## 1. Swiss Franc Exchange Regime Estimation Results

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### A. Introduction and motivation
- Switzerland is a globally-integrated small open economy; major international currencies and their associated monetary policies provide important reference points for the Swiss franc and Swiss monetary policy.
- Stylized shifts in CHF behaviour:
  - Before 2010: franc relatively stable against the euro; movements against the US dollar paralleled those of the euro vis-à-vis the dollar.
  - 2010–end-2011: franc strengthened against both the euro and the US dollar.
  - end-2011–early-2015: SNB maintained an exchange rate floor for the Swiss franc against the euro; CHF and EUR moved together relative to the dollar.
  - Since early-2015: removal of the exchange rate floor; franc tended to depreciate somewhat against both currencies, with larger appreciation relative to the euro earlier and subsequent depreciation.

### B. Estimation approach and data
- Model framework:
  - Builds on Frankel and Wei (2007, 2008) and Frankel and Xie (2010).
  - Regresses changes in the Swiss franc (CHF) on a weighted average of percentage changes in leading reserve currencies (valued in SDR terms) and an exchange market pressure term (EMP).
  - EMP = percentage change in CHF relative to the SDR + percentage change in SNB monetary base (monetary base denominated in Swiss franc).
  - Coefficients wi capture the weight of each currency in the de facto exchange rate basket; sum of wi constrained to unity.
  - Coefficient β measures de facto exchange rate flexibility: β = 0 implies pegged regime; β = 1 implies pure float.
- Sample and estimation:
  - Monthly data for July 1999 to January 2019.
  - Sample split into four sub-periods:
    - July 1999–December 2007 (pre-GFC)
    - January 2008–August 2011 (GFC)
    - September 2011–December 2014 (exchange rate floor against the euro)
    - January 2015–January 2019 (post-floor)
  - Estimation via ordinary least squares.

### C. Empirical results (coefficients, significance, fit)
- Estimated coefficients and fit by sub-period:
  - July'99 - December'07
    - Constant: 0.000 (p-value 0.612)
    - Δlog EUR − Δlog GBP: 0.748 (p-value 0.000)
    - Δlog USD − Δlog GBP: 0.063 (p-value 0.233)
    - Δlog JPY − Δlog GBP: 0.123 (p-value 0.003)
    - EMP: 0.154 (p-value 0.000)
    - R-squared: 0.781
  - January'08 - August'11
    - Constant: 0.006 (p-value 0.212)
    - Δlog EUR − Δlog GBP: 0.694 (p-value 0.000)
    - Δlog USD − Δlog GBP: -0.024 (p-value 0.903)
    - Δlog JPY − Δlog GBP: 0.320 (p-value 0.027)
    - EMP: -0.011 (p-value 0.713)
    - R-squared: 0.589
  - September'11 - December'14
    - Constant: 0.001 (p-value 0.735)
    - Δlog EUR − Δlog GBP: 0.918 (p-value 0.000)
    - Δlog USD − Δlog GBP: -0.212 (p-value 0.036)
    - Δlog JPY − Δlog GBP: 0.030 (p-value 0.655)
    - EMP: -0.066 (p-value 0.002)
    - R-squared: 0.781
  - January'15 - January'19
    - Constant: -0.005 (p-value 0.005)
    - Δlog EUR − Δlog GBP: 0.495 (p-value 0.000)
    - Δlog USD − Δlog GBP: 0.375 (p-value 0.000)
    - Δlog JPY − Δlog GBP: 0.160 (p-value 0.041)
    - EMP: 0.570 (p-value 0.000)
    - R-squared: 0.907
- Fit and significance:
  - Model fit: R-squared 0.907 (most recent period), ≈ 0.781 (first and third intervals), 0.589 (GFC).
  - Currency weights are often highly statistically significant even when overall fit is weak.

### D. Key empirical findings (weights, EMP dynamics, synthetic CHF)
- Currency weight dynamics:
  - The euro has had a major weight in the estimated franc “basket” since the beginning of the sample.
  - Euro weight:
    - rose from 70–75 percent prior to and during the GFC,
    - peaked at more than 90 percent during September 2011–December 2014.
  - The yen’s weight increased sharply to around one-third during the GFC (January 2008–August 2011).
  - Since removal of the exchange rate floor, sizable weights on the euro, dollar and the yen imply the franc can be characterized as a multipolar “basket.”
  - The pound’s weight is relevant mainly during the time of the floor, likely reflecting identification issues owing to co-movement with the euro.
- Exchange rate flexibility (EMP coefficient):
  - Prior to the GFC and during the floor, the franc tracked the estimated currency “baskets” closely (small EMP coefficient), implying idiosyncratic shocks were absorbed mostly through changes in monetary base.
  - Since removing the floor, monetary policy became considerably more flexible: EMP coefficient rose to 0.570 in January'15 - January'19 (interpreted in text as 57 percent).
- Synthetic CHF vs. actual CHF:
  - A synthetic franc constructed from cumulated basket-weighted currency changes shows:
    - A large divergence during 2010–11 with actual CHF appreciating nearly 25 percent more than synthetic in August 2011—gauging safe-haven pressure on the franc.
    - Appreciation pressures around late 2014–early 2015 induced a substantial franc appreciation even as the synthetic franc weakened.

### E. Interpretation and implications
- Regime alignment:
  - Implied regimes align with Switzerland’s de facto exchange rate arrangements and monetary policy frameworks documented in AREAER.
  - Official arrangement prior to and after the exchange rate floor is free floating, with an “other” monetary policy framework; de facto classification was crawl-like during the floor and floating after removal in 2015.
- Convergence toward SDR composition:
  - The estimated exchange rate “basket” during the most recent period is more aligned with the currency composition of the SDR basket, although the weight on the euro and the yen remain higher than in the SDR.
  - Exchange rate weights are also relatively similar to the currency composition of the SNB’s reserves.

