Recording of the Entire Conference

Introduction by Gerhard Schwarz

«What Makes Good Money ?»

Speech by Thomas Jordan (in German)

Director of the Swiss national bank (SNB) 

The title of today’s event could not be clearer: Getting good money into the economy is a recurring challenge. I am therefore delighted to have this opportunity to discuss with you in greater depth the question of what makes good money. After all, as Chairman of the Governing Board of the Swiss National Bank (SNB), I represent an institution that, since its foundation 113 years ago, has had the task of ensuring good money in our country. Good money is of central importance in a society characterised by the division of labour and the exchange of goods – this has been demonstrated not least by the experience gained over many centuries with a wide variety of monetary systems. Today, money is used in almost all economic transactions. A sound monetary system is essential for a modern economy, efficient trade and social stability.

In view of the importance of the monetary system, it is right and important that developments in this area should continue to be discussed in public. With this conference devoted exclusively to sound money, you are making an important contribution. Sound money is a fragile achievement and therefore always under threat. However, in the wake of the global financial crisis, the concern that our good money might go bad has grown considerably in recent years. On the one hand, this is understandable. The central banks’ fight against the crisis has led to an extraordinary expansion of the money supply and interest rates are at record lows – in the past, these were often indicators of impending inflation and hence currency depreciation. On the other hand, the facts suggest that the value of money has never been as stable as it has been over the past 20 years. From this point of view, the central banks have merely met the enormous demand for central bank money with their expansionary monetary policy. This high demand is actually a great vote of confidence in the central banks.

The fact that inflation has been tamed for so long may also be one reason why ideas from a completely different corner have gained popularity. Proponents of modern monetary theory want to put central banks at the service of government financing. According to this interpretation, independent central banks are really just an obstructive relic, since the financing needs of the state should largely determine monetary policy, which, according to all historical experience, would sooner or later lead to an economic policy fiasco.

As you can see, the positions are far apart and the facts are interpreted in diametrically opposed ways. The aim of my speech is to help clarify the situation from the Swiss central bank’s point of view. To this end, I will make some fundamental observations on the characteristics of good money and the different types of money, before examining whether the Swiss franc can continue to be described as good money in the light of our current monetary policy.

Good money is money that keeps its value

But first, let’s take a step back and look at the concept of money. Money is a commonly accepted medium of exchange, and it also fulfils two other important functions: as a unit of account and as a store of value.

As a unit of account, money is used to make economic transactions comparable. In this function, money is also used to represent the nominal value of claims or obligations of all kinds. As a unit of account for determining value, money plays a prominent role in almost all areas of life – from the world of work to healthcare and pensions.

For money to be a generally accepted medium of exchange, it must be possible to buy goods or services not only today, but also tomorrow or the day after tomorrow. This is why money can also be used as a store of value. But money is not the only, and often not the most rewarding, way to hold and grow wealth. Although it offers security and flexibility, it offers little or no return, unlike risky financial investments.

So what is good money? My answer should not surprise you: Money is good when it does its job as well as it can. And that is the case when it is stable in value. Only such money will be widely accepted as a medium of exchange in the long run. At the same time, as a unit of account, stable money enables and facilitates planning and calculation and is suitable for storing value. However, the importance of stable money goes far beyond these three narrowly defined functions. Good money helps to maintain the real value of financial claims that are fixed in nominal terms. This is usually the case with savings, bonds, employment contracts or pensions. Good money thus creates security and trust, which are conducive to social peace and cohesion.

Money is therefore good when it neither depreciates nor appreciates, i.e. when there is neither inflation nor deflation. But how can we measure the evolution of the value of money over time? We have to look at the development of its purchasing power. It is therefore useful to measure the value of money on the basis of a basket of goods purchased by a consumer who is as representative as possible, as is done in Switzerland with the national consumer price index. The value of money thus depends on the transaction prices of goods and services, and its evolution can be measured by the price of the basket of goods and services over time.

