rfr · H30WRFR7 · 2016-01-19 00:00:00 — By far the biggest questions in the implementation of inflation targeting are the time horizon over which it is desirable to bring inflation back to target and the “model” of the economy which is being used to judge the future path of the economy. They reflect deep issues which became apparent to central banks during and after the global financial crisis. There may be times when monetary policy should also be concerned about a disequilibrium, or imbalance, in the economy that cannot easily be explained solely in terms of its effects on resource utilisation or the current inflation rate. It may then be appropriate to deviate from targeting inflation in order to correct “imbalances” in the economy that may stem from previous periods of excessive optimism, not necessarily in the housing market, in order to prevent major swings in output and employment later on. Such imbalances may not necessarily originate in the financial or any other particular sector (housing, for example) and so may not be easily amenable to macro-prudential policy which is directed to particular sectors. It is a mistake to think that all possible needs for policy intervention can be divided into two types – those which require the meeting of an inflation target two years ahead and those which require the adoption of macro-prudential policies. Monetary policy will have to take a broader view in order to correct the imbalances. The fact that most statistical models used by central banks, including the Riksbank, preclude such a possibility is no reason to ignore it. The Riksbank’s own description of its monetary policy strategy, as described in Chapter 5, states that “A well-balanced monetary policy is normally a question of finding an appropriate balance between stabilising inflation around the inflation target and stabilising the real economy”. This should be extended to say that if the Riksbank feels that an adjustment to the real equilibrium of the economy is necessary then it should be prepared to accept deviations of inflation from target for a period longer than the conventional two years which it uses in normal times. Recommendation: the mandate given by the Riksdag to the Riksbank should state that the monetary policy objective of the Riksbank shall be to maintain price stability, as defined by the inflation target, with regard to the long run sustainability of the path for the level and composition of output and its implications for inflation. Where, in the opinion of the Ex- ecutive Board, it is appropriate to deviate for a while from targeting inflation some two years ahead, the Riksbank shall explain its reasons and defend them in front of . In other words, if the Riksbank believes that circumstances justify deviating from targeting inflation two years ahead in order to prevent major swings in output and employment later on, then, rather than pretending otherwise, it should explain why it has chosen to deviate from the target, and be prepared to defend itself in front of . It is precisely in circumstances where there is room for reasonable disagreement about the immediate 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK challenges facing monetary policy that it is important to expose the thinking of the Riksbank, as well as that of outside commentators, to regular and informed constructive criticism. It is in this area that transparency is so important. The Riksbank Act also sets out responsibilities in terms of the transparency of the Riksbank. Chapter 6 article 4 states that “the Riksbank shall submit a written report on monetary policy to at least twice a year”. There is no doubt that the Riksbank provides a great deal of information to the public on its understanding of the economy, its own internal deliberations, and its decisions. It is one of the most transparent central banks in the world. But the process of accountability could be improved, and we return to this below. Most of the remaining articles in the Riksbank Act describe in detail the operational framework within which the Riksbank should pursue its objectives.12 There are two areas in which (in the English translation) the Act is surprisingly vague: foreign exchange policy and financial stability. On the first, Chapter 6 article 2 states that “the Riksbank shall follow developments on the foreign exchange and credit markets and implement necessary monetary policy measures”. And Chapter 7 article 2 states that “in pursuance of its foreign exchange policy, the Riksbank is to hold assets in foreign currencies, foreign claims and gold”. There appears to be no definition of what is meant by the Riksbank’s “foreign exchange policy”. In practice, the choice of the exchange rate regime is a matter for government. After 1992, ’s exchange-rate regime has been to adopt a floating exchange rate which permits the Riksbank to pursue its own monetary policy. It would be helpful for the Act to make clear the division of responsibility between the Government and the Riksbank on matters of exchange-rate policy, not least because there is some confusion about that division within the euro area and it would be sensible to avoid that in . Recommendation: the Riksbank Act should be amended to make clear that the choice of exchange rate regime is a matter for government, and that the mandate to meet the inflation target is subject to the Government deciding that the exchange rate should float freely. During the period covered by our evaluation, the absence of any clear reference in the Act to either the role of the exchange rate or that of financial stability considerations for the pursuit of price stability turned out to be extremely important. Many of the controversial aspects of monetary policy during the period were the result of decisions to achieve price stability over a longer time horizon than hitherto because of concerns about either financial stability or the exchange rate. This is apparent from the narrative history of monetary policy in Chapter 5. The advantages of an inflation target are two-fold: first, monetary policy geared to targeting inflation enables the exchange rate to fluctuate freely to insulate the domestic economy from external disturbances. 