annual growth rate of CPI between 1994 and 2007:

0.9%

  • Seldom higher than 2%
  • On a monthly basis there were some exceptions in 1995 (introduction
  • f the VAT)
  • f the VAT)
  • Inflation was higher than 2% between December 2007 and

November 2008 due to temporary oil price effects November 2008 due to temporary oil price effects

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The role of the exchange rate

  • The SNB has no exchange rate target
  • However, the exchange rate cannot be ignored in a small

, g g

  • pen economy like Switzerland
  • It is relevant for inflation forecast
  • A change in the exchange rate affects inflation through

different channels in the models:

  • Directly, through traded good prices
  • Indirectly, through its impact on activity
  • Indirectly through expectations
  • Indirectly, through expectations
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Part II REACTION TO THE CURRENT CRISIS

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... bubble in the US housing market

Peak Decline

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... bubble in the US housing market

  • Property price boom in

the US...

  • Causes:
  • excessive global liquidity
  • lending practices in US

property sector (excessive risk-taking + g securitisation)

  • excessive level of

household debt household debt

increasing US interest

rates solvability problems for “subprime” borrowers

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Effect on the financial markets

  • 2 types of liquidity problems:
  • Financial liquidity: investors confronted with difficulties to refinance

their positions (raising capital)

  • Market liquidity: investors confronted with difficulties to sell their

assets rapidly and at a good price assets rapidly and at a good price

  • Debtors: contraction of balance sheets and de-leveraging
  • Rapid decrease in equity capital due to leverage effects

raise capital p q y p g p

  • Simultaneity effect

Runs on debts and equity capital

  • Creditors: accumulation of precautionary liquidities
  • Uncertainties concerning their own financial situation

f d h b k k ( ll l d)

  • No more confidence in the interbank market (not collateralized)

Illiquid assets

principle of first arrived first served

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Effect on the financial markets

  • Financial institutions start to write-off bad assets (July-

August 2007):

  • interbank lending slows down significantly
  • jump in Libor rates / risk premium

L h Subprime Lehman Brothers collapse Subprime crisis collapse

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Macroeconomic impacts

  • Deterioration in financial conditions
  • Increased risk premium
  • Credit-crunch

Hampers investment and durable goods consumption (e.g. cars)

  • Decrease in wealth
  • Drop in property prices

Drop in asset prices

  • Drop in asset prices

Hampers investment and consumption

  • Confidence loss of firms and households

Confidence loss of firms and households

  • Value of waiting increases

Hampers investment and consumption and decreases hiring

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Macroeconomic impacts

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Macroeconomic impacts

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SNB responses to the crisis

1) Interventions on the money market

a)

In USD

b)

In CHF

2) Monetary policy stance

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Money market: USD

  • Liquidity problems on the USD market
  • Swap agreement with the Fed
  • Coordinated with other central banks

USD Neutral for the CHF ECB Fed Euro S t Euro USD CHF Swap agreement Repo auction SNB SNB Commercial b k Loan in USD p banks Collateral

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Money market: USD

35 USD bn

SNB's outstanding volume of USD-Auctions

Lehman

25 30

Lehman Brothers collapse

20

1W ON

collapse

10 15

28d

5

84d 28d

Dec 07 Mar 08 May 08 Aug 08 Oct 08 Dec 08 Mar 09

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Money market: CHF

  • Decision taken independently of the financial crisis
  • Redefinition of the criteria for collateral eligible for SNB repos

list

  • f securities considerably expanded
  • Instruments used to ease liquidity strains

d i f l i ( k h)

  • Introduction of long-term CHF repo transactions (3-week to 12-month)
  • Reduction of the premium for liquidity-shortage facility
  • Temporary enlargement of the equity capital admitted as covered bond
  • Temporary enlargement of the equity capital admitted as covered bond
  • Financing of the transfer of illiquid assets of the UBS to a special

purpose vehicle for orderly liquidation (based on SNB's statutory d ib h bili f h fi i l ) mandate to contribute to the stability of the financial system)

  • Issue of SNB Bills

see next slide

  • Swap EUR/CHF

see next slide

  • Swap EUR/CHF

see next slide

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Money market: CHF

  • SNB bills

SNB bill + interest Increases Commercial banks SNB SNB bill + interest liquidity of the CHF on the money market banks CHF money market Issue of SNB bills Loan in CHF Repo auction SNB SNB Commercial banks SNB bill SNB bill

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Money market: CHF

  • Depreciation of eastern

European currencies

  • A large amount of mortgages

and credits issued in the Eastern European countries in CHF Hi h d d f CHF

  • High demand of CHF

pressure on CHF interest rates

  • Temporary EUR/CHF swap
  • Temporary EUR/CHF swap

with the ECB, NBP, MNB

  • Provide CHF to banks with no
  • Provide CHF to banks with no

direct access to the SNB

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Money market: CHF

Abschöpfungsgeschäfte SNB Bills FX Swap 1W 2W 3W 1M 3M NST 6M 12M

CHF bn 100 120

Ausstand geldpolitische Operationen

60 80 20 40 40

  • 20
  • 40

Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Nov 08 Dec 08 Jan 09

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SNB monetary policy stance

  • 13.09.2007: First turbulences

in the financial markets, 3- Month CHF Libor increased to 2.9% while target was 2.5%

SNB d i i b

  • SNB decision: +25 bp to 2.75%
  • 13.12.2007: Increasing

inflation pressures but inflation pressures but deteriorating economic outlook and increasing uncertainties g

  • SNB decision: no change
  • 13.03./19.06./18.09.2008:

idem

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SNB monetary policy stance

  • 08.10.2008: Joint statement

by central banks (Fed, ECB, Bank of Canada, Riksbank, BoE, SNB). Intensification of th fi i l i i d the financial crisis and downside risks to growth while inflationary pressures started inflationary pressures started to moderate. 3-Month CHF Libor increased to 3.0% while target was 2.75%

  • SNB decision: -25bp to 2.50%
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SNB monetary policy stance

  • 06.11.2008: Economic

environment deteriorated while the oil price declined and the CHF appreciated

SNB d i i b

  • SNB decision: -50bp to 2.00%
  • 20.11.2008: Further decline

in prices of raw materials and in prices of raw materials and

  • il
  • SNB decision: -100bp to 1.00%

p

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SNB monetary policy stance

  • 11.12.2008: Economic

environment further deteriorated

  • SNB decision: -50bp to 0.50%
  • 12.03.2009: Economic

situation deteriorated sharply and risks of negative inflation and risks of negative inflation

  • ver the next three years
  • SNB decision: -25bp to 0.25%

p

  • Buying CHF bonds issued by

private sector borrowers P h i f i

  • Purchasing foreign currency on

the foreign exchange markets

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Conclusions

  • In January 2000, the SNB adopted a new monetary policy

strategy which aimed at maintaining price stability by fixing a target range for the 3M-Libor on the basis of a general analysis of the economic situation contained in a published i fl ti f t inflation forecast

  • This strategy helps the SNB to have the necessary rigor to

maintain its goal of price stability with the necessary maintain its goal of price stability with the necessary flexibility to deal with external shocks

  • Reaction to the financial crisis

To be continued Reaction to the financial crisis... To be continued...

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More questions?

WWW.SNB.CH

More questions?