This cyclical component is the direct consequence of the financial and economic crisis itself, the appropriate monetary policy reaction to the crisis and the increased demand for safe assets which has fuelled capital flows into perceived safe havens such as Switzerland. In the second part, I will describe the risks that accompany such a prolonged period of low interest rates. In particular, I will argue that while a period of this kind does not pose a threat to price stability in the foreseeable future, it may be a breeding ground for financial instability. Finally, I will examine the implications of our analysis for interest rate perspectives. I will argue that, while the current weakness of the global economy still weighs on market and policy rates, the cyclical downturn will eventually reverse, and, over time, interest rates will gradually recover to more normal levels. Causes of low interest rates But first things first. Why are interest rates so low? When discussing the determinants of nominal long-term interest rates, it is useful to think of them as the sum of two elements, the real long-term interest rate and the inflation premium. Economic theory tells us that the real interest rate is the price that matches the supply of savings with the demand for capital used for investment.
In the analysis of potential future paths, we have to distinguish between policy rates and market rates. Market rates, in general, respond faster to changes in the economic situation and outlook than policy rates. The low inflation environment, subdued economic outlook and downside risks that prevail all warrant the continuation of a very accommodative monetary policy with low interest rates. Given the fragile state of the global economy, a premature increase in policy rates would carry the risk of choking off the recovery. In Switzerland, specifically, the subdued inflation outlook (chart 17), the highly valued currency and the fact that a recurrence of financial market tensions cannot be excluded warrant a continuation of the minimum exchange rate policy. In the current situation, the minimum exchange rate remains an essential instrument for preventing an undesirable tightening in monetary conditions should the upward pressure on the Swiss franc intensify again. Market rates are still determined by the current cyclical weakness of the global economy. Once the global economy gets back on a stronger and broader-based growth path and uncertainty wanes, rates should return to more normal levels. For Switzerland, this would mean that safe haven forces would become less relevant, removing some of the additional negative pressures on domestic interest rates. Conclusion In sum, given that we expect a slow, but continued improvement of the world economy, market rates are set to gradually recover to more normal levels over time.