Central bank money and bank deposits

Now that we have analysed what good money is, let us turn to the two types of money that circulate in parallel and are interchangeable in today’s monetary system: Central bank money and bank deposits or bank book money. In the case of Switzerland, central bank money consists of the banknotes issued by the SNB and the sight deposits that financial market participants – primarily banks – hold in their current accounts with the SNB.

The Federal Act on Currency and Payment Instruments stipulates that the SNB’s money is legal tender in Switzerland and that the Swiss franc, divided into 100 centimes, is the country’s monetary unit. Central bank money and its unit of account thus form the anchor of our monetary system. The SNB’s money defines the value and characteristics of our currency and thus also forms the basis for bank money.

A bank deposit, on the other hand, is not legal tender. Rather, it represents a private claim on a bank that can be exchanged on demand on a one-to-one basis for central bank money – banknotes for non-banks. Economic agents are willing to hold bank deposits instead of central bank money as long as they have confidence in the solvency of the bank and as long as bank deposits provide them with added value compared to central bank money. For example, bank deposits facilitate the settlement of transactions – most of us would probably not find it very convenient if, for example, wages and rents were paid in cash. Bank deposits also offer protection against theft and are often a better store of value than central bank money, as they generally yield a return, although they do carry some credit risk.

In Switzerland, more than 90% of the money held by households and companies in Swiss francs is in bank deposits and less than 10% in banknotes. This means that it is not enough for central bank money alone to be good. Bank deposits also have to be good money.

When is central bank money good money?

But first let’s look at the money that anchors the monetary system. Today, central bank money is paper money: by definition, there is no obligation to redeem it in precious metals, which makes the issuance of money completely flexible. This has important advantages: The central bank can adapt the supply to demand and thus keep the value of money stable over time. Thanks to this flexibility, the central bank can make an important contribution to damage limitation in a crisis by providing additional money and thus avoiding a liquidity shortage in the financial system. This was hardly possible under the gold standard. Because of the obligation to redeem in gold, the central bank money supply was largely rigid, which significantly exacerbated the recurrent banking crises. Despite the glamour of gold, the monetary system was far from stable and many citizens lost their savings in banking crises.

However, there are also many examples in history where paper money proved to be extremely bad money, as high inflation led to rapid depreciation, sometimes with devastating consequences for the economy, society and politics. The flexibility that characterises the paper money system is both its strength and its Achilles’ heel. Used correctly, i.e. with an eye to value stability, flexibility contributes to the stability of economic development and the soundness of the banking system. It becomes dangerous, however, when it is misused to solve political or structural problems by issuing central bank money – as advocated, for example, by the proponents of modern monetary theory mentioned above. Of course, the more politicised monetary policy becomes, the greater the temptation to fulfil such wishes with the printing press or with money out of thin air. A sound paper money system therefore rests on three central pillars: a clear central bank mandate with the objective of maintaining price stability and thus good money, protection from political influence through central bank independence enshrined in law and practised in practice, and sound public finances. Experience shows that high government deficits also increase political pressure on the central bank, and with politicised monetary policy there is a high risk that money will sooner or later lose much of its value.

When are bank deposits good money?

This also allows us to answer the question of when bank deposits are good money. Stable central bank money is an essential prerequisite for good bank money. Since bank deposits in Switzerland are denominated in Swiss francs, their value is largely determined by the SNB’s money.

Good central bank money is therefore a necessary but not a sufficient condition for good bank money. Bank deposits are only good money if the bank in question is solvent and liquid, i.e. if depositors can be sure that they can easily exchange their deposits for banknotes or deposits of another bank at any time.

To ensure that this remains the case in turbulent times, banks should have a strong capital base and sufficient liquidity. They must always be able to meet their obligations and therefore not take excessive risks. This is the case if banks organise their business strategy accordingly and regulation is stability-oriented. This also reduces the likelihood that the central bank will have to act as a lender of last resort, i.e. provide liquidity to solvent banks in a crisis if they are no longer able to obtain funds on the market.

Is the franc good money?

This brings us to today’s key question, which is whether or not the Swiss franc is good money. The fact is that the price level in Switzerland has never been more stable – and therefore the value of the franc has never been more stable – than in the past 20 years. But even over the longer term, the franc is extremely stable by international standards.

