Is Swiss fiscal virtue too much of a good thing?

The Swiss National Bank (SNB) is in no hurry to tighten monetary policy as the economy recovers. Rather, persistent low inflation risks de-anchoring inflation expectations.

Swiss GDP fell by 3% in 2020, according to the State Secretariat for Economic Affairs. Although sharp, the contraction was less severe than initially feared. Furthermore, GDP is expected to rebound by about 3% in 2021 and grow strongly also in 2022. If this materialises, GDP would return to its pre-pandemic level at the end of this year, although this remains subject to a high degree of uncertainty.

Consumer price inflation has been negative since late 2019 and was  -0.5% year-on-year in February. Worryingly, this reflects both a slump in core inflation and in the prices of volatile components like food and energy. Unsurprisingly, households’ inflation expectations seem to have stabilised at a level consistent with inflation hovering at the low end of the 0-2% range the SNB uses to define price stability (see Chart 1). The risk that they fall further seems to be rising, a development to which the central bank should pay more attention than it appears to be doing.

1. Household expectations and actual inflation

The SNB will delay signalling a tightening to prevent pressure on the Swiss franc.

The Swiss franc has weakened recently but remains slightly overvalued on a Purchasing Power Parity basis against a basket of exchange rates including EUR and USD (see Chart 2). The SNB will reiterate that the currency remains highly valued, that foreign exchange risks persist and that, therefore, it stands ready to intervene as needed.

2. CHF exchange rate basket and PPP*

Stronger fiscal support would help the SNB’s pursuit of price stability.

Despite the large resources deployed, the Swiss fiscal response is moderate compared to that of other developed countries. Furthermore, the Swiss authorities seem determined to return quickly to fiscal rectitude. The Federal Council envisages a balanced budget in 2022 and a small surplus in the following two years. This plan complies with the so-called debt brake in place since 2003.

However, the rule gives the Federal Council six years to offset any excessive budget shortfall. This flexibility should be fully exploited as a premature fiscal tightening would risk dampening the recovery, with adverse consequences for equality, inclusion, social cohesion and the long-term potential of the Swiss economy. And too tight a fiscal policy would leave the burden of supporting the economy on monetary policy, complicating the SNB’s exit from negative interest rates and foreign exchange interventions that attract so many critics.

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