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK policy geared to targeting inflation frees interest rate policy to focus on stabilizing domestic inflation and employment regardless of the consequences for the exchange rate. Both advantages of the inflation targeting framework were very much in evidence in in 2008-09. The large depreciation of the krona (against the euro and against the US dollar) by early 2009 – due in part to the crisis abroad and partly to the aggressive easing of monetary policy in that followed –helped to stabilise employment and inflation in . And CPIF inflation was stabilised around in 2009-10. But when the exchange rate changes markedly, it is not always sensible to keep inflation as a whole close to target. ’s major export markets had weakened sharply, and was faced with a substantial one-time adverse adjustment to its terms of trade. How should that affect policy? As a result of the credibility of the Riksbank’s inflation target, nominal wage growth in was well anchored. So it might have been better to cope with the need for a one-time downward adjustment in real wages in by allowing the large depreciation of the krona to pass through to prices of consumer goods and services and letting CPIF inflation overshoot the target for a few years while retaining stability in domestically generated inflation. Once higher foreign prices had passed through to the domestic price level, inflation would have returned to target. Such a policy, not dissimilar to that followed by , would have left inflation close to the target once the adjustment had been achieved, rather than well below target as happened in practice. In the event, Swedish inflation never got much above and soon began to fall below the target with adverse consequences, in part because the Riksbank began to tighten monetary policy in 2010 which more than reversed the depreciation of the krona that had occurred in 2008-09. As regards financial stability, there is no explicit description of any responsibility for the Riksbank in the area of financial stability. Chapter 6 article 8 states that “in exceptional circumstances, the Riksbank may, with the aim of supporting liquidity, grant credits or provide guarantees on special terms to banking institutions and Swedish companies subject to the supervision of Fi- nansinspektionen”. Although ’s financial system weathered the storms of 2008 rather well, the size of the banking system relative to the economy as a whole – bank assets in 2014 were around of annual GDP – means that the health and stability of the financial system is bound to be a matter of concern for the Riksbank as well as . Before the crisis, Swedish banks started to raise substantial funds in US wholesale markets, and now rely on over of such external funding to finance their domestic loan portfolios. This created a substantial maturity and currency mismatch. This situation was important both for monetary policy and banking supervision during the crisis. As Goodhart and Rochet pointed out in their own Review, the saving grace for was the ability of the Riksbank to negotiate swap arrangements in US dollars with . 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK Since the crisis, and during the period under review, there has been growing concern in about the buoyancy of house prices and the associated rise in household indebtedness. In its 2014 Article IV for , the IMF noted that much of the rising house prices could be attributed to constraints on the supply side resulting from inadequate of apartments to meet the rising demand in cities and as a result of substantial immigration. There is no sign that these factors are likely to abate, and unless the Government take signifi- cant steps to improve the supply side of the housing market, the financial au- thorities are likely to be faced with considerable challenges resulting from the rise in household debt for some time to come. We urge the Government to take this problem extremely seriously. As we have shown in Chapter 5, concerns over financial stability played a growing role in the views of the majority to be cautious in the speed at which the policy repo rate was cut in 2012 and 2013. With clarity about the respective roles of the Riksbank and , it was perhaps not surprising that tensions developed between the two institutions. wanted stronger and earlier action to deal with the rise in house prices. nansinspektionen was by no means inactive in dealing with concerns about household indebtedness and financial stability. In 2010, it introduced a ceiling on loan to value ratios for new mortgages of . In the previous year, one third of new mortgages had been extended at higher loan to value ratios. measure was controversial then, and attracted much criticism from the industry Within a year, however, most commentators had come round to the view that the measure had been necessary. It appears to have had some effect in stabilising household debt to income ratios. Further measures were taken to raise the capital requirements on banks for mortgage lending (see 3). But neither nor the Riksbank had been given powers to take any such measures for explicitly macro-prudential reasons. ment was slow to resolve this question, resulting in an unfortunate period dur- ing which both and the Riksbank were campaigning to ac- quire such powers. Only in was the formal decision taken to give macro-prudential powers to . primarily a supervisory authority, and, as we have noted, has been more reluc- tant than the Riksbank to regard rising indebtedness is a matter for concern. In part, this may reflect the fact that it is directly responsible to Government. And when was given responsibility for macro-prudential powers, the relevant minister stated that the main advantage of making Fi- nansinspektionen the lead agency is that it answers directly to government thus improving democratic responsibility. But there is a difference between the democratic decision by an elected government about the set of macro-pruden- tial policy instruments which can be used, and the decisions of the authority to which those powers are delegated on the use of such instruments. risk that present arrangements will lead to slow responses to future concerns about financial stability, and they should be reviewed periodically. 