Is Switzerland Bound for Recession and Deflation?

Executive Summary

The Swiss franc (CHF) jumped sharply in value after the Swiss National Bank (SNB) on January 15 abandoned the policy that had kept its currency artificially depressed versus the euro. If the CHF maintains its recent gains vis-à-vis other currencies throughout the course of the year, then Swiss export growth could be dented significantly in 2015. Our empirical analysis suggests that exports could weaken enough this year to pull the economy into a mild recession. Although there does not appear to be much direct effect of exchange rate changes on the rate of Swiss CPI inflation, economic weakness likely would depress the consumer price index in Switzerland even further this year. Although Switzerland likely will not experience a decade or more of mild deflation à la Japan, near-term prospects for the Swiss economy do not appear to be very bright.

Swiss Franc Has Risen Sharply Versus Most Currencies

The SNB shocked financial market participants on January 15 when it decided to abandon the floor that had kept its currency above 1.2 CHF per euro since September 2011. Once unshackled, the CHF soared in value. Relative to January 14, the CHF is up more than 15 percent on balance against the euro and more than 10 percent versus the U.S. dollar (Figure 1).1 In a previous report, we discussed the SNB’s motives for allowing its currency to float freely again against the euro.2 In this report, we analyze the implications of the CHF’s sharp appreciation for the Swiss economy.

The Swiss economy is very open with exports and imports equivalent to nearly 70 percent and 60 percent of GDP, respectively. The sharp appreciation of the CHF in recent days could weaken Swiss export growth significantly, potentially exposing the economy to recession. In addition, the jump in the value of the CHF could reduce import prices. With CPI inflation in Switzerland already in negative territory (Figure 2), the appreciation of the CHF could impart another negative price shock, thereby threatening the country with a potentially more serious case of deflation. In the remainder of this report, we analyze the implications of the sudden and sharp appreciation of the CHF for Swiss economic growth and inflation.