Between October and December 2008, the Swiss National Bank (SNB) lowered its key rate, the three-month Libor, from 2.57% to 0.5%. The interest rate for one-week repo transactions is now close to zero. Given that interest rates cannot fall below zero, a further easing of monetary policy using the classic interest rate instrument is hardly an option, as there is very little room for manoeuvre left.

In a speech held on 21 January 2009 at the University of St. Gallen, SNB Vice President Philipp Hildebrand asserted that this did not mean that the SNB is incapable of action. There are other options available to it, he explained.

Here are the possibilities he mentioned:

First, the SNB can try to influence not only short-term interest rates, but also long-term interest rates. More often than not, investment and consumer decisions are based on the long-term rates. To this end, the SNB has already extended the terms of its repo transactions to up to twelve months. Another option would be to purchase Swiss Confederation bonds. This would push down the yields on such bonds and serve as a signal for lower corporate bond interest rates. The SNB could even purchase long-term corporate bonds itself. All of these measures would help lower private borrowers’ interest expenses.

Second, the SNB can also influence the exchange rate, as it has often done in the past, by selling the Swiss franc against foreign currency. A weaker franc encourages foreign trade and boosts the economy.

These steps would result in an expansion of the money supply. Hildebrand therefore added that the National Bank will [if necessary] reduce the liquidity which was temporarily created as soon as it is no longer needed; i.e. before it shows signs of becoming inflationary.

On behalf of the iconomix team

Boris Kaiser