Switzerland's Approach to Monetary Policy
Olivei, Giovanni P., New England Economic Review
Monetary policy as conducted by the Swiss National Bank is aimed at maintaining price stability in the medium term. Between 1980 and 1999, the Bank used the seasonally adjusted monetary base as monetary target and as indicator. (1) Given the continually distorted indicator value of the monetary base after 1996, the Bank fundamentally reviewed its modus operandi. As of the beginning of 2000, the Swiss National Bank (SNB) considers price stability to be achieved with an annual inflation (CPI) rate of less than 2 percent. The Bank bases its monetary policy decisions on a medium-term (three-year) inflation forecast. (2) Despite similarities to inflation targeting, the new framework differs from it in one important respect, namely, it does not contain an institutional commitment to an inflation target as the overriding objective of monetary policy.
Swiss National Bank's Main Monetary Policy Instruments
In the new monetary policy framework, the Bank sets a target range for the three-month Libor, with a width of 100 basis points. The three-month Libor is the economically most important money market rate for Swiss franc investments. While the Bank communicates its long-term monetary policy course with the inflation forecast, it announces its short-term intentions with the location of the target range. As a rule, the Bank influences the Libor indirectly via short-term repo transactions. (3) Maturities of repos are between one day and several weeks. Longer-maturity repos provide the markets with base liquidity. The average maturity of repos in the year 2000 was nine days. The Bank fixes the repo rates depending on market conditions and the maturity of the executed transactions. Fluctuations in repo rates, however, frequently have no connection with the monetary policy course but rather, among other things, with fluctuations in market rates.
Open Market Operations
Repo transactions are the Swiss National Bank's main tool for market operations. The Bank is in principle prepared to purchase any securities from several collateral baskets, which contain Bank-eligible securities. In its auctions, the Bank invites tenders for the SNB basket, the German GC-basket, and the German Euro Jumbo Pfandbrief-basket. The composition of the SNB basket is determined largely by legal restrictions. (4) These restrictions, listed in Table 1, concern currency, liquidity, type of eligible securities, minimal ratings, and ineligible securities. Article 14 of the National Bank Law also restricts the debtors of eligible securities, listed in Table 2, and the maturity of securities eligible for repo transactions. All domestic securities eligible for repos must have a maturity of six months or less. Bills drawn on payees abroad must have a maturity of six months or less. Easily marketable debt securities of foreign states, international organizations, and foreign banks must have a maturity of 12 months or less. The Swiss National Bank's own interest-bearing debt certificates must have a maturity of two years or less. In 2000, the collateral from repo transactions was distributed as follows: 39 percent of CHF bonds of domestic borrowers, 39 percent of CHF bonds of foreign borrowers, and 22 percent of euro bonds.
The German GC-basket includes German federal government paper and some World Bank issues. The owner of this basket is the Swiss Exchange. The third basket--the German Euro Jumbo Pfandbrief-basket-- consists of German mortgage bonds with a minimum issue volume of 1 billion euros. This instrument has not been used since 1999.
The Swiss National Bank, like all other participants in the market, accepts borrowed securities as collateral for repo transactions. In principle a number of options are available to reduce risk in repo transactions. Several central banks have a system that involves haircuts, which takes into account the interests of the cash provider but not those of the cash taker. …