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### Currency composition, trade invoicing, and external trade shares

- Trade and invoicing:
  - About two-thirds of Switzerland’s external trade is conducted with European countries (euro likely currency of invoicing).
  - Trade share with the US and the rest of the world has risen, reaching around 30 percent.
  - Gopinath and others (2018): 53 percent of Swiss imports invoiced in euros, 13 percent invoiced in dollars.
  - Swiss exports oriented to the quasi dollar-block region; imports sourced mostly from Europe.
- Financial center exposures:
  - About half of Switzerland’s FX-denominated private-sector foreign assets and liabilities are held in dollars, and a third are euros.
  - Deeper spot and swap markets for the franc-dollar pair than for the franc-euro pair (BIS Triennial Survey (2016)) supports a sizable weight on the dollar.
- Safe-haven and diversification:
  - The US dollar, yen and the franc share safe-haven characteristics; negative surprises cause the franc and yen to appreciate, with stronger reactions during the GFC.
  - Increased weight on the yen during the GFC reflects these safe-haven co-movements.
  - Recent diversification toward dollar and yen may reflect common safe-asset characteristics.
- Monetary policy divergence and constraints:
  - Prior to the GFC, Swiss 3-month LIBOR was below comparable rates for other major reserve currencies; negative differential averaged around one percentage point before the crisis.
  - During the GFC, effective interest differential compressed as central banks converged to the ZLB.
  - Switzerland faced the ZLB constraint earlier than other countries and a lower bound on the effective interest differential.
  - A negative policy rate was introduced (below the ECB’s) to help lessen appreciation pressure.
  - Policy divergence around 2015 (Federal Reserve vs. ECB) contributed to greater diversification of Switzerland’s “currency basket.”

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### Reserve accumulation, SNB balance sheet, and reserve management

- SNB balance sheet and interventions:
  - Since the GFC, foreign exchange purchases by the SNB and returns on these assets have grown its balance sheet to around 120 percent of GDP.
  - Increase due to purchases of foreign—rather than domestic—assets.
  - In September 2011, SNB introduced an exchange rate floor against the euro (commitment to purchase foreign exchange); removal in early 2015 saw additional large inflows and further accumulation of reserves.
  - SNB FX purchases concentrated into relatively few episodes: intervention especially large in August 2011; sizable around April 2010, June 2012 and January 2015.
  - Around 85 percent of cumulative foreign exchange purchases occurred during inflow surge episodes (monthly purchases exceeding the mean by 1 standard deviation or more).
  - SNB intervention occurred mainly in the spot market (unlike some other central banks).
- Reserve composition and investment approach:
  - Foreign Assets (Percent of total): Foreign currency Reserves 94%, IMF SDR 1%, Gold 5%.
  - Of foreign currency assets:
    - nearly 70 percent in government bonds (including deposits at central banks and the BIS),
    - 12 percent in corporate and other bonds,
    - equities account for one-fifth.
  - By currency:
    - nearly 40 percent in euros,
    - 35 percent in US dollars,
    - 8 percent in Japanese yen,
    - 15 percent in other currencies.
  - Of fixed-income assets:
    - just-below 60 percent rated AAA,
    - over 20 percent rated AA,
    - most others A-rated.
  - Equities form a sizable share of SNB’s foreign exchange reserves; equity portfolio consists of mid- and large-cap companies in advanced economies and, to a lesser extent, small-cap and emerging-economy companies.
  - SNB invests passively (standard equity indices); does not invest in shares of mid- or large-capitalization banks or in companies that are “gross violators of ethical principles”; exercises voting rights selectively.
  - SNB occasionally invests in derivatives such as futures or interest rate swaps.
- Reserve coverage and systemic indicators:
  - Reserves stand at around 120 percent of GDP and cover around 22 months of imports.
  - Reserves cover around 120 percent of banks’ short-term foreign liabilities and around three-quarters of economy-wide short-term foreign liabilities.
  - Reserves more-than-adequate from the perspective of foreign exchange mismatches; banks required to comply with liquidity coverage ratios on foreign currency exposures.
- Returns, valuation, and profitability:
  - Total returns (in Swiss franc terms) on reserves have averaged 2.6 percent since 2006.
  - Cumulative profits since 2006—mainly attributable to reserves—reached around one-sixth of 2018 GDP by early 2019.
  - Example sensitivity: a 5 percent depreciation of the NEER would lower the value of reserves by around 6 percent GDP (illustrative).
- SNB capital and distribution rules:
  - Provisions raised by a minimum of 8 percent per year; a small amount paid as dividends to shareholders.
  - Current profit shared with Confederation and cantonal governments in the amount of CHF 1 billion per year.
  - Remaining unallocated profit accumulated in a distribution reserve to support an additional annual CHF 1 billion disbursement whenever balance exceeds CHF 20 billion.
  - SNB’s provisions: CHF 73 billion (11 percent of GDP); distribution reserve balance: CHF 43 billion.
- Governance and disclosure:
  - SNB governed by investment policy guidelines; monetary policy takes primacy over reserve management.
  - SNB provides disclosures of its US equity holdings with the Securities and Exchange Commission.
  - Proposals to reallocate large balance-sheet profits (sovereign wealth fund, more gold, invest in Switzerland, change SNB function) have been rejected to preserve SNB flexibility.
  - A recent initiative proposed to prohibit SNB investing in companies making weapons.

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### Jobs, wages, migration, and cross-border wage gaps

