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					                    Rules in the Conduct of Swiss Monetary Policy
                    May 5 and 6, 2003
                                                                    1




Rules in the Conduct of
Swiss Monetary Policy

    Norges Bank Workshop
      May 5 and 6, 2003

          Thomas J. Jordan
Head of Research Swiss National Bank
                                    Rules in the Conduct of Swiss Monetary Policy
                                    May 5 and 6, 2003
                                                                                    2




Contents

   Part I     Elements of the SNB's monetary policy framework


   Part II    The decision-making process


   Part III   The SNB framework and policy rules
              Rules in the Conduct of Swiss Monetary Policy
              May 5 and 6, 2003
                                                              3




          Part I:
 Elements of the SNB’s
monetary policy framework
                                                Rules in the Conduct of Swiss Monetary Policy
                                                May 5 and 6, 2003
                                                                                                4




The SNB framework: overview

    After 25 years of monetary targeting, the SNB adopted a new monetary
    policy framework at the end of 1999. Although the ultimate goal of
    maintaining price stability has remained unchanged, it was the most
    important adaptation of the SNB’s strategy since the transition to flexible
    exchange rates in 1973.


The framework consists of three elements:
   An explicit definition of price stability
   An inflation forecast as the main indicator for policy decisions
   A target range for the 3M-Libor (London Interbank Offered Rate) as an
    operational target
                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
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Element I:
An explicit definition of price stability
   Price stability is defined as an annual CPI inflation of less than 2%. (same
    definition as the ECB). The definition of price stability takes into account the
    measurement bias in the CPI of approximately 1.0% and an uncertainty
    range of ± 1%.

   The definition of price stability delivers the nominal anchor for the medium-
    term orientation of monetary policy and is the benchmark for the
    accountability of the SNB.
                                           Rules in the Conduct of Swiss Monetary Policy
                                           May 5 and 6, 2003
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Element II:
Inflation forecast as the main indicator
   Monetary policy decisions are based on a consensus inflation forecast
    extracted from the information from different models and indicators.
   There is no mechanical reaction to the forecast; the forecast is rather used
    as the main indicator.
   The inflation forecast serves as an important means of communication for
    explaining the policy decisions and the current stance of monetary policy to
    the public.
   The forecast is published quarterly as a point forecast under the assumption
    of an unchanged 3M-Libor. The forecast horizon is 3 years due to long lags
    in the monetary transmission mechanism.
                                            Rules in the Conduct of Swiss Monetary Policy
                                            May 5 and 6, 2003
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Element III:
A target range for the 3M-Libor
   The SNB specifies its monetary policy decisions by setting an operational
    target range for the 3M-Libor with a width of normally 100 basis points.
   The SNB usually announces the position where it wants to have the 3M-Libor
    within the target range (middle, upper, or lower part).
   A longer-term interest rate (i.e., 3M instead of overnight) and a large width for
    the target range allow for some flexibility in the very short run to react to
    market and exchange rate disturbances without having to change the stance
    of monetary policy.
                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
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SNB framework differs from typical inflation
targeting
   The concept knows no inflation target but rather a definition of price stability:
     – It should be valid for an extended period of time.
     – It should only be changed for economic and not for political reasons.
   The SNB does not only have instrument independence but also substantial
    goal independence (within the limits of its mandate): The SNB determines the
    exact definition of price stability.
   The inflation forecast is not used as an intermediate target but rather as the
    main indicator.
   The time horizon after an inflationary shock to return to the range of price
    stability is not determined in advance.
   There is no attempt to fine-tune the inflation rate but rather to follow a
    medium-term stabilization. There is no obligation to keep inflation under all
    circumstances in the range of price stability.
               Rules in the Conduct of Swiss Monetary Policy
               May 5 and 6, 2003
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           Part II:
The decision-making process
                                          Rules in the Conduct of Swiss Monetary Policy
                                          May 5 and 6, 2003
                                                                                            10



