MNI INTERVIEW: Swiss In Negative Rates Trap- Ex-SNB Economist

The Swiss National Bank will struggle to raise rates above zero with its current monetary policy toolkit, one of its former senior economists told MNI, adding that it is unlikely to consider any increase in its policy rate before inflation rises above 1%.

A revamp of monetary policy strategy is "probably the only possibility to abandon negative interest rates and weaken the Swiss franc at the same time," Daniel Kaufmann, who worked at the SNB for nine years until 2014, said in an interview in which he called for the bank to target higher inflation and a lower exchange rate via forex intervention.

"The question is, are they really working on a new strategy that could replace it? Honestly, I doubt that they are."

The SNB is expected to keep its current policy rate of -0.75% in place at least until the end of this year, and President Thomas Jordan is likely to link any possible tightening to the outlook for the real economy and prices, while taking "indirect" account of a successful vaccination campaign, Kaufmann said. The SNB's next policy meeting is on March 25.

"Even if we get over the crisis faster than we expected, inflation has been too low to begin with. I think the SNB would be very slow to increase interest rates, even if inflation goes to say 0.5% or so. Before inflation gets above 1%, I don't think that the SNB will raise rates."

PRODUCTIVITY PUZZLE

The pandemic's longer-term effect on productivity and growth remains a "big question," Kaufmann said, citing innovations such as increases in homeworking, which simultaneously boost productivity by eliminating wasteful commutes but raise the risk of stifling creativity through lack of personal contact.

"The net effect is very unclear. I would tend to be a little bit pessimistic," he said.

The increased difficulty of measuring the gap between potential and actual output will complicate the SNB's calculations, Kaufmann added, although he added that progress on vaccines had given him more confidence in recovery.

"If you look at the GDP figures that are so heavily impacted by the lockdown measures, they fluctuate like crazy," he explained. "But what does it mean for the output gap and inflation if, for example, restaurants are closed? Demand is there, but you don't have supply, you don't even have prices. So it's even more difficult to assess the size of the output gap and its impact on inflation."

The SNB has been hesitant to use forward guidance as a tool because it prefers actions over words, Kaufmann said. But, he added: "concrete actions can be quite inefficient, in the sense that they imply large purchases of foreign currency and a ballooning balance sheet."

Formally adopting exchange rate intervention as a policy tool would be to "acknowledge reality," Kaufmann, now an Assistant Professor of Applied Macroeconomics at the University of Neuchâtel and Research Fellow at the KOF Swiss Economic Institute, ETH Zurich, continued.

The SNB could announce that it would use intervention to target an exchange rate of around 1.20 francs to the euro, and commit to 1% or higher inflation on average, he said. Such moves, similar to those recommended by other Swiss economists, would allow it to get out of negative territory "quite quickly."

PRICE STABILITY

Given that average inflation since the financial crisis has been negative, it is "at least questionable" whether the SNB's 0-2% definition of price stability "still matters" Kaufmann said.

"They still publish an inflation forecast, but it's not clear that it really has a big impact on policy decisions anymore," he added.

In December the SNB revised its inflation projection for this year down to 0% from 0.1%, and prices are currently flat.

How much weaker the Swiss franc would have to be before the SNB no longer deemed it "highly valued" is hard to quantify, Kaufmann said, adding that it is "probably hard to argue that it is strongly overvalued against the euro [...] From my point of view the FX interventions do not aim to correct an overvaluation, but, as a last resort, to avoid deflation."

It is difficult to judge the extent to which Joe Biden's accession to the White House was behind the SNB's recent decision to publish FX intervention data, a move which came soon after it was branded a currency manipulator, he said, pointing to previous such releases in response to IMF demands.