What are the factors behind this? The solidity of the Swiss franc is due on the one hand to the strength of the Swiss economy and on the other hand to the stability of government institutions. One such institution is the SNB. The Swiss franc has maintained its value because the law guarantees the SNB’s independence and gives it a clearly formulated mandate to ensure price stability, taking account of economic developments. In addition, public budgets are in a good position in terms of debt, which reduces political pressure on the central bank.

Bank deposits in Switzerland retain their value because central bank money retains its value, the banks operate sensibly and stability is at the heart of the regulation of the banking system. The strong capital base and high liquidity of banks in Switzerland increase the resilience of the system in times of crisis and foster depositor confidence. Both contribute to the preservation of the value of bank deposits.

Current monetary policy and the role of the central bank’s balance sheet

Our findings are therefore quite reassuring. In Switzerland, central bank money and bank deposits are basically good money. But there is no guarantee that this will remain the case in the future. Or, to put it more bluntly, does the SNB’s expansionary monetary policy of recent years jeopardise the solidity of the Swiss franc in the future? The issuance of too much central bank money can indeed undermine the foundations of sound money, especially if the money is created to solve political or structural problems. However, the unprecedented expansion of the central bank money supply in recent years does not pose a particular risk to the stability of the Swiss franc. By increasing the supply of money, the SNB has responded solely to the increase in demand, always guided by its mandate to ensure stable value and thus good money. It should be noted that bank deposits, which are also relevant for the development of inflation, have grown comparatively moderately. The monetary aggregates referred to by economists as M2 or M3 have grown much less strongly than would have been expected on the basis of the increase in the central bank money supply or the monetary base M0 alone. In other words, the money multiplier has fallen sharply.

The increase in the monetary base reflects the increased demand for the Swiss franc, which is seen worldwide as a safe haven, especially in times of crisis. Without an expansion of the monetary base, the price of money, which is in short supply, would have risen massively. As a result, the price level would have fallen sharply, our currency would have appreciated even more and economic activity would have collapsed.

Can this strong expansion be reversed if necessary? The answer is yes. If demand for Swiss francs weakens, the money supply can be reduced at any time, thereby ensuring value stability. In principle, the SNB has various ways and means of absorbing liquidity. However, an important condition for a successful reduction in the money supply is that the SNB has unrestricted access to its balance sheet and, in particular, can sell foreign currency investments for Swiss francs if necessary – a mirror image of the foreign currency purchases of recent years. As a result, we must also firmly reject ideas aimed at subsidising a sovereign wealth fund out of our assets, even if we have great sympathy for the associated concerns, such as safeguarding pension provision.

Summary and outlook

Let me conclude by reiterating the value of addressing the fundamental issue of sound money. In my remarks, I stressed the paramount importance of the three pillars of a sound paper money system: a central bank mandate with price stability at its core, central bank independence in the conduct of monetary policy, and sound public finances. As we have seen, good money is always under latent threat. Only if we remain vigilant can we identify and avert the dangers in good time.
What are the main threats to good money today? In my view, there are two developments in particular that we need to keep an eye on. First, the instrumentalisation of central banks for government financing would undermine the second pillar, central bank independence.

Second, the impact of the coronavirus crisis could also reduce the quality of money. For example, the financing needs of governments, and hence their debt levels, have increased significantly overall, which could undermine the third pillar if no countermeasures are taken in the medium term. In addition, many central banks have themselves acquired an extraordinary amount of their own government debt. This may be the right thing to do in a crisis from a monetary policy point of view, but it must not be done with the motive of financing the state.The challenge is to maintain a clear division of responsibilities between monetary and fiscal policy, even in this crisis situation, and thus to preserve the independence of central banks not only on paper but also in reality. In particular, it is important to avoid a situation where excessive government debt effectively forces a central bank to base its decisions on the impact on public finances. This would mean that price stability, and thus good money, would no longer be at the centre of monetary policy.

