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Switzerland’s monetary policy - What happened during coronavirus?

Updated: Mar 16, 2023

1. Pre-coronavirus: a difficult starting position

During January 2020, before the pandemic’s outbreak, the Swiss National Bank policy rate was at a historical low of -0.75%, what caused rates to break the 0% threshold? The answer to this question leads us back to the European sovereign debt crisis and the Global Financial Crisis. Taking into consideration the fact that the Swiss franc is acknowledged as a safe haven for investors, the currency tends to appreciate when the global risk worsens, and this was the case during those times. Furthermore we know that Switzerland, as a small open economy, is highly exposed to external events and that inflation is strongly dependent on foreign countries’ economic conditions, leading to many challenges to keep the CPI under control. In order to maintain prices steady the SNB has provided a definition of what is considered “price stability”, which consists of a positive inflation rate below 2%.

In this crisis interest rates were lowered from almost any Central Bank and the upward pressure on the franc rose. This led the SNB to face many challenges and adopt alternative monetary instruments, such as negative interest rates and interventions in the Foreign Exchange Market.

In this global situation of general crisis, the central banks of most economically developed countries reacted by lowering their policy rates close to zero by applying what is called quantitative easing (QE), where Central Banks implement liquidity in the system by repurchasing government bonds from the open market in order to reduce interest rates and increase the money supply, more specifically the M2 measurement, creating new bank reserves and encouraging lending and investments.

This is the standard monetary procedure Central Banks usually undertake. As other countries were lowering their interest rate, Switzerland found itself stuck, since it already had interest rates close to 0, and a further decrease would lead to, first of all, negative territories which where unexplored, and furthermore to an increase in the interest rates spread with other countries, which would be eaten away and there would be an additional upward pressure on the franc.

This continuous pressure on the franc led inevitably to it being overvalued and pushed inflation into negative territory. Definitively not good news, since it represents a menace for Swiss companies given the fact that it is directly related with the CPI (Consumer price index) this means that consumptions and the aggregate demand are not growing. In this scenario, how was SNB able to conduct an expansionary monetary policy? By introducing a minimum exchange rate against the euro, by intervening in the foreign exchange market and by lowering the policy rate below zero to restore the usual interest rate differential with other countries.

In 2015, the SNB was one of the first central banks to lower its monetary policy rate significantly into negative territory, so far this tool has produced some positive results: spreading to money and capital market rates, reducing the pressure on the franc. Negative interest rates mean that interest will actually be paid to the borrowers rather than to the lenders, in order to encourage lending, investment, and consumption, therefore we can say that a negative cost of borrowing will incentivize a country’s population and institutions to consume rather than to keep money in a deposit account, since storing cash actually incurs a fee rather than earning interest, this procedure is used during deflationary periods.

Nevertheless countries cannot only benefit from negative interest rates, right. If at first glance we saw only beneficial aspects of this measure, we need to consider some side-effects this has caused on banks, pension funds, insurance companies and savers. One of the consequences is that it could attack financial stability because having negative interest rates could push people to search for higher yields and by doing so they expose themselves to more risky operations.

To limit or avoid this side-effects there are some other measures: first of all granting the banks a considerable exemption threshold, so that the negative interest is charged on a small portion of their sight deposit at the SNB; the second tool consists of the countercyclical capital buffer, which basically is a way of accumulating capital to create buffers in order to help banks withstand periods of stress and losses to help with the supply of credit, usually it is designed to counter procyclicality in the financial system, so when the risk is increasing this measure is activated.

We need to remember that interest rates cannot be lowered forever and this leaves space for an intervention in the foreign exchange market.

2. Foreign exchange market intervention

In contrast to nearly all Central Banks of major economies, which since the ‘Great Recession’ of 2007-2008 have engaged in large-scale asset purchases, in 2009 the SNB decided to implement, for various reasons, a different monetary policy instrument: intervention in the foreign exchange market. The main line of reasoning that pushed Jean-Pierre Roth and the remainder of the national bank’s board to intervene in this alternative manner is the relatively small size of Switzerland’s capital market, which would strongly limit a QE program, as well as the minor role it played in the fundraising of firms. This instrument is seen by the Swiss National Bank as the most effective and direct, in the company of negative interest rates, against a strong appreciation of the franc, in order to properly function, this strategy needs continuous cost-benefit analysis, since these operations help the SNB to fulfill its main goal, maintaining and ensuring appropriate economic conditions, yet this comes at a tradeoff, this investments on the currency exchange market strongly increase the financial risk of the national bank in the long term. In order to diversify such risk and increase the Sharpe ratio of the SNB’s portfolio, Swiss central bankers invest quite a big portion of the capital under management in equities. The merger of this monetary policy instrument and a negative interest rate is seen as highly effective and with limited disadvantages in comparison to the use of a single tool.

3. Challenges during coronavirus pandemic

As previously mentioned, Switzerland in the early stage of 2020 already found itself in a difficult monetary stance, as the franc was experiencing a strong upward pressure, inflation was quite low, sometimes even negative, and the current economic environment was topped by negative SARON (Swiss Average Rate Overnight). As if this was not enough the whole World was struck by a black swan, a pandemic, which would influence the future perspective of humanity under every aspect. The economy experienced a strong slowdown, which spread throughout nations as quickly as the virus did. Switzerland, during the first quarter of 2020, experienced the worst economic performance since the ‘73 oil crisis, in which more than 400,000 people became unemployed. During this volatile period caused by Covid-19, the SNB main role was to inject the liquidity needed in the system, in order to avoid a hard landing of the economic environment in the long term.

The financial aid program launched during the first quarter of 2020 was titled ‘’SNB COVID-19 refinancing facility’’ (CRF), the aim of this project was to offer the banks a new system for refinancing the corporate loans guaranteed by the government at a policy rate of −0.75%, in order to provide more liquidity to financial institutions which, in turn, could grant credit, on beneficial terms to third parties, which due to several restrictions found themselves in an unfavorable position, since the majority of these business activities experienced a sharp drop in revenue while majority of costs still were being incurred, therefore to cushion the pressure of the expenses, Swiss struggling businesses needed financial stimulus. The ‘’SNB COVID-19 refinancing facility’’ had much success, during the first week 10% of Swiss companies received corporate loans, such a figure increased to 20% in the first month. The repayment conditions of such loan were very advantageous, charging an interest rate of 0% for amounts up to 500’000 CHF. In order to access such a facility there was a minimum of red tape to undergo, especially to guarantee that there were collaterals to back the granted credit. Aforesaid, given the reputation of safe haven assigned to the franc, every period of economic uncertainty corresponds with a strong appreciation of the currency, the pandemic exacerbated such problem leading to a flight in safe assets. Furthermore, given that most CBs around the world performed monetary easing, cutting interest rates, and buying back Government Securities, Switzerland found itself with a narrow nominal interest rate differential. Therefore the Monetary Stance Switzerland took against these difficult problems, the combination of negative interest and foreign exchange market interventions, was more necessary and effective than ever before.

4. Conclusion

This article tries to summarize the various instruments Switzerland, as a small open economy, uses to cope with disruptions from abroad and how it has to operate different policies from other countries in Europe. However this shows how monetary policies are not always the answer and how foreign exchange market interventions are necessary to deal with negative interest rates and face negative inflation, avoiding a recession. This is the perfect example of how monetary and fiscal stance, which have quite different roles and should not be seen as a unique policy, can cooperate.


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