Monetary policy should operate with a roughly two-year lag. On that basis, now is a good moment to evaluate the Swiss National Bank’s abrupt decision to abandon a floor on the franc in January 2015. It led to an immediate 20 per cent appreciation of the franc against the euro.
Currency traders cannot recall the experience without shaking. It was meant to be similarly calamitous for Switzerland. Signs of disaster appeared within the two-year timeframe. According to the OECD, Swiss nominal GDP fell hard that first quarter of 2015. Over the past two years, the Swiss economy measured in its own currency has barely grown; only Greece and Norway are worse on that measure. Back in Switzerland, year-on-year price falls have continued every month since 2014. Retail sales are negative and rates well below zero.
But look at real economic variables. Here Switzerland is doing passably well, with low unemployment (3 per cent), a large trade surplus and GDP growing when adjusted for prices, albeit at a mediocre, sub-European pace below 2 per cent. The government forecasts a fiscal surplus. Deflating nominal GDP, which in other places is a cancer that saps vitality and breeds financial risks (see Italy), is something Switzerland can live with.
How? Mostly, due to a flexibility that few others can match. The Swiss economy has been ranked the most competitive for eight consecutive years by the World Economic Forum. Those less flexible rely more on the solvent of gently rising prices. Few other countries with unemployment so low would get away with wage rises of just 0.5 per cent. Swiss workers trust in deflation to grant them a real-terms rise. A small country in a large continent, the wealth-enhancing effect of a stronger franc is apparent to Swiss shoppers, who can pop over the borders and fill their baskets.
When citizens tolerate deflation the central bank can too. And currency traders can pile in, confident that inflation will not eat up their nominal gains. Switzerland may be the first advanced country to live happily with stagnant prices. That could ensure deflation sticks around for a while.
Copyright The Financial Times Limited 2017