2012 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; Statement by the Executive Director for Switzerland

1. While the Swiss economy is fundamentally strong, ensuring macroeconomic stability has been challenging. Switzerland is a very open, highly productive, innovative economy, with many successful global companies, a highly skilled workforce and an increasingly open and flexible labor market. Medium-term growth has been good, unemployment is low, there is a track record of low and stable inflation, the public finances are in better shape than in most advanced countries, and the external position is healthy, with a large positive net foreign asset position and current account surplus. Yet, just four years ago, the global financial crisis affected the Swiss economy deeply through the exposure of its large and globalized financial sector. That crisis was ultimately successfully managed, but now macroeconomic stability is being threatened once again by the ramifications of the euro zone crisis. Safe-haven capital inflows from the euro zone turmoil pushed the exchange rate to new heights last summer, just as slower global economic activity was curtailing export growth. To protect the economy, the central bank moved away from the long-standing floating regime and committed to an exchange rate floor. A carefully-charted and well-coordinated set of policies is needed to ensure macroeconomic and financial stability in this new framework.


1. While the Swiss economy is fundamentally strong, ensuring macroeconomic stability has been challenging. Switzerland is a very open, highly productive, innovative economy, with many successful global companies, a highly skilled workforce and an increasingly open and flexible labor market. Medium-term growth has been good, unemployment is low, there is a track record of low and stable inflation, the public finances are in better shape than in most advanced countries, and the external position is healthy, with a large positive net foreign asset position and current account surplus. Yet, just four years ago, the global financial crisis affected the Swiss economy deeply through the exposure of its large and globalized financial sector. That crisis was ultimately successfully managed, but now macroeconomic stability is being threatened once again by the ramifications of the euro zone crisis. Safe-haven capital inflows from the euro zone turmoil pushed the exchange rate to new heights last summer, just as slower global economic activity was curtailing export growth. To protect the economy, the central bank moved away from the long-standing floating regime and committed to an exchange rate floor. A carefully-charted and well-coordinated set of policies is needed to ensure macroeconomic and financial stability in this new framework.


1. While the Swiss economy is fundamentally strong, ensuring macroeconomic stability has been challenging. Switzerland is a very open, highly productive, innovative economy, with many successful global companies, a highly skilled workforce and an increasingly open and flexible labor market. Medium-term growth has been good, unemployment is low, there is a track record of low and stable inflation, the public finances are in better shape than in most advanced countries, and the external position is healthy, with a large positive net foreign asset position and current account surplus. Yet, just four years ago, the global financial crisis affected the Swiss economy deeply through the exposure of its large and globalized financial sector. That crisis was ultimately successfully managed, but now macroeconomic stability is being threatened once again by the ramifications of the euro zone crisis. Safe-haven capital inflows from the euro zone turmoil pushed the exchange rate to new heights last summer, just as slower global economic activity was curtailing export growth. To protect the economy, the central bank moved away from the long-standing floating regime and committed to an exchange rate floor. A carefully-charted and well-coordinated set of policies is needed to ensure macroeconomic and financial stability in this new framework.


A. GDP Growth is Falling and Inflation is Negative with the Exchange Rate at New Heights

2. At end-2011, the Swiss economy decelerated sharply from a strong recovery, driven by lower domestic demand and net exports. After registering a brisk output expansion of 2.7 percent in 2010, the growth momentum tailed off in the second half of 2011, in line with other advanced economies. GDP growth fell from 0.4 percent q-o-q in 2011Q1 to 0.1 percent in Q4 with the economy growing by 1.9 percent for the year. Despite the real income growth, consumption was surprisingly weak, possibly reflecting statistical difficulties in accounting for larger cross-border shopping.1 With the rapid appreciation of the exchange rate, growth in exports of goods and services halved but remained positive.

3. While unemployment is low, the labor market is expected to weaken. After rebounding from the 2009 recession, the official unemployment rate fell to around 3 percent in 2011, well below that of most other European countries. The slowdown in economic activity is expected to drive the unemployment rate higher, especially in industries hit by the strong franc such as the mechanical and electrical engineering sector and tourism. A decline in employment may also occur in the financial sector, where shrinking value added has so far not been matched by workforce reduction.

4. Inflation is in negative territory, driven by declining import prices. In March, headline inflation dropped to -1 percent y-o-y, while core inflation was below -1 percent because of the pass-through from the strong currency. Despite the current negative price growth, the latest survey shows that inflation expectations are firmly anchored in low but positive territory. In its March Monetary Policy Assessment, the SNB forecasted moderate deflation in 2012 and moderate inflation afterwards.

5. Currency appreciation following intensified safe haven inflows in the summer was halted by the introduction of a floor on the exchange rate. The Swiss franc has been on an upward trend since 2008, reflecting unwinding of carry trades and, more recently, intensified safe haven capital inflows triggered by the euro area debt crisis. The CHF/euro rate went from 1.6 in late 2007 to almost parity in early August 2011, with a cumulative real effective appreciation of over 30 percent. The appreciation was especially rapid in July 2011, as the euro zone crisis intensified. In early August, the SNB responded through a massive liquidity expansion, carried out through foreign exchange swap operations, the non-renewal of maturing SNB Bills, as well as the repurchase of outstanding SNB Bills. As pressures continued, on September 6 the bank announced that it would defend a floor of 1.2 Swiss francs per euro, thus abandoning the floating exchange rate regime. The new policy has successfully stabilized the nominal exchange rate so far (Selected Issues Paper “Unprecedented Currency Appreciation and Policy Response”). The real exchange rate has depreciated by about 11 percent since the introduction of the floor, thus undoing about one third of the cumulative appreciation since 2007.

6. Weak foreign demand and the effects of real appreciation have made a dent in export revenues in the second semester, but the current account surplus remains large. Notwithstanding the slowdown in export growth, the watch-making and, to a smaller degree, the pharmaceutical industries have been buoyant. The net balance of services trade was strong even though tourism and bank financial services have performed poorly, thanks in part to good results in the commodity trading sector. All in all, in 2011 the current account continued to register a large surplus of 14.8percent of GDP despite the large real exchange rate appreciation.2

7. Balance of payment statistics likely overstate the true economic size of the current account. The foreign-owned component of the retained earnings of Swiss multinationals and the Swiss-owned component of the retained earnings of foreign multinationals are not captured by balance of payment statistics. The SNB estimates the net effect of correcting for those biases would reduce the current account balance by about 5 percent of GDP in 2011. In addition, cross-border shopping is largely unaccounted for in import statistics, which further distorts the current account balance upwards. Although the precise size of the underestimate is difficult to gauge, it may have been of the order of 2 percent of GDP in 2011. Nevertheless, the Swiss current account surplus still stands out as sizable relative to other economies that are not commodity exporters even if these factors are taken into account.