- Jobs, skills, and migration:
  - New high-skill jobs (requiring at least a college degree) during 2003–17 were broadly equal to total job creation; middle- and low-skill jobs remained broadly unchanged.
  - Around half of new jobs were filled by foreign nationals.
  - Swiss nationals disproportionately filled new high-skill jobs.
  - Two-thirds of new EU/EFTA workers in Switzerland were college graduates.
- Price levels and wages:
  - Zürich and Geneva are top two most-expensive cities in the world.
  - Switzerland has the second-highest price level in Europe; consumer goods and services some 60 percent higher than the EU average.
  - Measured at current PPP exchange rates, the wage gap stood at about 30 percent in 2017 (in percent of Swiss salaries), compared to about 50 percent at market exchange rates.
  - PPP-adjusted wage gap has been relatively constant over time.
- Taxes and labor-market institutions:
  - Swiss companies pay lower corporate tax rates relative to neighbors; employers’ mandatory contributions on wages are lower than neighboring countries.
  - Posted-worker rules, notice periods, vacancy publication requirements, and quotas on permanent residency for nationals from Bulgaria and Romania apply.
  - Minimum wage of CHF 20 per hour in Cantons Jura and Neuchâtel; no national minimum wage elsewhere.
- Do Swiss wages align with fundamentals? (Econometric evidence)
  - Model: ECM and wage Phillips curve for annual data 1990–2017; dependent variable: year-on-year change in nominal Swiss wages (compensation per employee adjusted for hours).
  - Long-run cointegration: A 1 percent increase in labor productivity raises real wages by 0.7 percent.
  - Short-run regression highlights (dependent variable: year-on-year growth rate of nominal average annual wages, 1990–2017):
    - Lagged domestic inflation: 0.77***, 0.81***, 0.82***, 0.92***, 0.91***, 0.86*** (across specifications).
    - Labor productivity growth: 0.26*, 0.25*, 0.31***, 0.36***, 0.38***, 0.31***.
    - Unemployment rate gap: -2.15*** (baseline); Unemployment rate gap, Swiss workers: -3.84***.
    - Lagged error correction term: -0.74***, -0.77***, -0.78***, -0.74*** (across specs).
    - Foreign workers: 0.40 (not significant); Foreign permanent workers: 0.57* (statistically significant); Cross-border workers: 0.45 (not significant).
    - Number of observations: 27; Adjusted R-squared: 0.64, 0.64, 0.80, 0.81, 0.82, 0.79.
  - Interpretation:
    - Baseline model explains about two-thirds of variation in nominal wage growth.
    - Error correction term negative: past wage overshoots dampen current wage growth.
    - Permanent foreign workers associated with higher Swiss wages; during 2012–17, permanent foreign workers contributed a cumulative 2½ percentage points to nominal wage growth.
- Cross-border wage gap dynamics:
  - Measurement: differences between Switzerland and PPP-GDP-weighted averages of Austria, France, Germany, Italy; Swiss wages/productivity measured in euros at constant exchange rate equal to 1991–2017 average CHF/EUR.
  - Long-run: A 1 percent increase in the labor productivity gap raises the real wage gap by about 0.5 percent.
  - Short-run regression highlights (dependent variable: year-on-year change in nominal wage gap, 1990–2017):
    - Labor productivity gap growth: 0.15***, 0.20***, 0.18*** (across specs).
    - Large CHF/EUR appreciation (indicator): -0.22*, -0.18*.
    - Change in firms’ profit gap (percent of GDP): -1.04***, -0.98***.
    - Lagged error correction term: -1.27***, -1.47***, -1.34***.
    - Number of observations: 26; Adjusted R-squared: 0.66, 0.75, 0.77.
  - Interpretation:
    - Higher Swiss labor productivity explains much of the long-run real wage differential.
    - Large CHF/EUR appreciations reduce year-on-year change in nominal wage gap.
    - Increases in firms’ profit gaps reduce the nominal wage gap.
    - Lagged error correction term negative and significant: corrections toward long-run equilibrium.
- Swiss wages adjust to large appreciation shocks:
  - A franc appreciation initially widens the euro-denominated wage gap; subsequent years show decreases in wages (measured at a constant exchange rate), narrowing the wage gap.
  - Example: following large appreciation episodes since 2011, cross-country wage gap (constant exchange rate) narrowed by almost 18 percent during 2012–17.
  - Despite adjustments, wage gap measured at current exchange rates remains 12 percent higher than in 2011.
  - Firms absorb higher labor costs partly through lower profit margins:
    - Quantitative: 1 percentage point of GDP decline in profit gaps increased the wage gap by about 1 percent.
    - During 2012–2017, compression of Swiss firms’ profits relative to firms abroad associated with a widening of the cross-border wage gap by 0.8 percentage points.
    - Between 2007 and 2017, firms’ profits declined by cumulative 4.5 percentage points of GDP.
- Cointegration evidence:
  - Engle-Granger tests:
    - Cointegration between Swiss real wages and labor productivity: t-statistic -3.22*.
    - Cointegration between real wage gap and labor productivity gap: t-statistic -2.42*.
  - Note: *p<0.10; **p<0.05; ***p<0.01.
- Cross-border and posted workers:
  - Number of cross-border workers more than doubled since 2002 to about 312 thousand in 2018 (about 20 percent of foreign workers).
  - Switzerland has the highest number of cross-border commuters in the EEA: 6 percent of workers commuting daily from other countries.
  - Posted workers from the EU in 2018: about 140 thousand (mostly construction); short-stay workers: 27 thousand self-employed, some 86 thousand employed by Swiss employers.

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### Reserve-use, market access, and systemic considerations

- Market stress during the GFC:
  - Onset of crisis froze US dollar market; repo markets seized; two Swiss G-SIBs affected by foreign exchange liquidity shortages.
  - Declining share of the Swiss franc in global FX market turnover (accelerated since GFC) may indicate less-liquid franc markets, intensifying stress and prompting need for precautionary balances.
  - Standing currency swap lines exist between Federal Reserve, ECB, Bank of England, Bank of Canada, Bank of Japan and SNB; SNB may participate in swap arrangements in severe stress, reducing need to hold reserves.
- Reserve management governance:
  - SNB’s Governing Board sets broad investment principles and strategy; Asset Management unit implements strategy; Risk Management unit monitors implementation.
  - Reserve management guided by security, liquidity and return; monetary policy primacy maintained to avoid conflicting objectives.
  - Proxy for intervention: sum of changes in sight deposits at the SNB and currency in circulation; excludes passive inflows from income and valuation changes.
  - As SNB conducted FX swaps during 2008–12, cumulative share of purchases (including first leg of swaps) occurring during surge episodes exceeded 100 percent for some time.
- Motives for holding reserves:
  - Central banks hold reserves to provide emergency liquidity in domestic and foreign currencies during crises.
  - Advanced and emerging countries pursuing inflation targeting (Sweden, Israel, Czech Republic, Poland) have acquired significant reserves since the GFC.
  - Swiss G-SIBs and domestically-focused banks are active internationally; their liquid foreign-currency assets provide first defense in liquidity stress, but during extreme disruption central bank provision of foreign exchange liquidity may be warranted.