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK Recommendation: in 2020 the Government should ask a small group of experts to carry out a review of the allocation of responsibility for macroprudential policy between and the Riksbank. Whatever the merits of the current arrangements, it should at least enable the Riksbank to focus on its primary objective of meeting the inflation target. Nevertheless, as we have noted above, there may well be imbalances in the Swedish economy for which the sector-specific macro-prudential actions are inadequate to ensure an adjustment towards full employment with price stability. There will be times when it is appropriate for the Riksbank to deviate from the normal and rather narrow focus on meeting the inflation target two years ahead. It is to that possibility that the second recommendation of this chapter is directed. It is important, therefore, that the Riksbank plays an role in discussions of policy towards financial stability. We see merit in separating the functions of the newly established between those relevant to an immediate crisis in which the use of public funds becomes a possibility and its role in monitoring financial stability outside a crisis. For the former situation, it is important that the finance ministry is involved because of the possible implications of any action for the use of public funds. But outside a crisis, it is important that decisions on macro-prudential responses be separated from day-to-day political pressures. Recommendation: that a joint () of the Riksbank and be established to meet quarterly to discuss the setting of the main macro-prudential policy instruments. The PPC should make recommendations to the Riksdag from time to time on whether the set of instruments delegated to should be expanded or contracted. The PPC should be the primary source of reports on financial stability and should appear before at least once a year. Public attacks by the Riksbank and on each other are unhelpful, but almost certainly inevitable in a world in which one institution has responsibility for monetary policy and the other for macro-prudential policy. Recommendation: the Riksbank Act should be amended to clarify the role of the Riksbank in financial stability, whether limited to participation in the proposed (see above) or more extensive if macro-prudential powers gravitate to it. The mandate of the Riksbank should include financial stability, and the Riksbank must have some formal powers to enable it to achieve its objective. In addition to our recommendations for amendments to the Riksbank Act, we feel some improvement in the accountability of the Riksbank to the Riksdag merits consideration. The accountability of policy decisions is rightly not to the but to the public and the Riksdag. We would encourage to crossquestion all members of in somewhat greater depth than at present. If such sessions of evidence on the votes of individual members of 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK are to be productive and increase public understanding of the challenges to and decisions about monetary policy in , then there will need to be a degree of self-restraint on the part of members of that is not entirely characteristic of politicians, at least outside . is conducting a review of “the modalities for the evaluation of Swedish monetary policy”. The current practice was introduced in 2007/2008. At present, the Committee holds three open hearings with the Governor and one Deputy Governor (who rotates) each year and the Committee publishes an annual evaluation based on a submission from the Riksbank. By inviting all members of to appear more regularly, the minutes of the Monetary Policy Meetings might play a more useful role in explaining the arguments for and against the actions that were taken. Recommendation: should hold three sessions of evidence a year with following publication of the Monetary Policy Reports. In addition to the Governor (each time), three deputy governors should appear so that each member of the Board would appear at least twice in any twelve-month period to explain and defend his/her votes on monetary policy decisions. The Riksbank operates under the control of its . In turn, the reports annually to . has the responsibility for controlling the way in which the Riksbank is managed and for appointing new members of . This is a unique arrangement in which the governance of the central bank is delegated by the Riksdag to a body with democratic legitimacy but which is separate from the Riksdag itself. We were impressed by the way in which the sees its role as a buffer between the central bank, on the one hand, and politicians subject to the daily pressures of media and public opinion, on the other. In particular, the way in which the manages the process of selecting new members of avoids the twin dangers of the existing Board recruiting its own successors and the immediate political pressures from the Finance Ministry and the Riksdag. We believe that if consideration is given to amendment of the Riksbank Act, then the should play an important role in proposing suggested amendments. Recommendation: should invite to submit recommendations for amendments to the Riksbank Act. Chairman and Vice-chairman have the right to attend meetings of , and to speak but