Our economy has been affected by a number of large shocks – to energy prices, the level of VAT, and the value of sterling – which have caused prices to increase. Some of these shocks were not predictable in advance. And even if they were, trying to use monetary policy to offset short-run movements in inflation is likely to have amplified output volatility. 9  Another defining feature of this recession is that it has been very deep. If companies are already down to their core customer base, cutting prices may generate little additional demand. Put more formally, as output fell, the demand curve faced by some companies may have become increasingly inelastic, thus reducing their incentive to cut their margins. See Bils (1989) and Ravn et al (2006) for examples of pricing models that incorporate such customer behaviour. 6  BIS Review 122/2010  But that does not mean that we should not learn from the behaviour of inflation. My current assessment is that changes in the structure of the economy, the nature of the financial crisis, and the different role played by policy all affected the behaviour of inflation during the downturn. And it is important that we learn from those developments to help set policy in the future. Conclusion So what are the implications for policy? Surely with inflation above target and expected to remain so for some time, the natural thing is to begin to reduce the degree of monetary stimulus?
Neither the EU, nor, as a matter of fact, Switzerland can be interested in such a development. Like any other country in Europe, Switzerland has a vital interest in EMU becoming a success. Switzerland’s economy is closely linked to the economy of the EU. High growth in Europe is essential for a sound economic development in Switzerland, whereas a lackluster economic situation in the EU contributes to sluggish economic growth in our country. The success or failure of EMU will thus directly affect our economic well-being. In fact, not only our economic well-being, but also our ability to conduct a relatively autonomous monetary policy will be affected. Market turbulence during the transition period, uncertainties about the future monetary policy of the ECB and unfulfilled expectations about the stability of the new currency and the degree of political independence of the ECB all have the potential to create an upward pressure on the Swiss franc. An appreciating currency would make it more difficult for our export-oriented companies to compete on the world market and would increase the competition faced domestically from abroad. Should the Swiss franc appreciate to an extent that economic activities in Switzerland were severely disrupted, we would have several courses of action open to us. The Swiss National Bank (SNB) could relax monetary policy in an effort to counteract the effects of the strong Swiss franc on the domestic economy. Attractive as this response may be, its major drawback is that we would have to walk a tight rope.