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*Source: 1cheea2019002 - 1. Swiss Franc Exchange Regime Estimation Results (IMF staff calculations).*

### 1. Swiss Franc Exchange Regime Estimation Results ______________________________________ 6

### 1. Swiss Franc Exchange Regime Estimation Results

### A. Introduction and motivation
- Switzerland is a globally-integrated small open economy; major international currencies and their associated monetary policies provide important reference points for the Swiss franc and Swiss monetary policy.
- Stylized shifts in CHF behaviour over the past two decades:
  - Before 2010: franc relatively stable against the euro; movements against the US dollar paralleled those of the euro vis-à-vis the dollar.
  - 2010–end-2011: franc strengthened against both the euro and the US dollar.
  - end-2011–early-2015: SNB maintained an exchange rate floor for the Swiss franc against the euro; CHF and EUR moved together relative to the dollar.
  - Since early-2015: removal of the exchange rate floor; franc tended to depreciate somewhat against both currencies, with larger appreciation relative to the euro earlier and subsequent depreciation.

### B. Estimation approach and data
- Model framework:
  - Builds on Frankel and Wei (2007, 2008) and Frankel and Xie (2010).
  - Regresses changes in the Swiss franc (CHF) on a weighted average of percentage changes in leading reserve currencies (valued in SDR terms) and an exchange market pressure term (EMP).
  - EMP = percentage change in CHF relative to the SDR + percentage change in SNB monetary base (monetary base denominated in Swiss franc).
  - Coefficients wi capture the weight of each currency in the de facto exchange rate basket; sum of wi constrained to unity.
  - Coefficient β measures de facto exchange rate flexibility: β = 0 implies pegged regime; β = 1 implies pure float.
- Sample and estimation:
  - Monthly data for July 1999 to January 2019.
  - Sample split into four sub-periods with three breaks:
    - July 1999–December 2007 (pre-GFC)
    - January 2008–August 2011 (GFC)
    - September 2011–December 2014 (exchange rate floor against the euro)
    - January 2015–January 2019 (post-floor)
  - Estimation via ordinary least squares.

### C. Empirical results (coefficients, significance, fit)
- Table of estimated coefficients and p-values (by sub-period)
  - Period: July'99 - December'07
    - Constant: 0.000 (p-value 0.612)
    - Δlog EUR − Δlog GBP: 0.748 (p-value 0.000)
    - Δlog USD − Δlog GBP: 0.063 (p-value 0.233)
    - Δlog JPY − Δlog GBP: 0.123 (p-value 0.003)
    - EMP: 0.154 (p-value 0.000)
    - R-squared: 0.781
  - Period: January'08 - August'11
    - Constant: 0.006 (p-value 0.212)
    - Δlog EUR − Δlog GBP: 0.694 (p-value 0.000)
    - Δlog USD − Δlog GBP: -0.024 (p-value 0.903)
    - Δlog JPY − Δlog GBP: 0.320 (p-value 0.027)
    - EMP: -0.011 (p-value 0.713)
    - R-squared: 0.589
  - Period: September'11 - December'14
    - Constant: 0.001 (p-value 0.735)
    - Δlog EUR − Δlog GBP: 0.918 (p-value 0.000)
    - Δlog USD − Δlog GBP: -0.212 (p-value 0.036)
    - Δlog JPY − Δlog GBP: 0.030 (p-value 0.655)
    - EMP: -0.066 (p-value 0.002)
    - R-squared: 0.781
  - Period: January'15 - January'19
    - Constant: -0.005 (p-value 0.005)
    - Δlog EUR − Δlog GBP: 0.495 (p-value 0.000)
    - Δlog USD − Δlog GBP: 0.375 (p-value 0.000)
    - Δlog JPY − Δlog GBP: 0.160 (p-value 0.041)
    - EMP: 0.570 (p-value 0.000)
    - R-squared: 0.907
- Fit and significance:
  - Overall model fit is strong in the most recent period (R-squared 0.907), moderate for the first and third intervals (R-squared ≈ 0.781), and relatively weak during the GFC (R-squared 0.589).
  - Where currency weights are economically meaningful, they tend to be highly statistically significant even if overall fit is weak.

### D. Key empirical findings (weights, EMP dynamics, synthetic CHF)
- Currency weight dynamics and interpretation:
  - The euro has had a major weight in the estimated franc “basket” since the beginning of the sample.
  - The weight of the euro:
    - rose from 70–75 percent prior to and during the GFC,
    - peaked at more than 90 percent during the period of the exchange rate floor (September 2011–December 2014).
  - The yen’s weight increased sharply to around one-third during the GFC (January 2008–August 2011).
  - Since removal of the exchange rate floor, sizable weights on the euro, dollar and the yen imply the franc can be characterized as a multipolar “basket.”
  - The pound’s weight is relevant mainly during the time of the floor, likely reflecting identification issues owing to co-movement of the pound with the euro.
- Exchange rate flexibility (EMP coefficient) and regime interpretation:
  - Prior to the GFC and during the floor, the franc tracked the estimated currency “baskets” closely (small EMP coefficient), implying idiosyncratic shocks were absorbed mostly through changes in monetary base.
  - Since removing the floor, monetary policy has become considerably more flexible: EMP coefficient rose from around zero in the floor period to 0.570 in January'15 - January'19 (interpreted in text as 57 percent).
- Synthetic CHF vs. actual CHF:
  - A synthetic franc constructed from cumulated basket-weighted currency changes shows:
    - A large divergence during 2010–11 with actual CHF appreciating nearly 25 percent more than synthetic in August 2011—gauging safe-haven pressure on the franc.
    - Appreciation pressures around late 2014–early 2015 (realignment of major central bank policies and exit from the euro floor) induced a substantial franc appreciation even as the synthetic franc weakened.