Switzerland has so far been able to cope well with the additional debt because it entered the crisis with its public finances in order. However, the coronavirus crisis has also fuelled desires in this country. Calls for the SNB to pay out massive additional dividends have become much louder. However, the following should not be forgotten: On the one hand, the size of the payout depends on the earnings potential of our investments. On the other hand, shareholders’ equity must be sufficiently high in relation to the risks on the central bank’s balance sheet.

Ladies and gentlemen, the monetary system must take account of the changing needs of the economy, society and the environment over time. Nevertheless, it is a system that has evolved over time, and ill-considered interventions can have serious consequences for our country and the population as a whole. The quest for sound money has been a constant in Switzerland’s chequered monetary history. The current paper money system with central bank money and bank book money has proved its worth. However, to ensure that the advantages of this system can continue to be used in the country’s interest in the future, we must ensure today that the three pillars of sound money can continue to fulfil their supporting function.

Thomas Jordan: Was macht gutes Geld aus?

«Maintaining Sound Money Amid and After the Pandemic»

Speech by Agustín Carstens

General Manager, Bank for International Settlements

Introduction

I would like to thank the SNB for inviting me to the 50th Economic Conference. It’s a great honour to be here today at this round anniversary. Let me mention that we too are marking a round anniversary this year, the BIS’s 90th, and we are grateful to the Swiss community for all the support you have given us over the years. The BIS has evolved over time to become a hub for central banks, with the overall goal of promoting global monetary and financial stability. Put differently, we aim to promote sound money worldwide. As the title of the conference suggests, sound money is a noble goal under constant fire and it is a continuous challenge for central banks to defend it.

For a long time, bringing inflation down and keeping it from rising was the main challenge faced by central banks. More recently, however, a new challenge has emerged: fighting persistently low inflation and economic stagnation in a low interest rate environment. The Covid-19 shock has massively compounded this challenge.

Central banks’ response to the pandemic

The pandemic has been a threefold shock: a public health crisis, an economic sudden stop and, initially, a short-lived but acute financial crisis. The consequence is, according to current forecasts, the most severe global economic downturn on record, at least since World War II (Graph 1). The IMF currently expects global real GDP growth in 2020 to fall by 5%, with an 8% contraction in advanced economies and a 3% recession in emerging and developing economies (IMF, World Economic Outlook, June update).

These numbers factor in the buffering effects of the unprecedented policy reaction. Governments have launched massive fiscal stimulus programmes. Central banks were again at the forefront, cutting policy rates where possible and launching large-scale balance sheet measures. A defining feature of the crisis response has been far-reaching direct support for households and businesses to limit social distress and avert unnecessary bankruptcies that could hold back the recovery.

The pandemic’s economic repercussions were propagated globally through large swings in capital flows and exchange rates. Emerging market economies (EMEs) confronted large-scale capital outflows and currency depreciation, contributing to a tightening of financial conditions and forcing many central banks to intervene supportively in currency and domestic bond markets. By contrast, safe haven capital flows have led to strong appreciation pressures on some advanced economy currencies, in particular the Swiss franc, forcing the Swiss National Bank (SNB) to intervene to stabilise the exchange rate.

Central banks’ responses were instrumental in avoiding a financial meltdown and buffering the recession both domestically and globally. But difficult challenges loom large going forward. In the following, I would like to highlight two such challenges. The first consists in the prospect of interest rates staying very low for a very long time in major advanced economies. The second is the strengthening of the fiscal-monetary nexus brought about by the policy response to the pandemic.

Low for very long

The pandemic has reinforced the low interest rate regime that has prevailed in advanced economies over the past decade. Short- and long-term rates are now at or near zero, or even below, in all advanced economies (Graph 2). After interest rates fell towards zero or below inJapan and in most European advanced economies over the past decade, they have now “zeroed in” across the board, including in the United States.