8. The Swiss franc is moderately overvalued. The Swiss franc is high based on historical values and purchasing power parity comparisons. On the other hand, the external position is strong, and has been resilient to the recent appreciation, with the export sector as a whole holding up well, though some subsectors are undoubtedly suffering. Applying the CGER methodologies to the latest WEO projections yields an overvaluation of 0–15 percent. The top end of the range reflects the equilibrium real exchange rate approach, while the lower end reflects the two methods based on the CA balance. Adjusting the medium-term current account projections by the overestimate identified by the SNB, the CGER calculations yield a misalignment of about 10 percent. This evidence, therefore, points to a moderate overvaluation of the Swiss franc. 3

B. The Fiscal Position is Anchored by Fiscal Rules and Discipline but Faces Pressures from Population Aging

9. Switzerland’s fiscal policy is well anchored in fiscal rules and a culture of fiscal discipline. Most prominently, at the federal level a “debt brake rule” mandates a structurally balanced budget. In addition, at the subnational level, most cantons have fiscal rules, albeit with varying strength. More broadly, the design of intergovernmental fiscal relations, a no-bailout presumption for cantons and municipalities, and considerable subnational tax autonomy create strong incentives to accept and comply with fiscal rules and foster a general culture of fiscal discipline (Box 1 and Annex II).

Switzerland: Fiscal Discipline in a Federal System1

Switzerland is a confederation with highly decentralized public finances, including considerable sub-national tax autonomy. All government levels have demonstrated remarkable fiscal discipline. This success rests on two pillars: streamlined intergovernmental fiscal relations with a no-bail-out presumption, and effective fiscal rules at each level of government.

Intergovernmental fiscal relations, reformed in 2008, feature a rationalized system of task assignments with clear responsibilities across government levels as well as a simplified and rules-based fiscal equalization scheme. The system ensures a close connection between

spending decisions and the responsibility for their financing. Equally crucial is a well-tested and deeply-engrained presumption that lower government levels will not be bailed out by the Confederation in case of financial difficulties. Together, these factors limit any deficit bias in the system.

These characteristics also create the basis for the acceptance of and compliance with fiscal rules both at the federal and cantonal level. In addition, these rules avoid over-complexity and are hence tractable both from a technical and political economy perspective.

1/ For more details, see Annex II.

10. The fiscal position is healthy and government debt low, with a broadly neutral stance projected for 2012. The general government balance, which stayed in positive territory in the 2009 recession, continued to register a surplus in 2011 (estimated at ½ percent of GDP on a GFSM basis). In particular, social security swung back into surplus due to reforms to unemployment insurance and a VAT increase earmarked for financing invalidity pensions. In contrast, the federal government surplus disappeared, reflecting in part measures to counteract the effects of the strong Swiss currency (some 0.15 percent of GDP) introduced in August 2011. The projected fiscal stance in 2012 and beyond is broadly neutral, with a small deficit at the federal level compensated by surpluses in the other components of general government. The debt-to-GDP ratio is projected to fall further to some 45 percent of GDP in 2015 (on a GFSM-basis).

Figure 1.
Figure 1.

Switzerland: Recent Economic Developments

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

Sources: Haver Analytics; Swiss National Bank; and IMF estimates.
Figure 2.
Figure 2.

Switzerland: Monetary and Exchange Rate Policies

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

Sources: Haver Analytics; Information Notice System; OECD; Swiss National Bank; CFTC, and IMF staff estimates.

11. However, fiscal policy faces longer-term challenges from population aging and there are contingent liabilities from the financial sector. Without reforms, the increase in public aging-related expenditure will start to bite in earnest around the end of the decade and is projected by the authorities at some 4 percent of GDP by 2050. This increase is about equally distributed between the pay-as-you-go pension pillar and the health care system (including long-term care).3 In addition, several second-pillar pension funds (of public entities) have a public guarantee and are partly underfunded, while almost all cantonal banks benefit from an unrestricted guarantee from their respective canton. Furthermore, in a tail risk scenario of a severe global financial crisis, government support to the financial sector may become necessary.

C. The financial sector is restructuring while risks are building up in the mortgage market

12. The very large and internationally exposed financial sector is a source of risk to the economy, but new legislation will force systemically important banks (SIBs) to hold more capital than peers. After one of the large banks was rescued in 2008, the authorities addressed the TBTF problem in Switzerland through a new legislative package centered on significantly higher capital requirements for systemic banks. The TBTF legislation, which came into effect in March, requires SIBs to hold a minimum 10 percent Common Equity Tier 1 capital ratio and 19 percent Total Capital, well above Basel III standards.5 The new standards will be fully phased in by 2019. The legislation also mandates SIBs to make progress toward increasing resolvability.

13. After a marked improvement in 2010, the performance of the two large banks worsened in 2011. In response to the new regulatory environment, the two large banks are restructuring their activities by reducing risk-weighted assets and increasing reliance on client-driven revenues and fee-based services. In 2011, as financial market turbulence and low customer activity hurt investment banking revenue, the two large Swiss banks lagged behind other global SIFIs in overall income generation. Although asset quality is better than peers, at over 80 percent the cost/income ratio is comparatively high and it has been negatively affected by the currency appreciation. All in all, profitability plunged in 2011, with ROA falling by 40 percent to less than 0.3 percent and ROE dropping from double digits to below 7 percent.6 On the other hand, CDS spreads remain significantly below those of peers, suggesting that markets see Swiss large banks as relatively well positioned to withstand current financial turmoil.

14. Although they comfortably fulfill current regulatory capital requirements, large banks have a thin layer of high quality capital. The two large banks have an average Tier I capital ratio of 15 percent and core Tier I capital ratio of 12 percent, well above the average of other global SIFI peers (12 percent and 10 percent respectively)7. However, because these ratios are computed under Basel II (or Basel 2.5 rules), they include low quality capital such as deferred tax assets and hybrids, which would not be available to absorb losses in a crisis, and assign low risk weights to certain exposures.8 Based on a more stringent capital quality indicator such as the ratio of tangible common equity to tangible assets (TCE), the large Swiss banks are below peers and have made little progress since 2009. Thus, significant progress will have to be made to satisfy the new, more stringent requirements as they come into force.

Capital Ratios for Swiss Large Banks and Global Peers, 2011

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15. Banks’ liquidity profile has improved, but dependence on wholesale funding remains elevated. Swiss large banks have loan/deposit ratios below peers and share of liquid assets comparable to peers, and comply with the Swiss liquidity requirement mandating them to be able to cover liquidity needs over a 30-day horizon under stress. However, the banks may still be especially vulnerable to disruptions in wholesale funding markets over a longer horizon, as their reliance on wholesale funding stands at over 70 percent, while peers have reduced this dependence to less than 60 percent. One of the large banks relies particularly heavily on money market funds for its U.S. dollar funding.9

16. Domestic mortgage credit and real estate prices continue to rise briskly, heightening the risk that a bubble may be forming. With short-term interest rates close to zero and abundant liquidity, mortgage rates have fallen to historic lows (about 2.5 percent on a 10-year, fixed-rate loan). Although average price growth seems contained relative to other countries, housing prices are high relative to income and there are signs of overheating in “hot spots” (such as the Geneva, Zurich, and Zug areas) and market segments (condominiums), as well as evidence of loose lending policies in some banks.