### E. Interpretation and implications
- Regime alignment:
  - Implied regimes align with Switzerland’s de facto exchange rate arrangements and monetary policy frameworks documented in AREAER.
  - Official arrangement prior to and after the exchange rate floor is free floating, with an “other” monetary policy framework; de facto classification was crawl-like during the floor and floating after removal in 2015.
- Convergence toward SDR composition:
  - The estimated exchange rate “basket” during the most recent period is more aligned with the currency composition of the SDR basket, though the weight on the euro and the yen remain higher than in the SDR.
  - The exchange rate weights are also relatively similar to the currency composition of the SNB’s reserves (as noted in accompanying Selected Issues Paper).

*Source: 1cheea2019002 - 1. Swiss Franc Exchange Regime Estimation Results (IMF staff calculations).*

### 14.      The implied currency weights and greater diversification of the “basket” accords well

### 14. The implied currency weights and greater diversification of the “basket” accords well with Switzerland’s economic fundamentals

### Currency composition, trade invoicing, and external trade shares
- About two-thirds of Switzerland’s external trade is conducted with European countries, where the euro is likely the currency of invoicing and medium of exchange.
- The trade share with the US and the rest of the world, where the US dollar is likely to be important, has risen somewhat during the past decade, reaching around 30 percent.
- Gopinath and others (2018) report that 53 percent of Swiss imports are invoiced in euros, while 13 percent are invoiced in dollars.
- Swiss exports tend to be oriented to the quasi dollar-block region while imports are sourced mostly from Europe.
- The euro has added importance for Switzerland in view of its open labor market with the EU and cross-border competition from EU firms.

### Financial center role and currency exposures of private-sector FX positions
- About half of Switzerland’s FX-denominated private-sector foreign assets and liabilities are held in dollars, and a third are euros.
- A significant weight on the dollar and the euro helps to limit currency risk in the context of financial dollarization and—to a lesser degree—financial euroization.
- The much-deeper spot and swap markets for the franc-dollar pair than for the franc-euro pair (BIS Triennial Survey (2016)) supports a sizable weight on the dollar in the currency “basket.”

### Safe-haven characteristics and diversification toward yen and dollar
- The US dollar, yen and the franc share the characteristic of a safe-haven currency; negative surprises to the world economy cause the franc and the yen to appreciate, and during the GFC these currencies reacted more strongly to negative surprises than to positive ones (Jäggi and others (2016)).
- These safe-haven co-movements explain increased weight on the yen during the GFC.
- The shift in recent years to a more-diversified currency “basket” for the franc, with a greater role for the dollar and yen, may reflect this common safe-asset characteristic.

### Monetary policy divergence, effective foreign interest rate, and constraints
- Prior to the GFC, Swiss 3-month LIBOR was below comparable rates for the other major reserve currencies. The negative differential between the Swiss interest rate and the effective foreign interest rate—defined as the time-varying “currency basket”-weighted interest rates—averaged around one percentage point before the crisis.
- During the GFC, the effective interest differential was compressed as central banks converged simultaneously to the zero lower bound (ZLB).
- Switzerland faced the ZLB constraint earlier than other countries (because its initial rates were lower), and also faced a lower bound on the effective interest differential, and was thus squeezed from below and above.
- To partly restore the historical differential, a negative policy rate was introduced at a rate below the ECB’s, helping to lessen the extent of appreciation pressure.
- The policy stances of the Federal Reserve and the ECB began to diverge around 2015. While the bilateral interest differential with the US widened, it remained compressed with the euro. This shift to asynchronous monetary policies by reference currencies likely contributed to the greater diversification of Switzerland’s “currency basket” in recent years.

### Interpretation of co-movements: markets, policy, and spillovers
- The approach identifies how the franc co-moves with the major reserve currencies but is agnostic about the driving forces behind these moves—whether markets, policy, or coincidence.
- McCauley (2014) observes that policy and market trading tend to align currencies into zones of shared movement.
- Relatively deep markets for the Swiss franc and franc-denominated assets suggest market trading plays an important role in moving the franc in the direction market participants want, implying persistent divergence between policy and markets would be costly.
- Reverse causality, reflecting spillovers from policy actions by other central banks, is also likely to affect the behavior of the franc; in the absence of capital controls, and if policies are credible, whether markets or policies drive exchange rates is largely moot.

### Reserve accumulation, SNB balance sheet, and motives for holding reserves
- Since the GFC, foreign exchange purchases by the SNB and returns on these assets have grown its balance sheet, which now stands at around 120 percent of GDP, one of the largest in the world relative to GDP.
- Unlike some other major central banks, the increase was due to purchases of foreign—rather than domestic—assets.
- Interest income and dividends received on these foreign assets will continue to passively raise international reserves, while changes in foreign prices of these assets and in the value of the franc will also affect the stock of reserves.
- In September 2011, the SNB introduced an exchange rate floor against the euro, committing to purchase foreign exchange to prevent the franc from strengthening. Removal of the floor in early 2015, even though accompanied by the introduction of a negative policy interest rate, saw additional large inflows and led to further accumulation of reserves.
- The SNB’s FX purchases were concentrated into relatively few episodes: intervention (proxied by the sum of changes in sight deposits at the SNB and currency in circulation) was especially large in August 2011, and purchases were also sizable around April 2010, June 2012 and January 2015.
- Around 85 percent of cumulative foreign exchange purchases occurred during inflow surge episodes (defined as monthly purchases that exceeded the mean by 1 standard deviation or more).
- Unlike some other central banks, SNB intervention occurred mainly in the spot market.

### Additional motives for holding reserves
- Central banks may wish to hold reserves because, during financial crises (including the GFC), they provide substantial emergency liquidity assistance in domestic and foreign currencies.
- Some advanced and emerging countries pursuing inflation targeting have acquired significant reserves since the GFC, including Sweden, Israel, the Czech Republic and Poland.
- The two Swiss G-SIBs—which are very large relative to the size of the domestic economy—as well as several domestically-focused banks are active in international financial markets. These financial institutions’ own liquid foreign-currency assets should provide the first line of defense during liquidity stress.
- However, during extreme episodes of market disruption, temporary provision of foreign exchange liquidity by the central bank may be warranted to protect financial stability.

