Abstract
This paper characterizes the relationship between monetary aggregates, inflation and economic activity in Switzerland since the mid-1970s. Traditional forms of money demand and quantity theory relationships have remained stable over the whole period. Broad money excesses over trend values, accounting for a secular decline in interest rates and thus in trend velocity, have been followed by persistently higher inflation and output with the usual monetary policy transmission lags. Money and exchange rate fluctuations can explain the major inflation developments in Switzerland over the past four decades.
Highlights
In the 1990s, with the emergence of the Taylor rule and issues related to monetary targeting implementation and communication, the monetary policy research focus drifted away from monetary aggregates towards interest rates which have since been used to summarize the monetary policy stance.1 Since the Global Financial Crisis (GFC) monetary policy interest rates have mostly been at their effective lower bound and central banks have turned to quantitative policies with direct effects on broad monetary aggregates
This paper extends the analysis of Reynard (2007), who derives a monetary policy stance measure based on monetary aggregates that can be used as an indicator enabling avoidance of a persistent increase in inflation above the monetary policy objective
6 Conclusions Traditional forms of money demand and quantity theory relationships have remained stable in Switzerland, a small open economy, since the end of the Bretton Woods system in the mid-1970s, even through the GFC and despite the recent low interest rate environment
Summary
In the 1990s, with the emergence of the Taylor rule and issues related to monetary targeting implementation and communication, the monetary policy research focus drifted away from monetary aggregates towards interest rates which have since been used to summarize the monetary policy stance. Since the Global Financial Crisis (GFC) monetary policy interest rates have mostly been at their effective lower bound and central banks have turned to quantitative policies with direct effects on broad monetary aggregates. As a result of the decline in opportunity cost, people hold about 50% more money for a given transaction (nominal GDP) level as in the mid-1980s As discussed, such changes in trend velocity, whether due to changes in the inflation environment or in equilibrium real interest rates, have important implications for monetary analysis and must be accounted for. Given the velocity decline that occurred since the 1990s with a decline in inflation and equilibrium real interest rate, people hold about 50% more money for a given nominal GDP level as in the mid-1980s Both of the potential GDP and trend interest rate adjustments are low-frequency adjustments derived from the quantity theory of money. As shown in the references at the beginning of this section and later in this paper, when money supply has been above the trend value of money demand, this has been followed by increasing inflation.
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