Talk – What does the Swiss National Bank do?

Dominik Boos is no stranger to the financial world. He spent three years developing the investment strategy for the Swiss National Bank (SNB), so he knows the SNB inside and out.

The role of the Swiss National Bank

Dominik: The Swiss National Bank has several important functions, but its top priority is to control inflation in Switzerland. It has set a clear inflation target, namely to keep inflation below 2 percent. While this target is not overly specific, in practice the SNB usually aims for an inflation rate of around 1 percent, emphasizing that inflation must be in positive territory. In addition to controlling inflation, the SNB also plays a crucial role in the stability of the Swiss banking system and has the ability to provide unrestricted funds in times of crisis. Finally, it has the general mandate to keep the economic environment in Switzerland stable.

The causes of inflation

Dominik: The origin of inflation is a complex issue. Inflation in Switzerland is partly influenced by imported inflation, especially from Europe. But even inflation in Europe has its own causes, and if you ask further, you come across inflation in the US. Here's where it gets a little trickier. Global inflation is a complex phenomenon, and the causes are many. One reason could be the pandemic, which has caused supply shortages and disrupted supply chains. Another important factor is the Ukraine conflict, which has led to inflation, especially in the energy sector. There are also demographic shifts that are impacting inflation. In short, inflation is a global phenomenon with multiple causes.

The Instruments for Fighting Inflation

Dominik: The National Bank has two main instruments to fight inflation. The first tool is to raise interest rates to cool down the economy. This is done to reduce demand, as higher interest rates make investments more expensive and dampen the demand for credit. A good example of this is mortgage rates, which have risen sharply in Switzerland. This leads to people having to pay more for mortgage loans and thus having less money available. This can dampen consumption and weaken inflation.

The second instrument is to control the money supply, although this approach has fallen into disrepute in recent years. Nevertheless, the money supply plays a role in inflation. However, the SNB cannot do much about structural inflation caused, for example, by demographic changes. In such cases, the SNB can only take cyclical measures to cool down the economy.

The challenges of fighting inflation

Dominik: Fighting inflation is often painful. Inflation usually affects the general population, especially the lower and middle income groups. People suffer from rising prices, which can lead to dispossession. It is politically difficult to justify high inflation because it increases discontent among the population.

National banks are often called «recession machines» because they have to stall the economy to fight inflation. While this does not sound good, it is often necessary. There is no easy way to eliminate inflation without painful repercussions.

Inflation in Switzerland compared to other countries

Dominik: Switzerland has some structural differences to other countries that dampen the inflation rate. One of the reasons is the SNB's strong monetary policy. The SNB has devalued the Swiss franc relative to the euro to offset imported inflation from the eurozone. This has helped to ensure that imported inflation is not felt as strongly in Switzerland.

Another reason is the higher prices in Switzerland compared to other countries. In Switzerland, margins are often higher for companies, which means they can cushion price increases without passing them on to consumers immediately. In addition, there are many administered prices, such as the reference interest rate for rents, which limits rent increases in Switzerland. All these factors contribute to lower inflation in Switzerland compared to other countries.

Outlook for inflation targeting

Dominik: There are certain global factors, such as demographic changes and the shortage of skilled workers, that drive inflation and over which national banks have limited influence. They can take cyclical measures to dampen inflation, but it is difficult to predict whether this will be enough. Structural inflation cannot be fully addressed by such measures. Therefore, fighting inflation remains a complex task, and national banks must carefully consider how they respond.

Do you have any questions or comments? Feel free to send an e-mail to Felix Niederer. See you soon!