*Source: IMF staff calculations and text from the provided document.*

### 5.      Prior to the GFC, the prospect of losing exchange market access and of external-sector

### 1cheea2019002 - 5.      Prior to the GFC, the prospect of losing exchange market access and of external-sector

### Background and market stress during the GFC
- Prior to the GFC, exchange market access loss and external-sector crises were perceived to be remote for a reserve-currency country such as Switzerland.
- The onset of the crisis caused the market for US dollars to freeze as risk-averse investors hoarded what was perceived to be the global safe asset; concerns about counterparty risk caused repo markets to seize.
- The two Swiss G-SIBs were affected by foreign exchange liquidity shortages during the crisis.
- The declining share of the Swiss franc in global foreign exchange market turnover—which has accelerated since the GFC—may indicate a less-liquid market for the Swiss franc, which could intensify during stress periods and create the need for precautionary balances.
- Standing currency swap lines exist between the Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Bank of Japan and the Swiss National Bank; the SNB may be able to participate in currency swap arrangements in the event of severe international financial market stress, thereby reducing the need to hold foreign exchange reserves.

### Reserve management and asset allocation (SNB governance and strategy)
- The SNB’s management of its reserves is governed by investment policy guidelines; monetary policy takes primacy over foreign exchange reserve management to avoid conflicting objectives.
- Reserve management is guided by security, liquidity and return on investment.
- As one of the world’s major investors, the SNB seeks to avoid disrupting the markets in which it participates, creating a preference for deep markets and adjusting gradually to its desired portfolio.
- The SNB’s Governing Board sets broad investment principles and strategy; the SNB’s Asset Management unit implements the strategy; the Risk Management unit monitors implementation.
- The proxy for intervention (sum of changes in sight deposits at the SNB and currency in circulation) excludes passive inflows due to income on reserves and valuation changes, and does not take into account other changes in the composition of SNB liabilities.
- As the SNB conducted FX swaps during 2008–12, the cumulative share of purchases (including the first leg of FX swaps) occurring during surge episodes exceeded 100 percent for some time.

### Composition of SNB foreign assets and investment approach
- SNB's Foreign Assets (Percent of total): Foreign currency Reserves 94%, IMF SDR 1%, Gold 5%, Other reserve assets Other foreign currency assets (chart context preserved).
- Gold represents around five percent of the SNB’s foreign assets.
- Of foreign currency assets:
  - nearly 70 percent are held in government bonds (including deposits at central banks and the BIS),
  - 12 percent are in corporate and other bonds,
  - equities account for one-fifth.
- By currency:
  - nearly 40 percent is in euros,
  - 35 percent is in US dollars,
  - 8 percent in Japanese yen,
  - 15 percent in other currencies.
- Of fixed-income assets:
  - just-below 60 percent are rated AAA,
  - over 20 percent are rated AA,
  - most others A-rated.
- Unlike most other central banks, equities form a sizable share of the SNB’s foreign exchange reserves, supporting diversification and higher returns.
- The equity portfolio consists of shares of mid- and large-capitalization companies in advanced economies and, to a lesser extent, small-capitalization companies and companies in emerging economies.
- The SNB invests passively, based on a combination of standard equity indices spanning different markets and currencies; this implies substantial absolute equity positions in US companies with high market capitalization.
- To avoid potential conflicts of interest, the SNB does not invest in shares of mid- or large-capitalization banks and does not own equities in companies that are “gross violators of ethical principles.”
- The SNB exercises its voting rights selectively, with instances limited to ensuring good corporate governance.
- The SNB occasionally invests in derivatives such as futures or interest rate swaps.

### Reserve coverage, external liabilities, and systemic considerations
- Standard indicators suggest the SNB has adequate foreign reserves notwithstanding a large financial sector.
- Reserves stand at around 120 percent of GDP and cover around 22 months of imports.
- Reserves also cover around 120 percent of banks’ short-term foreign liabilities and around three-quarters of economy-wide short-term foreign liabilities.
- Relative to gross foreign liabilities by individual currency, reserves cover a substantial portion, but with considerable variation across currencies.
- Reserves appear more-than-adequate from the perspective of foreign exchange mismatches; banks are required to comply with liquidity coverage ratios on their foreign currency exposures.
- For the private sector as a whole, foreign assets are denominated in foreign currencies while foreign liabilities are mostly denominated in Swiss franc; this net long foreign currency position of the private sector is augmented by the long foreign currency position of the SNB.
- Nonetheless, segments of the private sector may still have foreign currency liquidity mismatches (for example, short-term foreign currency liabilities could exceed liquid foreign currency assets).

### SNB returns, valuation effects, and profitability
- Exchange rate fluctuations and changes in asset valuations generate mark-to-market gains and losses for the SNB.
- Because the NEER tends to increase over time, large FX reserves—whose fluctuations against the franc are unhedged—tend to generate sizable valuation losses.
- Total returns (measured in Swiss franc terms) on reserves have averaged 2.6 percent since 2006, despite negative outcomes in five of those years.
- Cumulative profits since 2006—mainly attributable to reserves—reached around one-sixth of 2018 GDP by early 2019.
- Example sensitivity: a 5 percent depreciation of the NEER would lower the value of reserves by around 6 percent GDP (illustrative figure provided in text).

### SNB capital, profit use, and distribution rules
- Profits are used to build capital and fund distributions to the general government.
- Part of profits is used to raise provisions by a minimum of 8 percent per year, and a small amount is paid as dividends to shareholders.
- Current profit is shared with the Confederation and cantonal governments in the amount of CHF 1 billion per year.
- Any remaining unallocated profit is accumulated in a distribution reserve to support an additional annual CHF 1 billion disbursement to the Confederation and cantonal governments whenever the balance in that reserve exceeds CHF 20 billion.
- The SNB’s provisions currently stand at CHF 73 billion (11 percent of GDP) and the balance in the distribution reserve is CHF 43 billion.

### Governance, disclosures, and policy debates
- The SNB provides disclosures of its US equity holdings with the Securities and Exchange Commission.
- The SNB’s large balance sheet and profits have attracted proposals on how these could be allocated or spent (proposals include creating a sovereign wealth fund, more than doubling the share of gold in reserves, investing in Switzerland, and changing the functioning of the SNB); these proposals have been rejected so far because they would restrict SNB flexibility to make monetary policy and reserve-accumulation decisions.
- More recently, an initiative has been proposed that would prohibit the SNB from investing in companies making weapons.