Timing of forecasting and the policy decision
at the SNB: regular quarterly basis


Defining scenarios      Computing                 Report and                   Meeting of
for the international   consensus                 policy                       board with
business cycle: Base    inflation-                suggestion to                policy
scenario and risk       forecast from             board                        decision
scenarios (board        model forecasts
approval)               and indicator
                        information


 T-6 weeks to           T-4 weeks                T-3 weeks to                      T
 T-5 weeks                                       T-1 week
                                            Rules in the Conduct of Swiss Monetary Policy
                                            May 5 and 6, 2003
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Internal analysis

   Forecasts and simulations with several models (traditional macro models,
    structural VAR models) for base and alternative scenarios
   Model simulations with different policy rules:
         – Unchanged 3M-Libor
         – Taylor-type rules
         – Forward-looking rules
   Analysis of important indicators (money and credit aggregates, equilibrium
    exchange rates, term structure of interest rates, output gap etc.)
   Synthesis of information from models and indicators to a consensus forecast
    (no fixed weighting)
   Computing consensus forecast for different levels of unchanged 3M-Libor
    (usually for current level of 3M Libor and ± 50 or + 50/+100, -50/-100 pb)
                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
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The inflation forecast and the policy decisions

   The board considers the inflation forecasts for the different levels of interest
    rates and the different risks scenarios.
   In general the board chooses a 3M-Libor which avoids a persistent
    departure of the inflation rate from the range of price stability. A temporary
    departure from the range of price stability does not automatically signal a
    need to change monetary policy. Due to the lags, monetary policy may not
    be able to control inflation in the short run.
   However: There is never a mechanical reaction to the inflation forecast. The
    inflation forecast serves only as a main indicator.
   Other aspects may be important for interest rate decision: Exceptional
    circumstances, timing, experience and judgment of central bankers in
    specific situations, etc.
   Monetary policy can even be changed without explicit computing of a new
    inflation forecast.
                                                                        Rules in the Conduct of Swiss Monetary Policy
                                                                        May 5 and 6, 2003
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                                           22 Mar preannounced date
                                                           17 Sep preannounced date

                                                           24 Sep non-preannounced date

                15 Jun preannounced date                          07 Dec preannounced date

                                                                                02 May non-preannounced date
        23 Mar preannounced date
                                                                                          26 Jul non-preannounced date
   03 Feb preannounced date
20 Jan non-preannounced date                                                                                   06 Mar
                                                                                                               non-preannounced date
                        Rules in the Conduct of Swiss Monetary Policy
                        May 5 and 6, 2003
                                                                        14



Example: The inflation forecast published in
December 2001
                                              Rules in the Conduct of Swiss Monetary Policy
                                              May 5 and 6, 2003
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Interpretation of the published forecast

   Although the forecast horizon extends over the subsequent three years, the
    individual forecast itself is valid for three months at most.
   Although the forecast assumes an unchanged 3M-Libor, it is highly unlikely
    that the 3M-Libor remains unchanged over the subsequent three years due
    to the reaction to new shocks and information.
   If inflation at the end of the forecast horizon is neither close to 2 or 0 percent
    nor displays any type of sustained trend, the published forecast offers no
    hint of potential changes in the 3M-Libor over the following three months.
   However, a published forecast with an upward inflation trend or even a rate
    above 2% at the end of the forecast horizon indicates that an increase in
    interest rate is more likely than a decrease in the future.
                  Rules in the Conduct of Swiss Monetary Policy
                  May 5 and 6, 2003
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            Part III:
The SNB framework and policy rules
                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
                                                                                             17



