Home > Uncategorized > The strange case of Swiss money. More money but less inflation (2 graphs)

The strange case of Swiss money. More money but less inflation (2 graphs)

In Switzerland, a fast increase in the amount of money did not lead to more consumer price inflation. Paul Krugman has an interesting post on money and inflation. More money can only lead to inflation when people, instead of hoarding it, (A) use it to spend their income (and maybe a bit more) and (B) the economy is at full capacity. To drive down his point he uses the example of Switzerland, where a doubling of ‘M1’ money and an unbelievable increases in ‘base money’ or bank reserves did not lead to higher consumer price inflation. To the contrary.

Krugman however uses lousy indicators: M1 is a bad indicator of the amount of ‘transaction money’. M3, a broader indicator, is generally taken to be a better metric. And consumer price inflation is a mediocre indicator of total inflation. Domestic demand inflation, a broader indicator and a kind of average of household consumption, fixed investment and government consumption inflation, is taken by me to be a better metric. What happens when we look at these superior indices and at a somewhat longer time span?

1) Swiss M3 growth (a six year running average, as the relation between money and prices is supposed to be characterized by long and variable lags) and domestic demand inflation show much stabler developments than M1 growth and consumer price inflation. And though M3 increased exceptionally fast it increased much less than M1 (source: central bank of Switzerland).

Inflationinswitzerland
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Aletschorn

2) Up to 2008, domestic demand inflation (source: Eurostat) is consistently about 1 to 2,5% lower than the increase in M3 – which is what is to be expected, considering about 2% economic growth. After 2008, it is however zero or negative in four out of five years, despite higher M3 money growth. (aside – nominal GDP increased with only 6% between 2008 and 2013).

This can be explained using a little ‘quadruple accounting’. After 2008, collecting Swiss francs suddenly came into vogue and quite a lot of people and companies changed foreign currencies into Swiss francs – not to spend them, but to hoard them. I did not know, but they were seemingly largely put on ‘on sight deposits’, included in M3. As this rage drove up the exchange rate of the Swiss franc, the Swiss central bank decided to overheat the printing press and print billions of francs, to prevent the franc from rising any further. And M3 exploded… without an increase in consumption or investment, for one reason as this increase in the amount of francs was, for the owners, just an asset swap. The additional amount of money is in fact not transaction money but a vehicle to save.From the perspective of the banks this indeed is a kind of liquidity trap situation and the interesting thing is that even a large increase of deposit money, instead of just base money, doesn’t lead to any mechanical increase of the price level. The situation is not as outspoken as stated by Krugman (though Switzerland did witness quite a bit of expenditure price deflation). But it is totally remarkable.

  1. Macrocompassion
    December 22, 2014 at 9:04 am

    In common with many other places the Swiss banking population uses a system of deficit money, where everyone owes something to the banks who advance their loans “out of fresh air”. So all that happened is that these debts were replaced with some actual (hard) currency. This way of behavior works everywhere else too and is one reason why in the US there is not serious inflation, considering how much paper has been printed by the Fed.

  2. December 22, 2014 at 9:12 pm

    Hoarding money instead of spending it implies decrease in money velocity v. Nominal demand is Y = Mv. M goes up but v goes down. Y remains fairly unchanged.

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