17. Domestically-oriented banks and insurance companies are exposed to the housing market. Aggressive mortgage lending and more reliance on fixed-rate longer maturity mortgages have increased interest rate and credit risk, especially for cooperative banks and cantonal banks, although there is a large variation among individual banks and among bank categories. The insurance sector is also exposed to the Swiss real estate market (14 percent of total assets). The authorities have warned about the financial stability risks associated with mortgage lending since 2010.

Price-to-Income Ratio

(SA, 2005 = 100)

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

Source: OECD.

Real House Price Index

(SA, 2000Q1 = 100)

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

Source: OECD.

18. Recent tax developments have put the private banking industry under pressure. An international push to broaden cross-border cooperation in tax compliance is challenging long-standing bank secrecy principles and practices in the Swiss private banking industry. In an effort to address legacy issues and improve tax transparency, Switzerland has signed several withholding tax agreements with other countries, including most recently with Austria and the U.K. In 2011, a number of Swiss banks (including one of the two SIBs) have been placed under investigation in the U.S. for allegedly helping clients evade taxes; one small bank in this group has been indicted and broke itself up preemptively. To help bring about a settlement, the Swiss parliament recently broadened the scope of administrative assistance offered to U.S. tax authorities under the double taxation agreement (whose ratification is, however, still pending in the U.S.). Following these developments, the Swiss wealth management business has seen outflows from European countries and the U.S., which have been partly offset by inflows from other countries. An additional development which might have an impact on the sector is the recent revision of the FATF standards which included tax crimes among the money laundering offenses. Some consolidation is expected to take place in the sector.

19. Insurance companies are coping with the low interest rate environment, strong competition, and natural catastrophes. Premiums for life, non-life, and reinsurance companies have grown moderately in 2011, but underwriting results are still weak. Low interest rates affect Swiss life insurance companies more than other European competitors because they have more traditional business. To reduce pressure, the guaranteed payout rate on life insurance policies (the BVG) was lowered to 1.5 percent from the beginning of 2012 after remaining at 2 percent for three years, but this has not been enough to narrow the gap with falling government bond yields. Among nonlife insurers, strong competition has put pressure on rates, while high claims related to natural catastrophes weakened the underwriting results of reinsurers in 2011. To boost financial results, some insurers have continued to rely on reserve releases. Insurers’ exposure to euro area countries under market scrutiny appears moderate. The full implementation of the Swiss Solvency Test (SST) has improved awareness of risk sources and enhanced understanding of profit and risk drivers and guarantees. All nonlife insurers and reinsurers and the majority of life insurers passed the 2011 SST.

Figure 3.
Figure 3.

Swiss SIFIs and Other Global SIFIs: Peer Comparison in Financial Performance

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

Sources: Bloomberg; Datastream; SNL; and IMF staff calculations.


The Central Scenario is Benign, but Risks Are Sizable

20. The economy is expected to stagnate in 2012 and regain momentum in 2013. In the near term, flagging demand abroad and the lagged effects of past appreciation will continue to slow exports and investment, while subdued employment growth will further weaken household disposable income and private consumption. GDP growth is expected to register at 0.8 percent in 2012, picking up steam in 2013 as the contractionary effect of the exchange rate appreciation peters out.10 In line with the WEO baseline scenario of a subdued global recovery, GDP growth should reach 1.7 percent and strengthen thereafter. With the exchange rate pass-through receding over time, positive growth in domestic good prices, and firmly anchored inflation expectations, the risk of an entrenched deflation is limited.

21. Risks to the outlook mainly relate to euro area developments and the large financial sector (Box 2). Swiss banks have foreign claims accounting for more than 60 percent of bank assets or three times GDP, the highest among advanced economies. They are most exposed to the U.S. and the U.K., while exposures to euro area countries under market scrutiny are moderate.11 However, the economy has close trade ties with the euro zone, so an intensification of the confidence crisis in the region would trigger an adverse trade shock that might tip the economy into a recession. A worsening euro area crisis would also likely accelerate safe haven capital flows into Switzerland putting the currency under pressure. If the floor was abandoned and the exchange rate appreciated, large bank losses on direct exposures to euro area countries would be aggravated by exchange rate movements given the currency mismatch in the banks’ cost/revenue structure; the crisis would also have the knock-on effect of dampening investment banking and wealth management business. In a tail risk scenario of a severe euro zone crisis, the Swiss economy would likely be dragged into a more serious and protracted recession than in 2009. A possible freeze in global wholesale funding markets, upon which the two large Swiss banks are heavily reliant, would compound the real shock.

Switzerland: Risk Assessment Matrix

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22. In addition, a “boom-bust” pattern in the real estate market would strongly affect domestically-oriented banks and the insurance sector. Given their large exposures, both sectors would suffer should a housing price bubble develop and then burst. Difficulties for the insurance sector would likely spill over to banks, as bank financing is partially provided by insurance firms, reinforcing the adverse spiral.

The authorities’ view

23. The authorities were somewhat more sanguine than staff with regards to the baseline scenario, but shared staff’s assessment of the main risk factors. Growth was seen as weak in 2012 in spite of recent signs of stabilization, with a somewhat stronger rebound in 2013 compared to staff (GDP growth of 1.8–2.1 percent). The difference was largely due to the authorities’ more optimistic assumptions on the external environment. The authorities agreed with staff that downward pressures on inflation would be contained under the baseline scenario, as price declines have not spread to nontraded goods or wages.


A. Overview

24. With a relatively benign central scenario, macroeconomic policies should focus on reducing vulnerabilities to the several risk factors that cloud the horizon. Under the baseline scenario, output will be close to potential in 2012 and thereafter, and inflation will go back to historical levels by 2013. Against this background, the return to a floating exchange rate and more neutral monetary stance needs to be well-timed and carefully orchestrated to avoid sparking inflationary pressures or fueling a new round of excessive currency appreciation. In the meantime, the risk of unstable housing price developments has to be kept in check through macroprudential tools, new and untried instruments in the Swiss context. As monetary policy has reached its limits, possible new external recessionary impulses will need to be addressed through fiscal policy, by making effective use of the limited available space under the fiscal rules. In the financial sector, risks from a turbulent external environment call into question the current, protracted timetable for transitioning to new regulatory standards.

