Who's afraid of deflation? Photographer: Johannes Simon/Getty Images
Who's afraid of deflation? Photographer: Johannes Simon/Getty Images

Europe's dismal economic performance in the second quarter of this year has led to renewed calls for the European Central Bank to pursue stimulus measures aimed at stoking inflation. The example of Switzerland, though, suggests that Europe's problems might stem more from broader economic mismanagement than from a mere lack of rising prices.

For more than four years, consumer prices in Switzerland have risen at an annual pace well below 1 percent. In 2012 and 2013, the country even experienced deflation. Yet its economy has grown at a steady pace, and is expected to expand by 2 percent this year. The unemployment rate is a low 3.2 percent.

The country's success has a lot to do with rising productivity: When output per hour rises, the economy can grow without fueling inflation. Beyond that, the government's balanced budget and small debt burden have helped by keeping borrowing costs low. Switzerland also has the highest household saving rate in the developed world and one of the lowest Gini coefficients, showing relatively little economic inequality.

Common sense is perhaps the most valuable asset in Switzerland, which is not richly endowed with natural resources. It's reflected in a business-friendly tax system and a direct democracy in which populist proposals are voted down in nationwide referendums. It also shows in the country's stand on divisive matters of international politics, such as Russia's meddling in Ukraine. Switzerland sanctioned some Russian individuals and companies, but stopped short of adopting sectoral restrictions in line with those introduced by the U.S. and the EU. As a result, it will not be hurt directly by the unfolding trade war. In fact, some of its exporters will benefit: Russia has banned the import of French but not Swiss cheeses.

Switzerland's biggest problem is that its prudent management has made its currency a haven in times of trouble. This puts upward pressure on the franc, making Swiss exports less competitive abroad and boosting imports, so the Swiss central bank is forced to keep rates at zero and intervene to keep the euro above 1.2 francs.

If the Swiss can survive deflation so well, why is Europe so afraid of it? A 2004 study by economists at the Federal Reserve Bank of Minneapolis suggests such fears are overblown: It finds a link between deflation and depression only during the Great Depression in the U.S., and not even during Japan's "lost decades." Could the Swiss be displaying more common sense by not trying to speed up price growth?

Here's how fund manager Richard Woolnough, one of the highest-paid financiers in the City of London, put it earlier this year:

I do not think deflation is bad. I think it is good. For example, if someone came and did some work on your house for you, and they charged you less than last time, that is good. There is good and bad deflation, just as there is good and bad inflation, and there are a lot of myths around it.

Then he mentioned Switzerland as an economy that has both low inflation and good growth. Perhaps it's an example worth following.

To contact the author of this article: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this article: Mark Whitehouse at mwhitehouse1@bloomberg.net.