Forward guidance from central banks signals that, in the major economies, policy rates will remain low for years to come. In line with this forward guidance, and reflecting the currently bleak economic prospects, financial market prices suggest that both short- and long-term interest rates will remain at very low levels for the foreseeable future. The pandemic thus seems to have pushed the advanced economies from a low-for-long into a low-for-very-long interest rate regime. But this does not mean that central banks have run out of ammunition with both their conventional and unconventional tools. With their pandemic responses, central banks have shown that they can overcome the limits posed by very low interest rates and provide additional stimulus through innovative balance sheet policies, such as purchasing corporate bonds, or even by directly lending to firms.

At the same time, even when long-term government bond yields are very low, this does not mean that central bank bond purchases cannot provide additional accommodation. During the pandemic, large-scale purchases by central banks helped to keep long-term bond yields low when the bond supply increased massively in the wake of the fiscal support. Without central bank purchases, bond yields would likely have risen, tightening financial conditions amid the pandemic.

That said, in a low rate regime, providing monetary stimulus is certainly harder. The exchange rate will, explicitly or implicitly, take on greater prominence in the transmission process and in policy deliberations. Indeed, since the outbreak of the pandemic, we have already seen large swings in global exchange rate constellations (Graph 3). In particular, the US dollar has fluctuated widely. It first appreciated sharply as panic spread in March, and then depreciated significantly when the pandemic’s first wave ebbed.

The outlook of prolonged low interest rates across all major advanced economies implies an environment of ample global liquidity amid high economic uncertainty. This combination may intensify the volatility of capital flows and exchange rates as market sentiment oscillates between risk-on and risk-off. For many EMEs, the main challenge will be the amplifying impact of capital flows and exchange rates on domestic financial conditions and the risk that inflation will become unanchored through large depreciations in the event of sudden capital outflows.

In small open economies with safe haven currencies, such as Switzerland, capital inflows during risk-off phases can quickly flood the country. Such floods can overwhelm the financial system’s absorption capacity and lead to excessive appreciation pressure. If excessive appreciations drive the currency’s value well above fundamentally justifiable levels, the economic consequences can be very damaging. They can sap exports and hence growth and employment, and they may even curb long-run growth potential if the viability of the productive export sector is undermined. At the same time, by depressing economic activity and weighing on domestic prices through the exchange rate pass-through channel, excessive appreciations can unanchor inflation towards the low side.

Clearly, in a situation when exogenous financial factors in the form of safe haven inflows threaten to push the currency far above its fundamental value, the central bank of a small open economy has no choice but to intervene to stabilise the exchange rate. With such FX interventions, the central bank is just following its mandate to safeguard price and financial stability.

Switzerland has been exposed to recurrent appreciation pressures since the Great Financial Crisis as safe haven inflows have shot up in several instances. The Swiss economy has weathered these pressures quite well so far. Inflation has been low and at times negative, but inflation expectations have not de-anchored from the SNB’s target range. At the same time, the Swiss economy has continued to grow and unemployment has stayed low.

This resilient performance is in large part attributable to the SNB’s determined and pragmatic unconventional policy response. This has centred on negative rates to discourage capital inflows and FX intervention to directly address excessive appreciation pressures. Like many other central banks, the SNB also faces criticism for the side effects of its policies, but I think everybody has to realise that these measures have been necessary to fend off material risks to the Swiss economy. In the end, negative rates and high FX reserves clearly appear to be the lesser of two evils, as compared with an unhindered appreciation of the Swiss franc, which would wreak havoc on the Swiss economy. Given the outlook of a prolonged period of very low rates in the major advanced economies, unconventional policies of this type will probably continue to be necessary in the coming years.

The fiscal-monetary nexus

Let me now turn to the second longer-term challenge for central banks brought about by the pandemic which I would like to highlight, the significant strengthening of the nexus between fiscal and monetary policy.

Central banks have launched renewed large-scale purchases of government debt as part of their crisis response, motivated by the stabilisation objectives within their mandates. As already mentioned, these purchases have coincided with massive increases in public debt on the back of the massive fiscal response. Hence, they have helped to smooth the impact on bond markets of a sudden ramp-up in fiscal spending.