B. Monetary and Exchange Rate Policies—Safeguarding Credibility

25. The introduction of the exchange rate floor was an appropriate policy response to the risk of economic contraction and deflation. In the summer of 2011, with the economy slowing down rapidly, negative inflation, and uncertainty in the euro area spurring capital inflows and pushing the exchange rate to historic heights, the risk was sizable that continuing exchange rate appreciation might lead to entrenched deflation and a recession. Furthermore, alternative policy options were limited, with interest rates at the zero bound, fiscal policy governed by the debt brake rule, and quantitative easing constrained by the small size of the domestic bond market (Selected Issues Paper and Box 3).

The Swiss Response to Capital Inflows: Lessons for Other Countries?1

The introduction of the exchange rate floor by the SNB last September has stabilized the exchange rate and the economy so far. Should other countries with currency appreciation pressures follow in the SNB’s footsteps? Several considerations suggest that other countries should be careful to emulate the Swiss approach, particularly where macroeconomic conditions, initial policy stance, and policy levers differ substantially from those of Switzerland:

1. It is too early to judge whether the exhange rate floor has been a complete success, as a smooth return to normal monetary policy has not yet been accomplished.

2. The floor was introduced in an environment where the risk of a sharp contraction and deflation was significant. If capital inflows and exchange rate pressure occur against the background of above-target inflation, loose fiscal policy, and strong domestic demand, a commitment to defend an exchange rate floor through unlimited monetary expansion would not be desirable or, most likely, credible: in these circumstances, defending the floor would exacerbate macroeconomic imbalances.

3. Even if exchange rate pressures occur where inflation is low and aggregate demand is weak, alternative policy tools may be available. Many countries have room to lower domestic nominal interest rates to discourage inflows; even with the policy rate at zero, quantitative easing or fiscal policy can be used to stimulate aggregate demand; and capital flow management measures might be considered. In Switzerland, interest rates are close to zero, quantitative easing is precluded by the small size of the domestic bond market; discretionary fiscal policy is constrained by fiscal rules; and capital flow management measures would be complex to design and costly given the country’s role as an international financial center.

1 For a detailed analysis and assessment of the SNB policies in 2011, see Selected Issues Paper “Unprecedented Currency Appreciation and Policy Response”.

26. The new strategy has successfully stabilized the exchange rate so far on the strength of the credibility of the SNB commitment. Available data suggests that very little if any intervention has been needed to maintain the floor, as the SNB commitment successfully curbed speculative bets on further Swiss franc appreciation and reduced the attractiveness of Swiss-franc denominated assets as safe haven investments. This contrasts with the limited effectiveness of previous foreign exchange interventions. Sizable inflation differential with major trading partners, if sustained, will continue to reduce the real exchange rate overvaluation.

27. The currency should be allowed to float freely again once inflation goes back to comfortable levels and growth picks up. While the economy is stagnant and inflation is forecasted to remain too low, the exchange rate floor helps to protect the economy from further contractionary pressures. In this situation, if capital inflows intensified, then intervention to defend the floor would appropriately result in a more expansionary monetary stance. On the other hand, once growth rekindles and inflation returns to normal levels, delaying the return to a freely floating currency could carry the risk of stoking inflation, in case money supply had to be expanded pro-cyclically to absorb renewed capital inflows. In such a situation, the willingness of the SNB to do “whatever it takes” to enforce the floor might be called into question.

The authorities’ view

28. The SNB viewed the exchange rate floor as an emergency measure, and hence temporary in nature. Concerning exit, the bank considered that the most favorable scenario was one in which, as the economic situation stabilized, the exchange rate weakened and traded above the floor. On the other hand, an exit while the floor continued to bind would be more difficult and would have to be carefully managed.

C. Containing Risks in the Mortgage Market—An Appropriate Macroprudential Toolkit

29. Overheating in the real estate market may hurt the economy and endanger the current monetary framework. With the new exchange rate policy, the SNB’s willingness to expand liquidity unboundedly to fulfill its exchange rate commitment is fundamental to credibility. If signs that abundant liquidity was fuelling a housing bubble were to emerge, this willingness might be called into question, threatening the framework.

30. To ward against this risk, monitoring and supervision in the mortgage market are being stepped up. During the 2011 consultation, staff stressed the need to move beyond traditional Swiss bank self-regulation in the mortgage market. The authorities have recently strengthened monitoring and supervision in this area, including through a new survey of lending practices and new, more precise guidelines for mortgage lending. These guidelines are adopted by the industry but approved and monitored by the supervisor (FINMA).

31. A proposal to introduce new macroprudential instruments has been put forward. A joint working group of the Federal Department of Finance (FDF), FINMA, and the SNB has proposed to amend the bank capital ordinance to implement early the counter-cyclical capital buffer (CCB) contemplated under Basel III. The buffer would be activated by the Federal Council upon request of the SNB and after consultation with FINMA. Banks would then have up to 12 months to raise their capital level. In addition, the working group proposed to improve the classification of risk weights in mortgage lending by taking into account the debtor’s risk profile and assigning a 100 percent weight to high risk exposures. Finally, under the proposal the SNB’s would be given power to request information from banks when such information is not already available from FINMA.

32. The preventive power of the envisaged macroprudential measures would be strengthened by adding minimum affordability ratios to the toolkit. With most domestically-oriented banks comfortably meeting current regulatory capital requirements, the proposed CCB and new risk weights will likely result in a small increase in mortgage interest rates which might not discourage imprudent lending and borrowing behavior when interest rates are at historical lows. Hence, instruments that more directly address such behaviors could usefully be added to the toolkit. One such instrument is a minimum affordability ratio, forbidding mortgages with debt service-to-income (DTI) ratios above a certain threshold. Loan-to-value (LTV) ratios could also be considered, but may require supervisory monitoring of real estate valuations to ensure that these valuations are not inflated by overly optimistic estimates.12 In addition, the envisaged activation process for the CCB could usefully be streamlined to ensure that the instrument can be deployed sufficiently quickly.

33. Broader reforms to reduce or eliminate the preferential tax treatment of mortgage debt service should be considered. As in other countries, in Switzerland mortgage interest payments are deductible from taxable income, so that households have incentives to increase mortgage debt. Homeowners are taxed on the imputed rents from their property (net of maintenance expenses), so a reduction in the tax benefit from mortgages would have to be balanced by a change in the taxation of imputed rents. 13

The authorities’ view

34. The authorities were confident that the planned macroprudential tools would have some preventive effects, and rejected affordability limits as too “market unfriendly.” The authorities noted that the need to set aside more capital would discourage mortgage growth, though they acknowledged that domestically-oriented banks were mostly well capitalized. They also noted that the measures would build buffers in the banking sector to absorb potential mortgage-related losses. Introducing affordability limits, on the other hand, would be equivalent to forbidding certain types of mortgages, an excessive restriction of private contracting freedom. The likelihood that reforms of housing taxation would muster the necessary political support was seen as low.

