Swiss Monetary Policy(2)

7/29/2019 Swiss Monetary Policy(2)

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SWISS MONETARY POLICY AND

THE CRISIS


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OUTLINE

SNBs behavior during the global financial crisis

Lessons from the crisis.


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SNBS EXPERIENCES DURING THE

GLOBAL FINANCIAL CRISIS

Like many other central banks, the SNB facedsevere market turmoil during the crisis andresponded with strong policy measures to prevent a

deflation scenario.

Five phases of the recent crisis in Switzerland can bedistinguished, each of which called for reactions bythe SNB.


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FIRST PHASE

1. In August 2007, the SNB was among the first central banks to

inject additional liquidity to accommodate a large increase

in bank demand for liquidity.

2. Since the Swiss economy was performing well and in view of

the fact that inflation rose above 2% in 2008, triggering risks

for price stability in the medium term, the SNB left the target

range for the three-month Libor unchanged between

September 2007 and September 2008.

3. The SNB also took measures motivated by considerations of

financial stability. A foreign exchange swap facility with the

US Federal Reserve was concluded in December 2007 to

enable the SNB to provide counterparties with US dollars.


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THE SECOND PHASE

In autumn of 2008, the deterioration in the worldeconomy increasingly affected the Swiss economyand, together with falling oil prices and the

appreciation of the exchange rate, increased therisk of deflation.

The failure of Lehman Brothers in September furtherintensified the turmoil in international financialmarkets. European banks were facing increasingdifficulties in refinancing themselves in Swiss francs,and this resulted in a significant rise in Libor rates.


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THE SECOND PHASE

1. The SNB engaged in EUR/CHF swaps with domestic andforeign counterparties, the ECB, and the central banks ofPoland and Hungary.

2. These funding facilities, through which the SNB providedSwiss franc funding to banks outside its spheres ofinfluence, successfully reduced the Libor.

3. In early November, the SNB lowered the Libor target

range, by 100 basis points to 0.51.5%.

4. the Libor target range was cut by an additional 50 basispoints to 0.01.0% in December.


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THIRD PHASE

1. In the spring of 2009, the crisis deepened and theappreciation of the Swiss franc further heightenedthe risk of deflation.

2. the SNB took several new measures, Itsubstantially increased the supply of liquidity andlowered the target range for the Libor to 0.00.75%, aiming for a level of around 0.25%.

3. It also engaged in long-term repos andpurchased private sector Swiss franc bonds andforeign currency, to prevent the Swiss franc fromappreciating further against the euro.


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FOURTH PHASE

1. In late 2009, the SNB felt that the risk of deflationhad receded and announced that only excessiveappreciation of the Swiss franc would beprevented and began a gradual exit from its

unconventional monetary policy tools.

2. However, the European sovereign debt crisis inthe spring of 2010 led to substantial upward

pressure on the Swiss franc, again triggering therisk of deflation. The SNB therefore intervened inthe foreign exchange market, putting downwardpressure on the three-month Libor, which reached0.09% in June.


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FIFTH PHASE

1. from the middle of 2010, the recovery of the Swissand global economy meant that the risk ofdeflation in Switzerland had largely disappeared.

2. The SNB therefore considered that anappreciation of the Swiss franc was no longer sucha threat to price stability and discontinued itsforeign exchange market interventions.


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BENS LESSONS ON THE CRISIS AND

THE SNB EXPERIENCE

The First lesson:

For purposes of how monetary policy influencesnonfinancial economic activity, what principally

matters is not money but credit: its volume, its price,and its availability.

Ben has argued that credit is no less informative

than money in ordinary times. It is therefore notsurprising that he has focused on their relativeimportance during the crisis.


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FIRST LESSON

The SNB realized that its information on creditmarkets was not sufficient to ensure monetary andfinancial stability.

Therefore, the SNB introduced a quarterly lendingsurvey and, in early 2010, conducted a specialsurvey on mortgage lending activity, to broaden its

information base to allow it to take timelycountermeasures.


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SECOND & THIRD LESSON

The second lesson Ben draws concerns theimplementation of monetary policy:

In light of how most central banks now set interest rates,central banks in effect have not one policy instrument

but two; over time horizons long enough to matter formonetary policy, the quantity of central bank liabilitiescan be varied more or less independently.

The third lesson he draws concerns the composition of

central bank balance sheets: The composition of central bank assets also matters;

central bank securities holdings, in large volume, affectmarket interest rate relationships.


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Ben notes that central banks have two instruments: theshort-term interest rate and the quantity of central bankliabilities.

Under normal market conditions the SNB controls one-week repo rates and the quantity allotted in daily repoauctions in order to steer the three-month Libor rate andthey can thus be considered a single instrument.

However, when the one-week repo rate reached thezero lower bound in December 2008, the SNB adoptedunconventional measures.


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First, it substantially expanded its balance sheet(quantitative easing, QE), which tripled by May2010. Second, it changed the composition of

central bank assets (credit easing, CE). Bothmeasures were aimed at affecting relative prices offinancial assets, either indirectly through QE ordirectly through CE.

In its choice of assets and diversification, the SNB ismore constrained than central banks in larger andless open economies.


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FOURTH LESSON

A further lesson:

By contrast, policymakers have not yet figured outwhat instruments are effective for restoring thevitality of bank lending markets once lenders have

become severely impaired.

During the 200709 crisis Switzerland saw thesharpest decline in GDP since 1975. However, thedrop in 2009 was less than 2 percent andSwitzerland was one of the first OECD countries toemerge from recession. By the third quarter of 2010,GDP had reached the same level as before thecrisis.


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FOURTH LESSON

One reason for this is that the real estate marketwas more or less unaffected by the turmoil. Anotherreason is the countermeasures taken by the SNB

after loan activity slowed.

On the other hand, the crisis has also highlightedthe importance of a sound financial system for the

transmission mechanism of monetary policy.


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FIFTH LESSON

Furthermore, it has exposed the limits of monetarypolicy in dealing with the problems of banks andshown that price and output stability is no

guarantee for financial stability if adequate bankingregulation is lacking. This is related to the next ofBens conclusions.

The Fifth Lesson:The classical rule for lender-of-lastresort policyrescue illiquid firms but not insolvent

onesis not longer useful. In a financial crisis thedistinction between illiquidity and insolvency hasbecome largely non-operational.


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FIFTH LESSON

As Ben suggests, the Swiss case shows that it isvirtually impossible to distinguish between illiquidityand insolvency of banks, and banks may therefore

have to be rescued even if they are still solvent froma regulatory point of view.

An additional problem in Switzerland is the systemicimportance of the two largest banks. The financialcrisis has made it clear that the too big to failproblem must be addressed in order to increase theroom for maneuver in a crisis.


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Thank You

Swiss Monetary Policy(2)

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