However, these purchases have also resulted in a significant increase in central bank holdings of government debt. According to current forecasts, a large part of the new issuance of government debt in major advanced economies is matched by central bank bond purchases (Graph 4). Thus, while they are grounded in central banks’ stabilisation mandates, the purchases have strengthened the fiscal-monetary nexus.

At the same time, there is an ongoing debate about the need for greater coordination of fiscal and monetary policy in an environment of reduced policy space due to persistently low interest rates, with some pundits arguing in favour of overt monetary financing. This raises the general question of how central banks can best contribute to economic growth and stability, in the current situation and in general. Is it by directly financing the government?

I will argue that the best contribution monetary policy can make is always to maintain sound money, to focus squarely on preserving price and financial stability. Support for the government is justifiable in the pursuit of these goals. Otherwise, the risk arises of real or perceived fiscal dominance undermining central bank credibility as the foundation of sound money.

The experience of many Latin American EMEs in the 1980s and 1990s tells a cautionary tale of fiscal-monetary interactions gone wrong, ending as these did in high inflation or even hyperinflation. Exchange rates and long-term yields are key barometers for credibility risks from the fiscal side. Growing concerns about fiscal dominance could lead to exchange rate depreciation and rising long-term yields, triggering adverse macroeconomic and financial feedback loops that would severely undermine the central bank’s ability to provide much needed support.

How can the spectre of fiscal dominance be kept at bay? There are two main conditions, and both need to be met.

First, governments need to safeguard fiscal sustainability. If confidence in fiscal sustainability is in doubt, central bank credibility may suffer as expectations may arise that the central bank will have to support governments through accommodative policy. Governments must therefore be prepared to take pre-emptive action to ensure fiscal sustainability.

Second, central bank policy actions need to remain credibly focused on maintaining price and financial stability, as opposed to financing the government debt. Central banks’ mandates and far-reaching institutional independence are essential for them to fulfil their stabilising role. At the same time, it will be of critical importance that the measures taken by central banks are also perceived as being in line with their stability mandates. Here, the credibility capital of a central bank plays a crucial role. In advanced economies, it may be possible for central banks to temporarily cross the boundaries between fiscal and monetary policy as they can rely on a high degree of credibility built on a long track record of stability-oriented policies. In contrast, despite significant improvements over the past two decades, central banks in many EMEs are not in the same position and adverse market reactions will act as a brake.

Conclusions

Let me conclude. Overcoming the Covid-19 crisis will require us to navigate through uncharted waters, in poor visibility and with some instruments possibly not working to full effect. The initial responses of central banks to the crisis have been instrumental in fending off financial meltdown and in buffering the economic contraction. As we progress from the liquidity to the solvency and recovery phase of the crisis, the heavy lifting would normally shift from monetary policy to fiscal and structural policies. Of course, that does not mean that central banks can sit back and relax. They should be prepared to proactively supply further accommodation if adverse macro-financial feedback loops need to be forestalled.

That said, it is vital to recognise the limits of monetary policy. Monetary policy alone cannot deliver higher sustainable growth. Getting back on track will require governments to play their part. Structural reforms that raise potential growth rates are called for, as well as growth- oriented fiscal policies focused on public investment. Boosting sustainable growth is not only critical against the backdrop of the pandemic. It will also be key for getting us out of the low- for-very-long interest rate regime and for bolstering fiscal sustainability. That said, it is politically no easy task to agree and implement growth-friendly policies, and this has probably become even more difficult in the wake of the pandemic.

Sound money is the best contribution central banks can make to sustainable growth in the post-pandemic world. Maintaining it will require central bank independence and credibility to be preserved. To that end, the natural boundaries between fiscal and monetary policy need to be respected.

Finally, international cooperation is more important than ever to overcome the pandemic and its economic woes. It will also be the key to maintaining sound money. We at the BIS will continue to do our part, fostering cooperation among central banks from around the world to support the stability and soundness of the international financial system.

Panel Discussion

• Thomas J. Jordan
• Agustín Carstens
• Ivan Adamovich, Progress Foundation
• Tobias Straumann, economic historian University of Zurich
• Moderation: Mark Dittli