The significance of rules for the SNB’s
monetary policy
   The SNB has never mechanically applied an instrument rule for its policy
    decision. In the individual decision, the SNB acts discretionary.
   However, the SNB has always tried to systematically use data and
    information from indicators and models in order to achieve its ultimate goal
    of price stability in a consistent manner over time.
   The goal of maintaining price stability limits the degree of discretion. This
    "constraint discretion" is the kind of rule consistently applied through various
    concepts for over 25 years.
                                                                                               Rules in the Conduct of Swiss Monetary Policy
                                                                                               May 5 and 6, 2003
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    Taylor Rates and 3M-Libor in Switzerland
                    14

                    12
                                                                                                                              min. Taylor rate
                    10                                                                                                        max. Taylor rate
percentage points




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                     8

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                     4

                     2

                     0

                    -2
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                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
                                                                                             19



The SNB framework as a targeting rule
framework
The current SNB framework can be largely interpreted as a general targeting
rule framework; however, the general targeting rule is applied in a very flexible
and broad way:
    – No explicit loss function
    – Medium term orientation (no inflation target, but definition of price
      stability, no explicit targeting horizon)
    – Multi-model approach (high model uncertainty; single indicators,
      judgment very important;)
    – Broad view and flexibility in certain circumstances for possible other
      aspects as e.g. financial imbalances, exchange rate
    – Timing, tactics, signaling important
                                           Rules in the Conduct of Swiss Monetary Policy
                                           May 5 and 6, 2003
                                                                                           20




Medium-term orientation of monetary policy

   The SNB does not endeavor a fine-tuning of inflation and the output gap.
   There is a limited power of monetary policy in steering the economy.
   The available knowledge of the transmission mechanism is not perfect.
   Excessive exchange rate movements may lead to policy adjustments.


 More modest objective of keeping inflation at a medium-term horizon within
  the rage of price stability by taking the business cycle situation into account.
                                             Rules in the Conduct of Swiss Monetary Policy
                                             May 5 and 6, 2003
                                                                                             21




Flexible reaction and tactics

   There is no fixed reaction to deviation of forecast from the definition of price
    stability. Even an interest rate cut is possible although the forecast is on an
    upward trend (Example March 2003).
   Often tactics (size of interest rate change; timing) is important in order to
    give strong signals to the market (Example March 2000: Increase of 75
    basispoints: more and earlier than the ECB).
                        Rules in the Conduct of Swiss Monetary Policy
                        May 5 and 6, 2003
                                                                        22



Example: The inflation forecast published in
March 2003
                                            Rules in the Conduct of Swiss Monetary Policy
                                            May 5 and 6, 2003
                                                                                            23




Importance of performance

   Reputation and credibility are crucial for being able to pursue a flexible
    medium-term oriented monetary policy.
   Past performance builds up reputation and credibility.
   Central bank independence must also be warranted through past
    performance.
                                                              Rules in the Conduct of Swiss Monetary Policy
                                                              May 5 and 6, 2003
                                                                                                                24




    Inflation performance of SNB

             4.0

             3.5
                                                                                     new concept
             3.0

             2.5
In percent




             2.0

             1.5

             1.0

             0.5

             0.0

             -0.5
                    1993   1994   1995   1996   1997   1998      1999      2000      2001      2002      2003
                                            Rules in the Conduct of Swiss Monetary Policy
                                            May 5 and 6, 2003
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Concluding remarks:
Are specific targeting rules necessary?
   The idea of a very general targeting rule describes quite well the actual
    policy process of the SNB.
   However, it is doubtful whether an attempt to introduce a specific targeting
    rule would improve policy making:
     – Loss functions differ between policy makers and may not be constant
        over time and policy makers do not usually think in terms of an explicit
        loss function.
     – Using specific targeting rules may easily lead to an overestimation of
        the possibilities of monetary policy given the high uncertainty about
        transmission mechanism, output gap, and natural real interest rate.
     – Multi-model approach/indicator becomes difficult to apply with specific
        targeting rules.
     – Policy makers may have a broader view: e.g. financial imbalances,
        exceptional circumstances etc. which cannot be captured by specific
        targeting rules.

				
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