D. Reducing Financial Vulnerabilities

35. More rapid implementation of Basel III and TBTF capital requirements is warranted. The two large Swiss banks, are still weakly capitalized relative to peers in terms of high-quality capital while they face sizable risks, such as direct and indirect exposures to the euro zone crisis, legal contingent liabilities, and exposure to the Swiss mortgage market. In addition, heavy reliance on wholesale funding is a vulnerability factor. Thus, it will be important for banks to build capital more rapidly, including by restricting cash distributions and raising external capital as early as feasible, as subdued profitability prospect makes it challenging to rely on retained earnings only. While raising capital in current market conditions may be costly, in a stress scenario this cost would likely become prohibitive, while market discipline would require banks to improve their capitalization rapidly. Banks have moved ahead with issuance of contingent capital (CoCos); however, the loss-absorbing capacity of these instruments remains untested.14

36. There is progress on bank resolvability, a key plank of the TBTF strategy. The new TBTF legislation requires SIBs to prepare a recovery and resolution plan to ensure the continuity of systemically important functions in Switzerland in case of financial distress. The legislation also creates incentives for banks to make further progress toward global resolvability, as such progress may result in rebates on capital requirements. The size of the rebates will depend on progress in achieving structural, financial, and operational unbundling. The SIBs will also be affected by new resolvability requirement in the U.S. and U.K., where they have large operations, and recovery and resolution plans will be evaluated by supervisors in all three countries. Progress has been made in upgrading the Swiss bank resolution framework, where reforms will grant FINMA new powers to intervene distressed banks.

37. Microprudential supervision is being upgraded, but reliance on external auditors remains a problem. FINMA has adopted a risk-based approach in all areas of supervision and increased on-site reviews and regulatory audits. However, the outsourcing of supervisory work to auditors (hired by the banks) is still prevalent. In addition, a costly “rogue trader” scandal at one of the SIBs last fall has highlighted the need to enhance the oversight of risk management and internal controls of large banks. Resources should be further expanded to broaden FINMA’s in-house supervisory capacity.

38. In the insurance sector, implementation of the Swiss Solvency Test (SST) by all insurers and reinsurers should improve risk management. Given pressures from strong competition and low interest rates, it is important to ensure the proper operation of the SST for all insurers. In 2011, FINMA rendered about 30 decisions on internal model approval requests, with full approval granted in 25 percent of the cases. The supervisory agency is also focusing efforts on less transparent intra-group transactions in order to identify and eliminate unlimited guarantees. In light of the relatively high level of intra-group balances, the oversight of intragroup connections needs to be strengthened to contain contagion risk arising from significant or undesirable transactions.

The authorities’ view

39. The authorities recognize that large banks remain thinly capitalized but are confident that progress under the new regulatory framework will be adequate. The authorities agreed that fast progress was desirable, were closely monitoring bank capital building progress, and were ready to act if banks did not fulfill the new requirements as they came into force. They also expected market discipline to put pressure on banks to move faster, and noted that forcing more transparent bank reporting of capital adequacy according to the full Basel III standards would foster such discipline. They also considered that CoCos would help mitigate the risk of low capitalization, as these instruments would be loss-absorbing. The authorities underscored the importance of rapid progress towards resolvability, acknowledged the complexity of the issue in a global context, and stressed that the Swiss approach was to put the banks in charge of devising convincing solutions. On supervision, they noted that there was ongoing progress in building up in-house capacity, but also pointed out that reliance on external auditors allowed for the flexibility of quickly putting into place supervisory capacity in specific areas. Finally, on risk management, FINMA has asked large banks to assess internal control procedure to prevent unauthorized trading against prudent practices, and will take action if needed.

E. Fiscal Policies—Standing Ready for Cyclical Support and Reforming Aging-Related Spending

40. The fiscal stance is appropriately neutral given growth prospects, but fiscal policy should be ready to support aggregate demand to the extent feasible under fiscal rules if the outlook deteriorates. From a longer-term perspective, fiscal policy should be conservative in light of population aging and financial sector risks (including from guarantees for cantonal banks and public pension funds). However, available leeway under the fiscal rules and additional room that may emerge during budget implementation should be used to prop up aggregate demand in case the envisaged recovery stalls in the course of the year. Fiscal multipliers are estimated to be similar to those of other advanced small open economies (see Annex IV).

41. Rapid progress in tackling the cost of an aging population is needed and automatic adjustors (“fiscal rules”) for pensions would be useful. Given the long gestation periods associated with the related reforms, time is running out quickly. Specifically in the pension system, equalization of the male and female retirement age and pension indexation to inflation only (rather than both inflation and wages) should be considered. In addition, automatic adjustors of the pension age and/or benefits to life expectancy would be a useful tool to reduce the need for repeated and often difficult reform discussions. Furthermore, as regards health care, recent reforms, including with respect to hospital financing, are welcome and should be carefully monitored. A further strengthening of coordination mechanisms, including across government levels, could facilitate the design of additional measures.

The authorities’ view

42. The authorities expressed skepticism about discretionary fiscal policy. They noted that the philosophy behind the debt brake rule is to eschew discretionary fiscal policy, and emphasized the built-in role of automatic stabilizers. This determination was confirmed by the reluctance by parliament to go beyond the fiscal measures for mitigating appreciation effects introduced in August 2011. From a practical perspective, feasible timely and targeted projects would be difficult to find, in particular infrastructure projects would not be advisable given the high degree of capacity utilization in the construction sector.

43. On aging costs, the authorities concurred with the case for additional reforms, but were concerned about the political acceptability of automatic benefit adjustors, which may take discretion away from the political process. As a potential alternative, they mentioned a stipulation mandating the government to pass reforms in case of financial imbalances in the social security funds, e.g. when the liquidity reserves of the public pay-as-you-go pillar fall below a certain percentage of annual expenditure. In parallel, temporary benefit and/or contribution measures to ensure liquidity would come into force (e.g. the suspension and/or postponement of the regular pension increases in line with inflation and/or wages). This would build pressure for a political consensus on more fundamental reforms while still keeping discretion about how such reforms should look like.


44. The economy is well positioned to return to moderate growth in the second part of this year, but uncertainty is high. As global demand picks up and the tradable sector adjusts to the new level of the exchange rate, output growth should recover in the second part of the year, with the output gap remaining close to zero and unemployment increasing modestly. Inflation should turn positive once exchange rate pass-through effects peter out. Possible financial sector ramifications of sovereign and banking sector fragilities in the euro zone are the main downside risk.

45. The introduction of the exchange rate floor in September 2011 was appropriate in light of risks. With economic indicators pointing downwards, negative inflation, and uncertainty in the euro area spurring capital inflows and pushing the exchange rate to historic heights, continuing exchange rate appreciation might have caused entrenched deflation and a recession. Furthermore, alternative policy options were limited, with interest rates at the zero bound, discretionary fiscal policy limited by the debt brake rule, and quantitative easing constrained by the small size of the domestic bond market. The SNB exchange rate commitment, which is seen as credible by the markets, has stabilized the currency and is thus helping shore up the economy.

