24. See Fornaro, L. and Wolf, M. (2021), “The Scars of Supply Shocks”, Barcelona School of Economics Working Paper, April. 25. This argument does not deny historical examples of central banks over-estimating potential and setting policy inappropriately. There is strong evidence to suggest that part of the reason the Federal Reserve lost control of inflation in the 1970s is that it missed a slowdown in productivity growth and did not realise that the economy was overheating. However, the lessons learned from that period indicate that when uncertainty is high, it is safest not to base policy around large, real-time revisions in potential output or any other unobservable variable. Indeed, those central banks that best navigated the 1970s energy shock – such as the Deutsche Bundesbank – reacted to changes in the output gap rather than estimates of levels. This was a more robust strategy because changes are less subject to mismeasurement and are therefore revised less ex post. Current output gap estimates by major institutions point to the output gap in the euro area becoming more negative in 2023 and only partly recovering in 2024 (see Chart 8). In other words, historical experience supports the case for waiting for stronger evidence on potential output and proceeding prudently. 8). See Orphanides, A. (2003), “The Quest for Prosperity without Inflation”, Journal of Monetary Economics, Vol. 50, No 3, pp. 633-663, Orphanides, A. and Williams, J.C. (2002), “Robust Monetary Policy Rules with Unknown Natural Rates”, Brookings Papers on Economic Activity, Vol.
It is naturally difficult to establish the point at which price movements of this kind need to be considered as excesses. In the past, long periods of rising prices were always followed by corrections. The hefty reaction of risk markets to the tapering debate can be read as a sign of the instability of certain asset prices. In Switzerland, for instance, the low interest rates have stimulated activity in the mortgage and real estate markets, where, for a number of years now, we have seen considerable momentum which can only be partially explained by movements in fundamental factors. As a result, imbalances have built up. For example, mortgage volumes have grown significantly faster than GDP for many years, as can be seen in chart 9. The SNB has issued repeated warnings about the risks for financial stability associated with these developments. This is the background to the Federal Council’s activation of the countercyclical capital buffer (CCB) at the beginning of this year, upon the proposal of the SNB. The CCB has been in force since the end of September and its primary aim is to increase the resilience of the banking system against these risks and to combat excessive credit growth. Since low interest rates can be expected to persist in Switzerland for some time yet, we are keeping a very close watch on developments in the mortgage and real estate markets. Waning motivation for reform measures: Lower interest rates mean more favourable refinancing costs for banks, companies and governments.