Switzerland Offers Counterpoint on Deflation's Ills

Switzerland is seeing steady economic growth and a low jobless rate despite deflation. Here, the Alpine country’s famed Matterhorn.
Switzerland is seeing steady economic growth and a low jobless rate despite deflation. Here, the Alpine country’s famed Matterhorn. Photo: Fabrice Coffrini/Agence France-Presse/Getty Images

It’s as close to an economic consensus as you can get: Deflation is bad for an economy, and central bankers should avoid it at all costs.

Then there’s Switzerland, whose steady growth and rock-bottom unemployment is chipping away at that wisdom.

At a time of lively global debate about low inflation and its ill effects, tiny Switzerland—with an economy 4% the size of the U.S.—offers a fascinating counterpoint, with some even pointing to what they call “good deflation.”

Consumer prices in Switzerland have fallen on an annual basis for most of the past four years. They hit a milestone last month with an annual price drop of 1.4%, the biggest in more than five decades. Even after food and energy prices are stripped out, core prices fell 0.7%.

“It’s hard not to call that deflation,” said Jennifer McKeown of Capital Economics, referring to the technical term for a sustained slump in consumer prices.

And yet evidence of deflation’s pernicious side effects—recession, weak employment, rising debt burdens—is pretty much nonexistent in Switzerland. Its economy is expected to expand this year and next, albeit slowly, in the 1% to 1.5% range. Unemployment was just 3.4% in September. Government debt is low.

“Usually people associate deflation with depression,” said Charles Wyplosz, a professor at the Graduate Institute in Geneva. “In the Swiss case, the economy is doing OK.”

Some of that success is due to the shattering of another long-held maxim: that central-bank policy rates can’t go negative to offset the effects of falling prices.

Switzerland, in a bid to sap demand for the franc and drive down the currency’s value, has a -0.75% rate on certain deposits parked its central bank, meaning financial institutions pay to keep their money there. This effectively amounts to a negative real, or inflation-adjusted, policy rate because core inflation is typically a good indicator of underlying price pressure. Denmark and the European Central Bank have taken a similar path with their deposit rates.

Although wage growth has slowed in Switzerland, it was 0.6% on an annual basis in the second quarter, which combined with falling prices means strong real pay gains, boosting spending power. Meanwhile, the rate on a 10-year mortgage is only around 2%.


For years, central banks from Japan to Europe and the U.S. have been fighting mightily to buck up their inflation rates and escape the deflationary trap. The concern: that falling prices will prompt consumers to spend less—based on expectations that prices will continue to decline—and businesses will delay investment amid uncertainty about revenues.

The Great Depression and, more recently, Japan’s two-decade struggle with deflation, are typically cited as Exhibits A and B on why central bankers should do all they can to avoid the trap.

The Federal Reserve spent trillions of dollars from 2008 to 2014 on government bonds and mortgage debt to combat this risk. More recently, it opted to keep interest rates near zero six years into an economic recovery with the unemployment rate barely above 5%, in part because inflation is so low—unchanged over the year ended Sept. 30.

Major central banks prefer annual inflation of about 2% to provide a cushion against deflation.

Faced with stagnant consumer prices, the ECB is in the midst of a €1.1 trillion ($ 1.249 trillion) bond-buying program. The Bank of Japan 8301 -2.47 % has purchased broad swaths of public and private assets, too. The reasoning behind all these moves is that once deflation becomes entrenched, it is difficult to reverse.

But in Switzerland’s case, falling prices, brought on in large measure by what most analysts see as a significantly overvalued franc, has generated some positive fruits. It has forced companies to raise productivity and stay competitive in global markets, particularly compared to the rest of Europe.

Despite the franc’s strength, Switzerland’s trade surplus was nearly 5% of gross domestic product last year, suggesting its products are still competitive globally. Consumer spending continues to grow, albeit at about half the rate of three years ago.

“You have to distinguish between good and bad deflation,” said Alexander Koch, economist at Raiffeisen Schweiz in Zurich. “There’s no crash, no strong increase in unemployment in manufacturing and as there are no bursting bubbles in other sectors, domestic demand and the labor market are quite resilient.”

Maybe it’s the Alpine air, but economists at the Basel, Switzerland-based Bank for International Settlements—a consortium of central banks—have also challenged some of the conventional wisdom on deflation’s pernicious effects.

It may have negative consequences, but “on the other hand, deflation may actually boost output,” they wrote in a March report. “Lower prices increase real incomes and wealth. And they may also make export goods more competitive.”

So why aren’t central banks embracing the Swiss example? Analysts note that it’s difficult to distinguish between good and bad deflation until it’s too late.

Nor is Switzerland without its own struggles. To keep the franc in check, the central bank may be forced to cut the deposit rate even further, analysts say, particularly if the ECB eases policy more. Super-low rates on mortgages and other forms of debt could create housing and other bubbles. An abandoned effort to cap the franc’s value to the euro led the central bank to book a loss of 50 billion francs ($ 52.45 billion) for the first half of the year. And average consumer price levels are still quite high compared to the rest of Europe despite declines in recent years.

But, says Jörg Krämer, chief economist at Commerzbank CRZBY 1.12 % in Frankfurt, Switzerland’s deflationary experience shows that for some, it’s “not as harmful as most people think.”

Write to Brian Blackstone at [email protected]

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