To put the discussion below in context, I start by providing the historical background. Figure 1 shows real GDP and CPI in demeaned log levels. In the nineteenth century, Switzerland was one of the early industrializing countries, characterized by both high industrial employment and successful engagement in international markets. Indeed, Bordo and James (2007, p. 30) refer to it as ‘a prime example of a highly open economy’. By the turn of the twentieth century, approximately 40% of the workforce was employed in the industrial sector, while the gross value-added by the agricultural sector had declined by about a quarter compared to the 1890s (Müller and Woitek, 2012). This industrialization transformed Switzerland from a net emigration to a net immigration country. An increase in the number of patents during this period points to a switch from technology-importing to technology-exporting and the high prevalence of self-financing of companies and the relatively low dependence on foreign capital point to a relatively high level of prosperity by the end of the nineteenth century (Müller and Woitek, 2012).
The monetary system of Switzerland was also established during this period. It was based largely on that of France, and Switzerland became a founding member of the Latin Monetary Union—dominated by France—in 1865. The Franco-Prussian War triggered a liquidity crisis [the Geldcrisis, see Baltensperger and Kugler (2017)] which highlighted the fragmentation of the Swiss financial system. To address this, the Banknote Act (1881) standardized note issuance and required convertibility of all bank notes at par regardless of their origin. The Act is generally seen to divide the free-banking era in Switzerland into two: with unrestricted free-banking occurring before 1881 and a much more tightly regulated regime after (Herger 2022). Kaufmann and Stuart (2022) find that the introduction of the Act coincides with improved financial integration in Switzerland. Overall, prices remained steady at close to the level in the 1850s until the outbreak of the First World War.
The suspension of gold convertibility by many countries during the First World War impacted Switzerland as an exporting economy: exports and imports fluctuated markedly and prices more than doubled during this period (Bordo & James, 2007) (Fig. 1).Footnote 1 Nominal wages also increased, but by less, with the effect that their purchasing power declined. Army mobilization, and other costs associated with the war, led to rising public debt. The effect was that real GDP declined during the war, with the result an increase in social unrest, culminating in a nationwide strike in 1918.Footnote 2
The end of the War is marked by an abrupt reversal in consumer prices and a severe economic slump characterized by both deflation and marked unemployment.Footnote 3 However, the SNB, which was established in 1907, re-established the pre-War gold parity in 1925,Footnote 4 and the relatively quick resumption of monetary—and social—stability after the War meant that Switzerland was able to consolidate its position in foreign markets as international trade regained some normality. Both GDP growth and real wages increased strongly in the 1920s compared to other European countries, driven largely by an increase in labour force participation of the working-age population (Müller and Woitek, 2012).
The period of strong growth was cut short by the Great Depression. Financial market upheavals spread to Switzerland in 1931. However, the damage was relatively limited since much of the population had not engaged in speculative activities in the stock market. Similarly, cantonal banks, which focused mainly on Swiss customers, generally did not experience major problems, although banks with large investments abroad came under pressure. Two phases can be identified: for 3–4 years after 1929, there was a decline in many domestic and export sectors. Indeed, Swiss industrial production fell 21% from 1929 to 1932.Footnote 5 However, the construction sector was a notable exception, experiencing a sustained upswing during these years. Thereafter, there was some recovery, particularly in exporting industries, first in watchmaking and then in textiles and machine industries, but the construction industry experienced a sharp slump.Footnote 6 Internationally, Switzerland was one of the last countries to devalue its currency, waiting until 1936 and thus delaying the subsequent upswing.Footnote 7
Prices began to rise again at the start of the Second World War, exacerbated by large gold inflows. Moreover, the growth rate in Switzerland turned negative again, albeit less so than elsewhere in Western Europe. The gold inflows proved controversial in the post-War era, playing a role in Switzerland’s initial economic isolation. Only a series of negotiated agreements with the Allied powers brought an end to this, and enabled exports and GDP growth to resume an upward trajectory in the post-War period (Bernholz, 2007). Growth was strong in the 1950s and 1960s, however, this ‘golden age’ was also experienced in much of the rest of Europe. As a result, real wages rose in Switzerland, but in a similar manner to other European countries.Footnote 8
During this time, the Bretton Woods system was in place, the Swiss exchange rate was fixed, and the authorities had little control over domestic inflation.Footnote 9 Indeed, the Bretton Woods system relied on conservative US monetary and fiscal policy to ensure price stability. In the 1960s, the US commitment began to waiver and Switzerland, which was experiencing strong economic growth,Footnote 10 began to encounter large capital inflows and imported inflation. The breakdown of the Bretton Woods system following the suspension of gold convertibility by the US in 1971 created a conundrum for the SNB (Bernholz, 2007). Having fought capital inflows for a number of years, and with financial markets in turmoil, the SNB decided to float the Swiss Franc in 1973 and adopted a policy of targeting M1 money growth in 1974.Footnote 11 The oil crisis in 1975 was an international shock, but the resulting economic slump was severe in Switzerland, since it was combined with particularly restrictive monetary policy (Rich, 2003). The result was that GDP slowed markedly (also impacted by the first oil crisis) (Fig. 1), while inflation also slowed, albeit with a lag (Baltensperger & Kugler, 2017, p. 70).
The international liberalization of capital markets following the collapse of Bretton Woods did not mean a drastic change for Switzerland, with its traditionally open capital market. Instead, it provided a strong growth impetus for Switzerland as an international financial centre. Indeed, in the subsequent period employment in the industrial sector declined markedly while that in the services sector increased.Footnote 12 The export-oriented services sector went from contributing a quarter of economic growth to contributing almost half, with all of this increase arising from the financial sector.
In addition to the monetary upheaval, in the 1970s another structural change occurred as measures to control immigration coincided with a reduction in labour market flexibility. As a result, the incentives for companies to relocate production abroad increased. The 1980s also saw growth in employment, not only due to the increase in foreign workers, but also to an increase in labour force participation among women. Towards the end of the 1980s, concerns regarding the international economic environment led the SNB to maintain a looser policy than might otherwise have been the case. These concerns did not fully materialize, however, and inflation rose, triggering a housing bubble which burst in the early-1990s causing severe problems for Swiss mortgage banks (Rich, 2003).
Structural change in the 1990s saw the share of domestic industry in GDP decline by a half, while the share of export industry increased, partly because several previously domestically oriented industries refocused on exports. Export-oriented services accounted for almost all of the economic growth during this period, which was relatively weak by international comparison in the 1990s. The contributions to economic growth became more balanced across the economy in the period up to 2005, however, with export-oriented industry and the domestic economy becoming more important.
By the end of the 1990s, inflation was low and in January 2000 the SNB adopted a policy strategy in many ways similar to inflation targeting.Footnote 13 The business cycle downturn associated with the bursting of the dotcom bubble was followed by an upswing in the mid-2000s, and throughout inflation remained below 5%. Following the failure of Lehman Brothers in September 2008, the downturn in the global economy increasingly came to affect the Swiss economy. Combined with low oil prices, the risk of deflation increased.Footnote 14 As the sovereign debt crisis in the euro area emerged, the Swiss Franc came under upward pressure. To combat this, the SNB introduced an exchange rate floor of 1.20 Swiss Francs to the euro in September 2011. However, inflation remained very low and in January 2015, with a euro area quantitative easing programme widely anticipated, the SNB removed the exchange rate floor.