46. Once economic conditions normalize, a return to a freely floating currency would be desirable. While the exchange rate floor has been successful, once an economic recovery gets under way and deflation risks recede the SNB should move back to a free float. Delaying exit would carry the risk of stoking inflation, especially in case money supply had to be expanded pro-cyclically to absorb renewed capital inflows. A strong economy and resurgent inflation might also undermine the credibility of the commitment to defend the floor.

47. The current fiscal stance is appropriate but would need to be loosened if support for the still fragile economic growth is needed. From a longer term perspective, a conservative fiscal policy is appropriate in view of potential fiscal risks related to the financial sector (including cantonal banks and public pension funds) and the cost of an aging population. In the short term, the current broadly neutral stance is appropriate. However, in case the envisaged recovery stalls it would be advisable to use countercyclically the limited leeway available under the fiscal rules.

48. In parallel, measures to tackle the financial consequences of population aging should gain center stage and include additional “fiscal rules”. Under unchanged policies, the increase in aging-related expenditure will already start to bite in earnest around the end of this decade. Consequently, time for reform preparation and implementation is running out quickly. Specifically, a “fiscal rule” that automatically links the retirement age and/or pension benefits to life expectancy could usefully be introduced. Such a rule would reduce the need for repeated and often difficult reform discussions.

49. Rapid implementation of Basel III and TBTF capital requirements as well as progress on bank resolvability are paramount. The TBTF legislation, recently approved by Parliament, will substantially raise the requirements for high quality capital in systemically important banks and is welcome, but it has a relatively long implementation period. Although this is in line with Basel III, it may be particularly detrimental in the case of the two large Swiss banks, because of their high vulnerability to risks that were not sufficiently recognized under Basel II and heavy reliance on low quality capital that will be phased out under the new rules. Thus, during the transition rapid progress to strengthen the quantity and quality of capital in large banks is needed, especially in light of the continued fragilities in the global financial system. In parallel, since more capital alone cannot fully eliminate TBTF risk, progress toward improving bank resolvability should continue.

50. A broad set of macroprudential instruments is urgently needed to address rising mortgage market risks. Since monetary conditions might remain loose for some time, the risk that a bubble may form is intensifying. Stepped up monitoring and supervision will help contain risks in domestically-oriented banks, where mortgage loan concentration is high. The Basel III counter-cyclical capital buffer and higher risk weights on riskier mortgages, if implemented, will usefully increase the buffer to absorb possible mortgage-related losses and may help prevent imprudent lending and borrowing behavior, However, the effectiveness of these measures warrants close monitoring, and more direct tools such as minimum affordability ratios should also be included in the macroprudential toolkit so that they could be readily deployed in case a housing bubble starts to develop. Improving access to bank information would also help the SNB better fulfill its macroprudential oversight responsibility. Furthermore, consideration should be given to reducing tax incentives for households to take on mortgage debt.

51. Efforts to upgrade bank and insurance microprudential supervision are welcome and more progress is encouraged. The adoption of a risk-based approach in all areas of supervision, increased on-site reviews, and stronger supervisory involvement in regulatory audits should improve the quality of supervision. However, resources should be further expanded to broaden in-house supervisory capacity and reduce reliance on external auditors. In the insurance sector, the implementation of the SST by all insurers has helped improve solvency and risk management in the industry. Given the relatively high level of intra-group balances in insurance companies, the oversight of intra-group connections needs to be strengthened to contain contagion risk.

52. It is recommended that the next Article IV consultation with Switzerland be held on the usual 12-month cycle.

Table 1.

Switzerland: Selected Economic Indicators, 2008–13

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Sources: Haver Analytics; IMF’s Information Notice System; Swiss National Bank; and IMF Staff estimates.

Contribution to growth.

Reflects new GFSM 2001 methodology, which values debt at market prices.

Based on relative consumer prices.

Table 2.

Switzerland: Balance of Payments, 2008–13

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Sources: Haver Analytics; Swiss National Bank; and IMF staff estimates.

Includes derivatives and structured products.

Official reserves for 2011 are as of end-December 2011.

Table 3.

Switzerland: General Government Finances, 2008–15

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Sources: Federal Ministry of Finance; and IMF staff estimates.

Includes the balance of the Confederation and extrabudgetary funds (Public Transport Fund, ETH, Infrastructure Fund, Federal Pension Fund).

Includes old age, disability, survivors protection scheme as well unemployment and income loss insura

Table 4.

Switzerland: SNB Balance Sheet

(Millions of Swiss francs; unless otherwise indicated)

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Sources: SNB; and IMF staff estimates.

Currency in circulation and sight deposits of domestic banks.

Table 5.

Switzerland: Financial Soundness Indicators

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Source: Swiss National Bank.

End-2011 unless otherwise specified.

For 2007–08, these ratios were calculated using Basle I as well as Basle II methodologies. Therefore, interpretation must be done carefully since they can vary within +/- 10%.

As percent of total credit to the private sector.

Table 6.

Switzerland: General Government Operations, 2001–09

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Source: Federal Ministry of Finance.

Annex I. A Long-term Perspective on the Swiss External Accounts

1. Switzerland has run sizable current account surpluses for longer than any other advanced economy.1 Since the early 1990s, its current account has trended upwards, reaching a peak at 15 percent of GDP in 2006, and again in 2010–11. This long-term improvement is accounted for by the growing surplus in the investment income account and by rising positive balances in the goods and services account.

2. The strong investment income performance reflects the large net foreign asset position and the high yield earned on the sizable net direct investment position. The surplus in goods trade reflects strong export performance in technology intensive and highly-specialized sectors such as watches, medical equipment, and pharmaceuticals. The latter benefited also from growing global health related expenditures. The widening surplus in services trade is fully accounted for by the merchanting sector, while the surplus in banking financial services has shrunk since the global financial crisis.2

3. To assess external performance in the case of Switzerland, it may be more useful to examine directly the country’s net foreign asset position rather than the current account, as the latter is somewhat misleading.3 Swiss net foreign assets have grown from 83 percent of GDP in 1995 to 138 percent of GDP in 2010. This is an impressive build-up, but far less than what would be implied by the accumulation of current account surpluses. In fact, the rate of accumulation of NFA has been on average 3½ percent of GDP per year over the last 15 years, vis-à-vis an average current account surplus of over 10 percent. The discrepancy, which has been noted before (Stoffels and Tille 2007), arises because valuation changes have affected foreign assets differently from foreign liabilities. More specifically, over 2000-10 capital gains have been close to zero on foreign liabilities but negative on foreign assets, reflecting in part the different asset composition (Swiss foreign liabilities have a larger share of equities) but also adverse valuation effects due to the long-run appreciation of the exchange rate.4

Note: Aging refers to the expected change in the dependency ratio 20 years ahead

4. What may explain the build-up in the Swiss NFA? The literature has found that rich countries and those with a large share of the population nearing retirement tend to have a larger net foreign asset position. Adding to the effect of a demographic structure conducive to NFA accumulation, the nature of the pension system may lead to high savings rates by households: Switzerland has a well developed system of mandatory second-pillar retirement saving, which accounts for half of overall household saving and 15 percent of gross national saving (Jarrett and Letremy, 2008). These pension funds held assets worth more than 100 percent of GDP already in 2009, one of the highest GDP shares in the OECD. In addition, Switzerland’s role as an international financial center may play a role in an explanation, as it is well known that such centers tend, on average, to run large current account surpluses and accumulate positive net foreign asset positions (Lee et al., 2008). However, so far there is no theoretical explanation of why this should be the case.