### Cross-border wage gaps — summary findings (opening of subsequent section)
- Long-standing wage differences between Switzerland and its neighbors reflect strong fundamentals and have been sustained notwithstanding increased international labor mobility.
- The average annual wage in Switzerland stood at US$88 thousand in 2017, second only to Iceland among the OECD countries.
- Country-average salaries in Austria, France, and Germany are about half of Swiss salaries, while average Italian salaries are a third.
- The share of foreign nationals in Swiss employment rose to about one-third of Swiss workers (up from around 22 percent before the bilateral agreement on free movement of workers in 2002), coinciding with rising employment of Swiss nationals and widening cross-border wage gaps.
- Swiss labor productivity is among the highest in the OECD when measured as annual gross value added per worker; from the perspective of adjacent cross-border regions, Swiss productivity remains higher than in neighboring countries.

*IMF staff compilation from the source content.*

### 4.      Switzerland has created mostly high-

### 4.      Switzerland has created mostly high-

### Jobs, skills, and migration
- New high-skill jobs (i.e., requiring at least a college degree) during 2003–17 were broadly equal to total job creation; middle- and low-skill jobs remained broadly unchanged.
- Around half of new jobs were filled by foreign nationals.
- Swiss nationals disproportionately filled the new high-skill jobs.
- Two-thirds of new EU/EFTA workers in Switzerland were college graduates.
- EU nationals also tended to fill mid-skill positions vacated by Swiss nationals.
- EU nationals made moderate employment gains in service and sales occupations, filling vacancies created by Swiss workers avoiding or leaving these professions.

### Price levels, nominal wages, and PPP adjustments
- Zürich and Geneva are consistently found to be the top two most-expensive cities in the world.
- Switzerland has the second-highest price level in Europe, with prices of consumer goods and services some 60 percent higher than the EU average.
- Prices of services and several products shielded from international competition are significantly higher in Switzerland than in neighboring countries.
- Measured at current purchasing power parity (PPP) exchange rates, the wage gap stood at about 30 percent in 2017 (in percent of Swiss salaries), compared to about 50 percent at market exchange rates.
- The PPP-adjusted wage gap has been relatively constant over time.
- Successive appreciation surges of the Swiss franc against the euro since 2008 expanded nominal wage differentials; cumulative franc-euro appreciation accounts for most of the widening of the wage gap since the early 1990s.
- Increases in foreign wages (measured in euros) and Swiss wages (measured in Swiss francs) nearly offset each other.

### Taxes, employer contributions, and institutional wage supports
- Swiss companies pay lower rates of corporate tax relative to neighboring countries.
- Employers’ mandatory tax and nontax contributions (first and second pillar pensions and health insurance) on wages are lower than those in neighboring countries.
- Foreign firms posting workers to Switzerland are required to meet Swiss minimum wage and labor conditions.
- An eight-day notice period of intention to work in Switzerland is required to allow authorities time to verify domestic wage protections.
- Employers must publish vacancies for five working days exclusively for job seekers in Switzerland in occupations with above-average unemployment rates as part of implementing the 2014 referendum aiming to slow EU migration.
- Quotas on permanent residency applications from nationals from Bulgaria and Romania are applied.
- A minimum wage of CHF 20 per hour applies in Cantons Jura and Neuchâtel; no national minimum wage elsewhere. Voluntary collective labor agreements require compensation ranging from CHF 2,200 to 4,200 per month for unskilled workers and CHF 2,800 to 5,300 per month for skilled employees.

### Do Swiss wages align with fundamentals? (Econometric evidence)
- Model: An error correction model (ECM) and wage Phillips curve are used for annual data during 1990–2017. Dependent variable: year-on-year change in nominal Swiss wages (compensation per employee adjusted for hours worked).
- Explanatory variables include: lagged domestic inflation (πt−1), unemployment gap (ut), labor productivity growth (∆yt, measured as real GDP per hour worked), lagged deviation of real wages from long-run relationship with productivity (error correction term), and year-on-year change in ratio of foreign workers to domestic workers (CRt).
- Long-run cointegration: A 1 percent increase in labor productivity raises real wages by 0.7 percent.
- Long-run deviations: Real wages were below productivity-predicted levels before the global financial crisis (2003–2008) and above predicted levels since 2012 (deviations modest).

Key short-run regression results (Table 1, selected coefficients; dependent variable: year-on-year growth rate of nominal average annual wages, 1990–2017):
- Lagged domestic inflation: 0.77*** (column 1), 0.81*** (2), 0.82*** (3), 0.92*** (4), 0.91*** (5), 0.86*** (6).
- Labor productivity growth: 0.26* (1), 0.25* (2), 0.31*** (3), 0.36*** (4), 0.38*** (5), 0.31*** (6).
- Unemployment rate gap: -2.15*** (1); Unemployment rate gap, Swiss workers: -3.84*** (column shown separately).
- Lagged error correction term: -0.74*** (3), -0.77***, -0.78***, -0.74*** (across specifications).
- Foreign workers (year-on-year change in ratio of foreign/… to domestic workers): 0.40 (column 4, not significant).
- Foreign permanent workers: 0.57* (column 5, statistically significant).
- Cross-border workers: 0.45 (column 6, not statistically significant).
- Number of observations: 27; Adjusted R-squared ranges: 0.64, 0.64, 0.80, 0.81, 0.82, 0.79 across columns.

Empirical interpretation:
- The baseline model explains about two-thirds of the variation in nominal wage growth over the past three decades.
- Adding the error correction term improves fit; its negative coefficient implies past wage overshoots dampen current wage growth.
- Foreign workers are associated with higher Swiss wages; the clearest effect is for permanent foreign workers (positive, statistically significant).
- During 2012–17, permanent foreign workers contributed a cumulative 2½ percentage points to nominal wage growth — as large as all other wage-boosting factors combined.

