The Many Faces of Swiss Inflation
In a nutshell
Introduction
Switzerland, a prosperous nation of 9 million people has experienced weak inflation for over a decade, while monetary policy has eroded consumer purchasing power and clouded the economic outlook. However, Switzerland is known for its responsible fiscal and monetary policy. In June 2022, the inflation rate was reported at 3.4 percent, while inflation in the Eurozone was 8.6% and 9.1% in the United States. The problem with this picture is that Switzerland is prone to lower inflation than most other advanced economies.
Until recently, the Swiss monetary was marked by an ultra-accommodative monetary policy, which erodes purchasing power since 2015. The Swiss situation is a case study of the multifaceted nature of inflation, which has been slow to rise, raising concerns about deflation. Inflation denotes an increase in the money supply that has not been supported by a corresponding increase in the production of goods and services. As such, the growing money supply without real collateral ballooned bank balance sheets, leading to a loss of purchasing power.
This loss, however, did not happen evenly across the economy. prices of some goods and services increased faster than others, causing a disparity in the relative price of goods and services. Meanwhile, the increase in prices is a manifestation of the loss of purchasing power together with rocket-high valuations of real estate and exchange-traded securities.
Looking at the consumer price index does not convey the entire picture. Ever rising money supply presents itself in different ways across the economy.
The bubble in Switzerland
To weaken the Swiss franc, the Swiss Central Bank has engaged in a protracted period of monetary easing. In January 2010, the Swiss monetary base aggregate was estimated at 87,000 million francs. By January 2020, it rose to 589,000 million, peaking at 757,000 in April 2022. The monetary base has expanded 8.7 times in the last 12 years.
On technical grounds, this bloat seemed fine. The central bank was seen as committed to price stability as well as an incipient need to fight deflation. One might ask why? Deflation can be economically viable (But this should be left for another time). Weakening the Swiss franc was a political move that was necessary to boost Swiss exports. After all, as a haven currency, the Swiss Franc attracted capital flows at the best and worst of times. Since the onset of this policy in 2010, the central bank’s balance sheet has expanded at an unprecedented pace. The central bank introduced negative rates after this policy seemed unsustainable and rather cut short-term interest rates to unprecedented lows. At the beginning of 2015, the policy rate was 0.25% to -0.75%. Since then, it stayed negative even after a very modest hike in June 2022. recently, the central raised the policy rate by 0.7 basis points to 0.5%. In doing so, the bank will counter the renewed rise in inflationary pressure and the spread of inflation to goods and services that have so far been less affected. Let’s look at some facts and figures regarding Swiss inflation!
Facts & figures: Swiss are less optimistic about the economy
In Switzerland, the KOF economic barometer measures the level of optimism across managers in the private sector and senior-level executives. In July 2022, it fell to 90.1 points after a peak of 143.6 points, but far higher than it’s an all-time low of 49.6 points.
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The SNB’s Struggle to bring inflation to?2%
The Swiss Franc broke parity against the Euro in 2022, after a marked appreciation imposed on it by Russia’s war in Ukraine. The Swiss Franc has become more valuable than most currencies, barring the dollar. The central bank tried to keep the currency at what it called a “fair exchange rate” of 1.20 franc per Euro. Central bankers failed to regard their other goals. To put this into context, the inflation rate in Switzerland was six times negative between 2010 and 2020. In other words, it remained well below 1% and below the SNB’s target of 2%.
House prices have risen making life more expensive
Central bankers’ decision to grow the money supply neither maintained the value of the Swiss Franc nor addressed their goal of preventing deflation. However, a weaker Swiss franc with lower interest rates and inflation differentials caused inflation to recover somewhat. So one can admit that the central bank did not immediately succeed in bringing inflation back to its target. The other half is marked by a tremendous loss of purchasing power due to the design and implementation of monetary policy.
Swiss housing Market Collateral Damage
Alongside the inflation linked to the Swiss money supply, the country’s residential house price index went from about 130 points in 2010 to 190 in 2021, an increase of over 46% or about 4% each year. This is much more than an increase in wages, which corrected the consumer price index. The result is that housing prices have risen in real terms, whole rents and other real estate prices have equally made life less affordable, especially for middle-class consumers.
Then the Swiss Market Index rose from about 6,500 points at the beginning of 2010 to about 12,900 at the end of 2021. Despite all the recent market turmoil, the Swiss stock exchange is still 11,100 points. At the highest point, the market exchange rate shares doubled and still trade at 70% higher than they did in 2010. In the same period, the Swiss economy grew 20% and the difference is that the increase in the monetary base and soaring house prices did not bring inflation back to the SNB’s 2% target.
So it’s clear that the money supply remained closer to financial markets and did not spur the real economy. A third whereby central banks’ monetary policy was diffused is through the pension systems. The defined contribution system is mandatory in Switzerland. The whole system is estimated at around 1.3 trillion francs under management. Negative interest rates cut across some assets as they were first applied to the pension scheme’s liquidity. Secondly, it lowered the bond market well into negative territory and reduced the returns on the pension fund. Third, it led many funds to find risks that were not previously appropriate for them, especially as negative interest rates chipped off 50 billion francs in planned contributions.
Scenarios
The Swiss case illustrates how a ballooning money supply doesn’t always lead to higher inflation. The loss of purchasing power was the price to pay for more competitive exports. However, the money supply should be thought of in terms other than the inflation outcomes as it diffuses to other sectors of the economy. In the Swiss case, the ultra-accommodative monetary policy stance caused the price of real estate to rise and equally ushered in a deterioration in pension funds. On the other hand, inflationary policies did not achieve their aim, and devaluing the Franc only prevented the worst effects of deflation rather than igniting inflation in any meaningful manner.
Let’s look at three scenarios for the Swiss Economy
In the best case, Switzerland could be hit hard by a short recession that corrects real estate and financial markets, forcing the central bank to hike interest rates and wind down its balance sheet. This could reduce the overheating in Swiss labor markets and increase productivity over time.
The most likely use appears to be that tighter monetary policy will persist, leaving interest rates slightly higher than the SNB’s current forecast for interest on sight deposits to reach 2% in 2025. Ironically, the Swiss Franc will likely remain strong, thereby absorbing some inflation. However, this could exacerbate sluggish growth, whilst accelerating the labor market and balance-sheet increases.
The worst-case scenario could see inflation fall back and the SNB resumes a more gradual pace of hiking interest rates. This could be accompanied by more gradual increases in wage growth, but the Ukraine war has illustrated that stagflation could very well be accompanied by rising wages. The question of what Swiss consumers spend their money on will be contingent on how inflation develops across product categories.
Conclusion
Switzerland illustrates the multifaceted nature of inflation and how the loss of purchasing power accompanied by ultra-accommodative policy can stymie inflation in the best of times. Swiss monetary policy is responsible as far as achieving the inflation target goes. If the central bank prevents further Swiss franc appreciation, it can cause inflation to rise at a faster pace and thereby cause the central bank to reach its inflation target at a much faster pace.
Not that the current drivers of inflation in Switzerland and elsewhere are due to failures in monetary and fiscal policy, severe COVID-related lockdowns, and rising supply and demand. In addition to rising energy stemming from the Russia -Ukraine war, the massive loss of purchasing power requires a mix of fiscal and monetary policy to ensure that the central bank achieves its target while achieving medium-term growth.