5. Whatever their fundamental determinants, the large current account balance surplus and net foreign asset build-up are likely to play an important role in exchange rate determination. While short-term movements in exchange rates are usually dominated by monetary and other high frequency factors, the currencies of countries with large NFA positions tend to have more appreciated real exchange rates (Lee et al., 2008) and their trade balance tends to deteriorate in the long-run (Lane and Milesi-Ferretti, 2002). This happens because a larger external wealth allows for higher consumption and trade deficits, which in equilibrium is accommodated by an increase in the price level of the country receiving the international transfers, as in the classic “transfer problem” analyzed by Keynes (Lane and Milesi-Ferretti, 2004). Thus, also in the case of Switzerland, the large net foreign asset position may be a long-term factor pushing up the exchange rate.


  • Jarrett, Peter, and Céline Letremy, 2008, The Significance of Switzerland’s Enormous Current-Account Surplus, OECD Economics Department Working Papers No. 594.

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  • Lane, Philip and Gian Maria Milesi-Ferretti, 2002, External Wealth, the Trade Balance, and the Real Exchange Rate, European Economic Review 46, 10491071.

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  • Lane, Philip and Gian Maria Milesi-Ferretti, 2004, The Transfer Problem Revisited: Net Foreign Assets and Real Exchange Rates, Review of Economics and Statistics 86, 841857.

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  • Lee, Jaewoo, Gian Maria Milesi-Ferretti, Jonathan Ostry, Alessandro Prati and Luca A. Ricci, 2008, Exchange Rate Assessments: CGER Methodologies, IMF Occasional Paper 261.

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  • Mauro, Paulo, 1995. Current Account Surpluses and the Interest Rate Island in Switzerland, IMF Working Paper 95/24.

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  • Swiss National Bank, 2006. Swiss Balance of Payments 2006.

Annex II. Switzerland: Fiscal Discipline in a Federal System

1. Switzerland is a confederation of 26 cantons and almost 2600 municipalities. Its public finances are highly decentralized (see table 3). In particular, subnational governments have considerable autonomy in determining key parameter of the bulk of taxes they receive, such as the tax rate. As a result, there is a substantial degree of heterogeneity across cantons in the level and nature of taxation, and tax competition is an important characteristic of the system.

2. The remarkable degree of fiscal discipline in this federal system rests on two pillars: (1) inter-governmental fiscal relations with a streamlined task distribution and close links at the same government level between spending decisions and the responsibility for their financing; these features restrain task duplications and, together with a no bail-out presumption, limit any deficit bias at lower government levels; and (2) effective fiscal rules that avoid over-complexity and, hence, remain tractable both from a technical as well as political economy perspective.

Inter-Governmental Fiscal Relations

3. The current system of intergovernmental fiscal relations was reformed recently. After a long preparation period, the new system became effective in 2008. The reform covered both the distribution of tasks across levels of government and the fiscal equalization mechanism.

4. The distribution of tasks across government levels was streamlined. Out of 40 areas for which the confederation and cantons used to have joint responsibility, 17 are now exclusively assigned to one of the two levels. As for the areas were a joint responsibility remains, there is a clearer division of labor between strategic tasks (assigned to the federal level) and operational tasks (allocated to the cantons). Cooperation among cantons has also been enhanced.

5. Simultaneously, the volume of earmarked transfers was substantially reduced, and the fiscal equalization scheme was rationalized to two mechanisms: 1

  • (a) Compensations for different fiscal resource potentials across cantons. These compensations are financed by both the federal level and relatively better-off cantons.

  • (b) Compensations for differing fiscal needs arising from either varying socio-demographic or geographic characteristics. The former criterion benefits mostly urban areas, while the latter is to the advantage of mainly peripheral cantons with low population density. These compensations are exclusively financed by the federal level.

6. A presumption of “no bail-out” at both the cantonal and municipal level, which avoids “fiscal moral hazard”. This presumption has been confirmed in the 1990s when several cantons were in dire financial straits due to their guarantees to cantonal banks. At the municipal level it was corroborated in 2003 when the Swiss Federal Court decided in the case of a municipality (Loèche les Bains) that the canton Valais was not responsible for its liabilities. In addition, cantonal ratings differ significantly and would not appear to assume federal bail-out support, and the variation of spreads across cantons suggests a close link with their fiscal position and the strength of their fiscal rules.2

7. The new system has put in place better incentives for each level of government. This rationalized system of intergovernmental fiscal relations, coupled with the credible no-bail out presumption and traditionally high tax autonomy, provides for a close link between spending decisions and the responsibility for their financing at the same government level. This sets the right incentives for a responsible use of public resources and the acceptance of and compliance with fiscal rules.3

Fiscal Rules

8. Fiscal rules exist at both the federal and the subnational level. The most prominent Swiss fiscal rule is the so-called “debt brake” rule at the federal level. It is, in essence, a cyclically-adjusted balanced budget rule with an error-correction mechanism in the form of a notional “compensation account”. The latter accumulates deviations of budget outcomes from rule requirements and mandates additional consolidation efforts once a negative balance of 6 percent of expenditure is reached.

9. Operationally, the rule is mapped into annual expenditure ceilings. These floors can only be raised in exceptional circumstances that are out of the control of the authorities, such as a severe recession. The severity of a recession is determined through a number of indicators and any deviation from the fiscal rule requires an absolute majority in both chambers of parliament.4

10. The federal fiscal rule led to a substantial reduction in the debt-to-GDP ratio. It was enshrined into the constitution and became effective in 2003 after a string of large deficits in the 1990s. After its inception, the federal debt-to-GDP ratio fell by some 10 percentage points, not least due to the asymmetry of the rule which allows for overperformance.

11. At the subnational government level, most of the cantons have fiscal rules as well. These are very heterogeneous and vary with respect to the target, operational implementation, exemption clauses, and sanctioning mechanisms. 5 Municipal finances are subject to the oversight by the respective canton.

12. Absorbing the imminent aging-related expenditure increases would benefit from additional “fiscal rules” that anchor long-term sustainability. In particular the pay-as-you-go pension pillar would gain from automatic adjustors of the pension age and/or benefits to life expectancy. This would be a useful tool to reduce the need for repeated and difficult reform discussions and potentially ad-hoc reform decisions.

