“Central banks are powerless to prevent supply shortages”

  • Monetary Policy
  • World Economy
  • Inflation
  • KOF Bulletin

KOF Director Jan-Egbert Sturm talks in an interview about the latest price increases in almost all currency areas, central banks’ potential counter-strategies and why inflation in Switzerland remains moderate.

SNB und Inflation

Germany has just put together a substantial support package to cushion the impact of rising prices, especially in the energy sector. Does Switzerland now also need to provide such support?

Although inflation has recently risen in Switzerland as well, the problem is not as acute as in Germany. That is why Switzerland does not need such a support package at the moment – at least not yet, because no one knows how prices will evolve given the volatile geopolitical situation. Even in Switzerland, though, we have to think about who will be hit hardest by the surge in energy prices and how to deal with it. But this is not a question that can be answered by economists – it is a question for politicians and society.

In your view, is this high inflation a temporary or permanent phenomenon?

We have been saying for quite some time that this elevated inflation should actually be temporary. I still see it broadly that way because it is essentially related to specific factors such as the COVID-19 pandemic and, now, the war in Ukraine.

"The most likely scenario from KOF’s point of view is that a large amount of this inflation will be temporary while a smaller portion will persist. But the latter is not necessarily bad per se."Jan-Egbert Sturm, Director of the KOF Swiss Economic Institute, ETH Zurich

The most likely scenario from KOF’s point of view is that a large amount of this inflation will be temporary while a smaller portion will persist. But the latter is not necessarily bad per se. Actually, we want to see inflation higher than it has been to date. After all, since the financial crisis we have considered inflation to be too low and have combatted excessively low rates and, potentially, deflation by pursuing highly expansionary monetary policies.

Is it a problem from a macroeconomic point of view if individual outliers drive up inflation, as is currently the case with energy prices?

Extreme upward outliers are never good. But, in principle, relative price changes are quite normal. For example, the quality-adjusted prices of IT products such as computers and mobile phones are constantly falling. Services, on the other hand, are tending to become more expensive. There are always such changes. Incidentally, even before the outbreak of the war in Ukraine, we wanted energy prices to rise for environmental reasons. In this respect, economic policy cannot be about smoothing out and adjusting all relative price changes.

Viewed from a liberal economic perspective, one could even argue that the best remedy for a high oil price is a high oil price. What do you think of this thesis?

This thesis cannot be completely dismissed. When the oil price rises, demand automatically falls and energy is saved where it is most efficient. At the same time, a high oil price ensures that supply is stimulated and expanded. The best example of this is fracking technology. When the oil price is low, this technology is not profitable, but the higher oil price now makes it profitable again. This expansion of supply combined with falling demand drives the price of oil back to a lower equilibrium price. This is according to the textbook and can also be observed in reality.

Currently, only two Western countries have low inflation rates, namely Japan and Switzerland. What is the reason for this?

Both the Swiss franc and the Japanese yen are considered to be stable currencies. This so-called safe-haven function enables Switzerland’s own strong currency to cushion inflation in times of crisis because inflationary pressures from outside do not feed through to the domestic market as much. Switzerland’s low inflation is also related to its particular economic structure. Switzerland is much less dependent on Russian gas than, for example, Germany, Italy and several countries in eastern Europe. On the whole, Swiss industry, with its focus on pharmaceuticals and finance, is also not quite as energy intensive as, say, Germany with its car and heavy-engineering industries.

What is fundamentally more effective at fighting inflation, fiscal policy or monetary policy?

Fiscal policy is not designed to control the price dynamics of an economy. Monetary policy, on the other hand, is aimed at ensuring price stability across the economy as a whole.

"KOF expects interest rates in the euro area to rise before the end of the year, probably in the autumn according to our latest assessment."Jan-Egbert Sturm, Director of the KOF Swiss Economic Institute, ETH Zurich

However, monetary policy cannot fine-tune and solve problems in sub-sectors of the economy. Fiscal policy does exactly that. If we have a crisis in the construction sector, fiscal policy thinks about how to support the construction sector. Of course, such government intervention can also affect inflation. But that is not the main issue – positive and negative side-effects are. The situation with monetary policy is exactly the other way round. Price stability is the main consideration and everything else is of secondary importance.

What are the limits of monetary policy? Can it be used, for example, to combat the currently acute supply shortages?

Monetary policy is a very blunt instrument. It can use interest-rate and exchange-rate policies to influence macroeconomic price dynamics. However, central banks are powerless when supply bottlenecks and shortages occur, as recently seen with semiconductors, intermediate products and raw materials. These frictions in the microeconomic production process cannot be mitigated by macroeconomic control of the money supply through interest rates and exchange rates.

The US Federal Reserve (Fed) has already reversed its monetary policy stance. When do you expect interest rates to start to rise in the euro area and Switzerland?

KOF expects interest rates in the euro area to rise before the end of the year, probably in the autumn according to our latest assessment. The Swiss National Bank (SNB) is then highly likely to follow the European Central Bank (ECB).

How great is the risk of a wage-price spiral at present?

From a Swiss perspective, this risk is not yet very great – unlike in the United States and Germany, for example. Eventually it will even be desirable, from an economic point of view, for wages to move in step with productivity growth and prices. But it is important not to go too far. Wage growth should not in turn stimulate price rises, otherwise the two variables would push each other up and a wage-price spiral would ensue, which would be difficult to exit.

Will we see interest rates return to above-inflation levels in the foreseeable future?

We will certainly return to such a situation. Major central banks have already started to raise interest rates. You also have to consider the fact that the interest rates applicable to the average consumer are usually not identical to central banks’ interest rates. At any rate, I don’t know anyone who pays minus 75 basis points for their mortgage loan. For most of us, longer-term lending rates are a better point of reference. These are usually higher than short-term central bank rates and therefore turn positive sooner in real terms, i.e. adjusted for inflation. Moreover, inflation will fall back eventually.

A presentation by Jan-Egbert Sturm on the economic consequences of the war in Ukraine for Switzerland – also with regard to inflation – is available here for review. 

The next KOF-NZZ Economists’ Surveys will also deal with the topic of inflation. You will find their results from mid-April here

Contacts

Prof. Dr. Jan-Egbert Sturm
Director of KOF Swiss Economic Institute
  • LEE G 305
  • +41 44 632 50 01

Professur f. Wirtschaftsforschung
Leonhardstrasse 21
8092 Zürich
Switzerland

Dr. Thomas Domjahn
  • LEE F 114
  • +41 44 632 53 44

KOF Bereich Zentrale Dienste
Leonhardstrasse 21
8092 Zürich
Switzerland

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