As oil is a key input to production, this acts like a negative supply shock for the Western economies: it costs firms more to produce the same level of output than before the run up in oil prices. And, like a tax, it acts to redistribute spending power from energy consumers to energy producers. In those circumstances, real-take home pay has to grow more slowly for a while in order to avoid the capital stock shrinking as firms sought to maintain the internationally-determined required rate of return. The role of monetary policy is to facilitate that process, recognising the potential redundancy of some capital resources given higher energy prices, and the upward pressure on real interest rates as households seek to borrow to tide them over the tough times. In other words, in the now standard set up, taking the cost shock on its own, the equilibrating short-term real rate (r star) has risen and the economy’s potential supply (y star) has probably fallen. So, ignoring other developments, policy would have to be tighter than otherwise, even if the direct effects of the cost rise on the price level were accommodated. But, of course, other things have been going on, and it is the net effect for our policy rate that matters. And that involves making a judgment about the tightness of credit conditions. The credit shock and monetary conditions In conducting policy, commentators usually take the short-run nominal interest rate, Bank Rate, as a summary measure of monetary conditions.
Also, we cannot exclude the possibility that we will have to intervene substantially again. From the beginning we made it clear that enforcement of the minimum exchange rate was associated with risks. We are endeavouring to reduce the balance sheet risks through suitable diversification of our foreign currency investment. However, the exchange rate risk on the foreign exchange reserves is based on monetary policy considerations and the SNB is therefore obliged to bear it. My colleague, Fritz Zurbrügg, will talk about the management of the foreign exchange reserves in his remarks. Through its monetary policy, the SNB serves as a buffer for the Swiss economy and cushions the effect of severe shocks. Because it has a long-term focus, it is in a position to carry substantial risks. This means we can react flexibly in exceptional situations in order to fulfil our mandate, which is to ensure price stability while taking due account of economic developments. BIS central bankers’ speeches  3