### Cross-border wage gap dynamics
- Gaps are measured as differences between Switzerland and PPP-GDP-weighted averages of Austria, France, Germany, and Italy; Swiss wages and productivity are measured in euros at a constant exchange rate equal to the 1991–2017 average CHF/EUR exchange rate.
- Short-run drivers considered: large CHF/EUR appreciation episodes, change in firms’ cross-border profit gap (as a share of GDP), labor productivity gap growth, and an error correction term from the long-run relationship.
- Large CHF/EUR appreciation indicator: average cumulative appreciation of the Swiss franc vis-à-vis the euro during the previous three years when that appreciation exceeded 3 percent per annum; otherwise set to zero.

Long-run finding:
- A 1 percent increase in the labor productivity gap raises the real wage gap by about 0.5 percent in the long run.
- Deviations from long-run equilibrium tend to persist for several consecutive years.
- Productivity gap widened by nearly 50 percent during 2004–2008, while the real wage gap increased by only 11 percent during this period.
- The current real wage gap exceeds the level predicted by labor productivity.

Short-term regression results (Table 2, selected coefficients; dependent variable: year-on-year change in nominal wage gap between Switzerland and neighbors, 1990–2017):
- Labor productivity gap growth: 0.15*** (1), 0.20*** (2), 0.18*** (3).
- Large CHF/EUR appreciation (indicator): -0.22* (2), -0.18* (3).
- Change in firms’ profit gap (in percent of GDP): -1.04*** (1), -0.98*** (2).
- Lagged error correction term: -1.27*** (1), -1.47*** (2), -1.34*** (3).
- Number of observations: 26; Adjusted R-squared: 0.66 (1), 0.75 (2), 0.77 (3).

Interpretation:
- Higher Swiss labor productivity accounts for much of the real, constant-exchange-rate wage differential with neighboring countries in the long run.
- Large CHF/EUR appreciations reduce the year-on-year change in the nominal wage gap (negative coefficient on the appreciation indicator).
- Increases in firms’ cross-border profit gaps reduce the nominal wage gap (negative, significant).
- The lagged error correction term is negative and significant, indicating corrections toward the long-run equilibrium.

*Source: IMF staff calculations.*

### 18.      Swiss wages adjust to large appreciation shocks. Measured at current exchange rates, and

### Swiss wages adjust to large appreciation shocks

### Wage dynamics and exchange rate shocks
- A Swiss franc appreciation initially widens the euro-denominated wage gap vis-à-vis neighboring countries, reducing the competitiveness of Swiss firms, because wages for the subsequent year tend to be agreed in the fall of the previous year.
- Following a large exchange rate shock, wages measured at a constant exchange rate (effectively, in Swiss francs) are found to decrease in subsequent years (Table 2, columns 1 and 3), helping to narrow the wage gap measured at current (and constant) exchange rates.
- Example: following a series of large appreciation episodes since 2011, the cross-country wage gap (measured at a constant exchange rate) narrowed by almost 18 percent during 2012–17 reflecting downward adjustment in response to appreciation episodes, as well as the error correction term.
- Nonetheless, despite this corrective response, the wage gap between Switzerland and neighboring countries (measured at current exchange rates) remains 12 percent higher than in 2011.

### Firms’ profits and labor costs
- Swiss firms tend to absorb higher labor costs in part through lower profit margins.
- Real wages in Switzerland increased faster than productivity since 2012, reducing corporate profit margins.
- Quantitative relationship: 1 percentage point of GDP decline in profit gaps increased the wage gap by about 1 percent (Table 2, columns 1 and 3).
- During 2012–2017, compression of Swiss firms’ profits relative to those of firms abroad was associated with a widening of the cross-border wage gap by 0.8 percentage points.
- Longer-term profit decline: between 2007 and 2017, firms’ profits declined by a cumulative 4.5 percentage points of GDP.
- Note: Many firms reduced their profit margins following the removal of the Swiss franc floor against the euro in early 2015 (Swiss National Bank 2015), raising the share of national income paid to workers to historically high levels.

### Conclusions on wage gaps and fundamentals
- Wage differences between Switzerland and its neighbors are found to be consistent with Switzerland’s strong fundamentals.
- Swiss real wages and labor productivity move in line over time; wages respond to cyclical conditions (including unemployment rates and deviations from the long-run wage-productivity relationship).
- An increasing share of foreign workers, most of whom are well educated, is associated with rising wages in Switzerland.
- The higher productivity of Swiss workers accounts for much of the sustained positive cross-border wage gap.
- Large appreciation shocks that initially expand the wage gap are gradually unwound through:
  - slower growth in Swiss wages (measured in Swiss francs),
  - some compression of profits among Swiss firms, and
  - increases in productivity.

### Cointegration evidence
- Engle-Granger two-step tests find cointegration:
  - Cointegration between Swiss real wages and labor productivity: t-statistic -3.22*
  - Cointegration between real wage gap and labor productivity gap: t-statistic -2.42*
- Note: *p<0.10; **p<0.05; ***p<0.01.

### Cross-border and posted workers (Annex I)
- The number of cross-border workers more than doubled since 2002 to about 312 thousand people in 2018, or about 20 percent of foreign workers.
- Switzerland has the highest number of cross-border commuters within the European Economic Area, with 6 percent of workers commuting daily from other countries (European Commission 2018).
- Geographic concentration: cross-border workers are concentrated in northwestern Switzerland near Basel, around Lake Geneva, and in Ticino; Ticino has foreign nationals and cross-border workers accounting for nearly half of the region’s employment.
- Composition by origin: 55 percent of cross-border workers are French resident, 23 percent Italian, and 19 percent German.
- Regional GDP per capita example (2016): US$32 thousand in Auvergne-Rhône-Alpes, Bourgogne-Franche-Comté, and Grand Est regions vs. US$78 thousand in Lake Geneva Region, Espace Mittelland, and Northwestern Switzerland.
- Posted workers and short-stay workers in 2018:
  - About 140 thousand workers from the EU were posted to Switzerland in 2018, mostly in construction (up to 90 working days per calendar year).
  - Short-stay workers (up to 90 days): 27 thousand declared as self-employed and some 86 thousand employed by Swiss employers.

*Source: 1cheea2019002 - Swiss wages adjust to large appreciation shocks (IMF country chapter).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1cheea2019002.pdf_