not vote. Our impression is that this power has been used wisely and sparingly. has not commented in public about monetary policy decisions. That is of critical importance if the role of the in the management of the Riksbank is to retain the confidence of the executive members of the Bank. 8 THE MANDATE AND GOVERNANCE OF THE RIKSBANK assured us that the executive members of the Riksbank provided adequate and full disclosure of all actions taken both in the monetary policy area and in connection with the balance sheet of the Riksbank. We concluded that there was a sensible and effective relationship between the two that was well managed. Chapter 1 article 4 of the Riksbank Act determines that the Executive Board comprises six members, who are appointed by period of five or six years. thought needs to be given to the role of the members of . Is there sufficient work to employ six full-time members? We recommend consideration be given to changing the structure of the Board. It makes sense to have six people with equal responsibility for the executive management of the Riksbank. We suggest a better arrangement would be to have three members with explicit executive responsibilities: the Governor, one deputy governor with responsibility for monetary policy and managing the staff in that area, and a second deputy governor with responsibility for work and staff in the area of financial stability. should also comprise three additional non-executive members, who could have other external part-time appointments provided those generated no conflict of interest. Recommendation: should become the Monetary Policy Board comprising three executive members of the Riksbank, the Governor and two deputy governors with responsibility for monetary policy and financial stability respectively, and three non-executive members. List of Tables and Figures Table 1: , Table 2: 2010-2015: Membership, Policy Decisions and Table 3: Various Forecasts for CPIF Inflation, January 2013 to 2015 Figure 1: Riksbank Repo Rate 2005-2015 Figure 2: GDP Growth, Figure 3: CPIF Inflation, Figure 4: Unemployment Rate, Figure 5: Rate (KIX) 2005-2015 Figure 6: Level of House Prices, Figure 7: Household Debt/Disposable Income, Figure 9: Riksbank Repo Rate and Market Expectations: 2010-2015 Figure 10: Riksbank’s Forecasts for Foreign Economies: 2005-2015 Figure 11: Accuracy and Bias in Various Forecasts for Foreign GDP and In- flation: 2007-2014 Figure 12: CPI, CPIF and CPIF excluding energy, 2005-2015 Figure 13: CPIF Forecasts and Outturns, January 2011 to 2015 Figure 14: Successive Forecasts in 2011-2012 for CPIF Inflation in 2012 Figure 15: Successive Forecasts in 2013-2014 for CPIF Inflation in 2014 Figure 16: Accuracy and Bias in Forecasts of CPIF Inflation, Various Forecasters 2008-2014 Figure 17: Accuracy and Bias in Forecasts of GDP Growth, Various Forecasters 2007-2014 Figure 18: Accuracy and Bias in Forecasts of Unemployment, Various Forecasters 2007-2014 Table 1: , Annual percentage change, except for trade surplus1 2000-2006 2007 2008 2009 (1)GDP and exports are measured in real terms; other quantities are in nominal terms. (2)Net exports of goods and services, per cent of GDP. (3)Valueguard Housing Index, total, annual percentage change, annual average. (4)Monetary Financial Institutions’ (MFI) lending to the private non-financial sector and the outstanding stock of commercial paper and bonds issued by the Swedish private non-financial sector, annual percentage change, annual average. (a) Average 2006. (b) Forecast, October 2015. Sources: Statistics , Valueguard (2) and the Riksbank (b). Table 2: 2010-2015: Membership, Policy Decisions and Votes 2010-2012 TABLES AND FIGURES 2015/16:RFR7 Table 2: 2010-2015: Membership, Policy Decisions and Votes (cont.) A) Reservation against the decision to buy government bonds. Source: The Riksbank web page Table 3: Various Forecasts for CPIF Inflation, January 2013 to 2015 Forecasts with horizons of one to three months for the Riksbank Source: Löf, , “Recent Inflation Outcomes and Forecasts,” Economic Commentaries, the Riksbank, No. 4, 2015, 7, Table 1 Figure 1: Riksbank Repo Rate 2005-2015 Per cent, daily observations Source: The Riksbank Figure 2: GDP Growth, Annual percentage change, seasonally adjusted quarterly data Figure 3: CPIF Inflation, Annual percentage change, monthly data Figure 4: Unemployment Rate, Per cent, three-month moving average of seasonally adjusted data Sources: Statistics and the Riksbank Figure 5: Rate (KIX) 2005-2015 Index, = 100, monthly averages of daily observations KIX refers to an aggregate of countries that are important for 's international transactions. Sources: National sources and the Riksbank Figure 6: Level of House Prices, Index, January 2005 = 100, seasonally adjusted monthly data Sources: Valueguard and the Riksbank Figure 7: Household Debt/Disposable Income, Per cent of disposable income, quarterly data Households' total debts as a share of their disposable incomes totalled over the past four quarters. Sources: Statistics and the Riksbank Riksbank Repo Rate and Market Expectations 2010-2015 Phase 1 Recovery and Tightening Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Phase 2 Pause for Thought Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Phase 3 Disappointment and Easing Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Phase 4 Another Pause for Thought Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Phase 5 Going to Zero Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Riksbank Repo Rate and Market Expectations 2010-2015 (cont.) Phase 6 Going Negative Source: The Riksbank Figure 10: Riksbank’s Forecasts for Foreign Economies 2005-2015 (The notes for Figure 10 follow the third panel on the following page.) Figure 10: Riksbank’s Forecasts for Foreign Economies 2005-2015 (cont.) Foreign GDP growth, inflation and policy rates are TCW-weighted for forecasts up until 2012 and KIX-weighted from 2013 onwards.