13. The Swiss system of fiscal federalism is working well. To summarize, a rationalized system of intergovernmental fiscal relations (including clear task assignments, rationalized financial equalization flows, a no-bail-out presumption, and a considerable degree of tax autonomy) has delivered a general culture of fiscal discipline and laid the basis for a credible commitment to and consistent compliance with fiscal rules.

Annex III. The Short-Term Effect of Real Appreciation on Swiss Economic Growth: A VAR Analysis

1. Using a VAR framework, this annex provides a quantitative assessment of the effect of exchange rate on Swiss GDP growth. The Swiss franc appreciated in real effective terms by almost 30 percent between 2008Q3 and 2011Q3, with an appreciation of similar size occurring in bilateral terms against the euro. Real appreciation is usually thought to slow down economic activity, as demand shifts away from domestic output. While the Swiss economy did experience a recession in 2009, growth recovered swiftly as the world economy improved in 2010 and early 2011 even though the real exchange rate continued to strengthen, suggesting that the positive effect of the world recovery dominated the contractionary effect coming from the exchange rate.

2. To quantify the importance of global and country specific shocks in Switzerland, we estimate a vector autoregression (VAR). The model has six endogenous variables and 8 lags (as determined by Akaike tests for lag length). The model distinguishes between global variables, i.e. those that are not affected by Swiss specific developments, and Swiss macroeconomic variables. That is made operational by constraining the effect of Swiss variables on global variables to be nil. The global variables we include are the world GDP growth (world) and the log change in oil prices in US dollars (dloilp). For the Swiss economy, we include GDP growth (growth), the differential in short-term interest rates between Switzerland and the euro area (Germany before the euro adoption) (dshort), the log change in the real effective exchange rate (dlreer) and CPI inflation (infl).

3. In the preferred specification, we estimate the model on quarterly data spanning from 1991Q1 to 2011Q4. The identification of the structural shocks is based on a Cholesky decomposition with world GDP growth going first, and then followed by the change in oil prices, Swiss GDP growth, the differential in interest rates, the change in the REER, and CPI inflation. The VAR is estimated so that in the reduced form Swiss variables do not enter the equations for world GDP and oil prices.

4. The main results are as follows (see Figures 1A1B):

  • The real exchange rate has had trend appreciation with some fluctuations around this trend.1 Shocks to the real exchange rate tend to vanish after a few years. A typical REER shock (a one-standard deviation shock) causes a quarterly appreciation of about 1¼ percent on impact.

  • During the sample period, real appreciations have been followed by brief but economically and statistically significant reductions in the differential between Swiss franc and euro short- term rates (Figure 1A). This is probably because monetary policy tends to respond to unexpected movements in the real exchange rate aiming to counter its effects on output or inflation. The peak impact of real appreciation on GDP growth rates happens in the second quarter after the REER shock (Figure 1A). Thus, the lag in the effect is relatively short. The cumulative effect on GDP is statistically significant and sizeable. A one standard deviation shock to REER causes a loss of about 0.2 percent in the GDP level relative to baseline, over 2 years (Figure 1B).

  • The effect on inflation is not immediate and is relatively small (for the typical REER shock, the price level is less than 0.1 percentage point lower after 2 years).

Figure 1A
Figure 1A

Response to a REER shock

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

90% confidence intervals
Figure 1B
Figure 1B

Cumulative response to a REER shock

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

90% confidence intervals

5. To gauge the impact of real appreciation (dlreer) on growth, we compare its magnitude to the impact of shocks to the interest rate differential (dshort) and world GDP growth rate (world). It turns out that a typical shock to world GDP has a larger estimated effect on the Swiss GDP growth than a shock to dlreer and dshort (Figure 2), and the effect of the interest differentials has the opposite sign than expected.

Figure 2
Figure 2

Comparing the cumulative impact of shocks on GDP

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

90% confidence intervals

6. Next we consider a variance decomposition of Swiss GDP growth. At all horizons, the effect of global GDP growth looms large, dominating the effect of own shocks to Swiss GDP and those of oil prices, monetary policy or real exchange rate (Figure 3).

Figure 3
Figure 3

GDP growth: Variance decomposition

Citation: IMF Staff Country Reports 2012, 106; 10.5089/9781475503395.002.A001

90% confidence intervals

7. Finally, we consider how much the recent real appreciation has contributed to weakness in GDP growth. To this end, we recover the structural shocks to the real exchange rate equation since 2008Q1 and calculate the impulse they generate to GDP growth going forward. In our preferred estimates, the REER equation has some explanatory power for GDP growth and its residuals since 2007, while negative for a few quarters, have been sharply positive over 2011 (Figure 3). According to the model, past movements in the real exchange rate will cut quarterly growth by about 1 percentage point between 2011Q4 and 2012Q4, with some of this effect offset from 2013 onwards. This confirms that the Swiss economy is facing headwinds in the near term as a consequence of the appreciation of the Swiss franc during the last few years.

Annex IV. Fiscal Multipliers in Switzerland

1. Economic research on the size of fiscal multipliers points to a wide range of values, depending on the model, monetary policy assumptions, the type and persistence of government spending and tax cuts, their financing, and the degree of excess capacity in the overall economy or the affected sectors.1

2. Empirically, recent work by the OECD on the effects of stimulus measures in the 2008–09 crisis confirms theoretical expectations that fiscal multipliers in Switzerland are smaller than in larger and more closed economies. However, they are not negligible and in a similar range as in other small open economies.

3. These estimates are based on an average of simulation results from various macro models surveyed in the OECD study. Only simulations in which monetary policy is set to be accommodative are considered, in line with current Swiss circumstances, and the multipliers take openness into account. However, they should be considered as an upper bound, as they are not adjusted for other factors that played a role in 2008/2009 and may play a role in a new downturn as well—such as an increase in the propensity to save in crisis times. For evaluating the fiscal packages of the 2008/2009 crisis, the OECD has therefore made some judgmental adjustment to the above multipliers and computed so-called “reference multipliers.”2 In addition, the study usefully computes separate multipliers for different expenditure and tax categories. In the case of Switzerland, as for other countries, increases in government investment have the largest effect on output, followed by government consumption, while increases in transfers or tax cuts have smaller effects. 3

4. In conclusion, these results suggest that a fiscal stimulus in Switzerland would be effective in mitigating an economic downturn, even if the exact magnitude of its impact remains hard to predict.

Short-term Fiscal Multipliers 1/

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Percentage effect on GDP, averaged over the first and second year, of a 1 percent of GDP change in the relevant budget compenent. Estimates are based on the survey of results described in box 3.1 of the OECD Economic Outlook Interim Report of March 2009, adjusted for openness as measured by the ratio of import to the sum of GDP and imports

Source: OECD Economic Outlook, Interim Report (March 2009), Appendix 3.2.

OECD Reference Multipliers

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Source: OECD