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Navigating the "Swissflation Paradox"

When you think of Switzerland, you might think of expensive watches or artisan chocolate, but in this day and age of stagflation, Switzerland has been taking the spotlight for its strong economy and low inflation rate. So how is it that this small European nation is capable of avoiding the inflation crisis that seems to plague other nations around the world?

In an attempt to explain why this one country has bucked the international inflation trend, many aspects of Switzerland’s economy have been highlighted. Many have pointed to Switzerland’s thriving export market, focusing on high-value products such as pharmaceuticals, machinery, and its world-renowned watches. This diversification helps to insulate the country from economic downturns in any one particular industry. This argument makes some economic sense but Germany and Ireland are the world’s second and fourth-largest exporters and they have inflation rates of 10% and 9% respectively. Clearly, there’s more going on here.

Some point to Switzerland’s monetary policy contributing to Switzerland's low inflation. The Swiss National Bank (SNB) is responsible for setting monetary policy in Switzerland, and it has a reputation for being cautious and conservative. One facet of this is the strong push to keep the value of the Franc propped up, which has the effect of shielding Swiss prices from global fluctuations. But if it was as simple as a policy choice then the powers that be in central banks around the world would be on it in a flash. What's clear to see is that Switzerland’s non-existent inflation is genuinely a head-scratcher.

If you were hoping to get a clean explanation for the “Swissflation paradox”, I’ll have to apologise in advance. I won’t be able to do that. But I can raise your attention to one underreported aspect of the debate which has implications, not just for Switzerland, but for the way we treat inflation data in general. The main measure of Inflation used around the world is the consumer price index, a weighted average of prices based on a basket of commonly consumed goods. This basket makes CPI unique because, unlike GDP or unemployment, there is no consistent formula to calculate it. While this method is excellent at explaining the cost of living through time, as it integrates changing consumption habits, it falls short when we began making comparisons across borders.

In the case of Swiss CPI, the weights of certain items have a huge effect on keeping the CPI low Healthcare, for example, which is provided by private firms, accounts for 17% of the CPI index, compared to 7% in the United States and 5% in Germany. Swiss consumers have historically set aside a large chunk of the household budget for healthcare, which as an industry has been almost completely unscathed by the skyrocketing food and oil prices.

Furthermore, WIth Switzerland's lakes, rivers and mountainous geography, hydropower accounts for over 55% of the country's energy mix. The result is that fossil fuel energy makes up just 5% of the Swiss CPI basket compared to 7% in the United States and 10% in Germany. Swiss electricity prices are essentially immune from global changes, which goes a long way in keeping inflation low; particularly during an energy crisis.

In general, the areas that have seen the biggest price increases, also happen to be the least weighted areas in the swiss basket. Filling up the car is much more expensive in Switzerland as it is everywhere; it's just the Swiss don’t spend so much on petrol. The takeaway here is that inflation is fundamentally a weighted average of prices based on spending habits within that country. But to fully understand why certain countries are where they are, we need to take into consideration the weights as much as we do the prices.

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