rfr · H30WRFR7 · 2016-01-19 00:00:00 — 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 the example did not answer the question of how monetary policy would affect the likelihood of imbalances up in the first place (Minutes, p. argued that monetary policy could counteract the effect on inflation and unemployment of the imagined fall in housing prices by promising to hold the repo rate near zero for a sufficiently long period of time (Minutes, p. countered by asking whether it would be credible for the Riksbank to hold such a policy rate for several years (Minutes, p. The growth of Swedish GDP, and especially exports, again surprised on the upside at the Monetary Policy Meeting. Exports were now expected to grow in 2010 by compared with at the meeting, stimulated by strength in the euro area, where GDP growth had been revised up for 2010 from to , despite the first signs of trouble in and elsewhere. And expected Swedish unemployment for 2010 was revised down to in from in , and from to in 2012, respectively. The 2010 CPIF inflation forecast was unchanged at , with inflation expected to be in 2012. voted to raise the repo rate from to and to leave the repo rate path decided at the meeting unchanged. justified its policy action saying: “When resource utilization increases, the repo rate will gradually be increased to more normal levels. Another factor is that household indebtedness has increased in recent years” (MPU, p. dissented against the repo rate path in the majority decision, preferring a flatter path starting from ending at at the end of the three-year forecast horizon. She was concerned that weaker development abroad could be expected to reduce growth and inflation in too in the period ahead. dissented, preferring a repo rate of and a low repo rate path that would rise gradually to only by the end of the forecast period. He was concerned that the higher repo rate path in the main scenario would, if it became credible and was incorporated in market expectations, imply a considerable tightening of current actual monetary policy with a substantial increase in market interest rates of longer maturity and a substantial appreciation of the krona, which would lower the already low CPIF inflation and increase the already high unemployment during the forecast period. , head of the Monetary Policy Department, began the policy meeting emphasizing that “monetary policy expectations expressed in the forward rates have also shifted down during the summer. Such shifts can be difficult to interpret. Historically the actual repo rate has often developed differently than expected by the market participants (according to forward rates)” (Minutes, p. Specifically, market expectations now followed the Riksbank's repo rate path reasonably well until the end of 2010 but terminated at at the end of the three-year forecast horizon compared to the Riksbank's end point. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 presented an analysis of the Monetary Policy Department suggesting that markets believed that i) uncertainty abroad and ii) recent sig- nals from central banks that they might postpone policy-rate increases would lead to a need for a more expansionary monetary policy in , presuma- bly to counteract an appreciation of the krona (Minutes, p. In other words, the market believed that “exchange rate smoothing” was implicitly constrain- ing Riksbank monetary policy--implicitly creating a degree of “incredibility” in the Riksbank’s intention of raising the published repo rate path in circum- stances where it was not accompanied by a commensurate rise in policy rates and both concurred in this view which became central to their perspectives and dissents on policy. Reasoning as above, argued that “[t]he entire repo-path should be shifted downwards to a level that roughly corresponds to market expectations” (Minutes, p. He “believed that the present good level of growth and recovery is due to the actual monetary policy, that is to market expectations and the current market rates for various maturities, rather than to the intended monetary policy, that is the repo-rate path” (Minutes, p. saying this, was arguing implicitly that shifting down the Riks- bank's repo rate path to conform to market expectations would not have much effect on market expectations themselves. Commenting on 's worry about the Riksbank's path becoming credible, responded that “[i]t appears as though the Swedish forward rates follow when forward rates abroad change…it would be useful to investigate more closely how for- ward rates are affected by the repo rate path and by forward rates abroad” (Minutes, p. challenged 's implicit argument that market repo expectations would be insensitive to the shifting down of the Riksbank repo rate path, saying that in his view doing so “would be regarded as clearly sig- nalling a more expansionary monetary policy and would thus also have [a] clear effect on both interest rates and exchange rates” (Minutes, p. stated that the issue raised by was key. she believed that “a major downward revision of the repo-rate path just now would influence market rates in a negative direction, making the ‘actual’ mon- etary policy more expansionary, rather than it unchanged”. pointed out that this was, however, merely a hypothesis and that “a deeper examination of the question of how decisions concerning changes to the repo-rate path affect market rates would be beneficial. Not least, this would be important information to have as underlying data if the problems regarding the level of the repo-rate path, mentioned by above, are to be addressed” (Minutes, pp. The forecast for 2010 GDP growth in in the main scenario at the October 2010 Monetary Policy Meeting was revised up sharply from to , almost reversing the large fall in Swedish GDP in 2009. the main scenario now forecast the unemployment rate to fall to by the 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 end of the three-year forecast horizon. CPIF inflation was forecast to average in 2010, and to fall to in 2011 due to the appreciation of the krona, before rising to in 2013. decided to raise the repo rate by to , but it cut the published repo rate forecast from to in 2011 and from to at the end of the three-year forecast horizon. Market expected repo rates conformed to the Riksbank repo rate path to early 2011, but then rose less steeply to about at the end of 2013 (MPR, p. 10 and Minutes, p.2). justified its policy action saying: “GDP is now growing quickly and resource utilization is rising. Moreover, households' debts have increased substantially in recent years. If the increase in debts in relation to incomes continues over a long period of time, there is risk of imbalances up in the Swedish economy” (MPR, p. This time, and entered identical reservations against the decision, preferring instead to hold the repo rate at and then gradually to increase it to at the end of the three-year forecast horizon. If the Riksbank's repo rate path were to gain full credibility in the market, “[t]hey considered that the repo rate path of the main scenario entail[ed] a tighter monetary policy than presented in the MPR. It would lead to a further strengthening of the krona than in the report forecast and considerably higher long-term interest rates than at present. This would reduce inflation and raise unemployment. The expectation that the main scenario's interest rate path will lead to greater strengthening of the krona than in the forecast is based on the view that foreign policy rates will rise more slowly and that the exchange rate is affected by current low foreign long-term market rates” (Minutes, p. In the discussion “was sceptical towards the forecast for foreign policy rates as expressed in the draft MPR, even though it implie[d] a downward revision from the equivalent path in the MPR” (Minutes, p. The assumed path for foreign rates followed implied forward rates for four quarters but then rose steeply to around by the end of 2013. pointed out that communications from the US central bank (Federal Reserve), (), and , indicated that, given their own forecasts, they saw a need to hold their policy rates unchanged longer than is implied by the Riksbank forecast. She “considered that the blue curve in Figure B11 in the draft MPR forms a more reasonable forecast for monetary policy outside ” (Minutes, p. The blue curve referred to was the Riksbank's measure of implied forward rates abroad which rose gradually to only at the end of 2013 (MPR, p. Later, as part of an unusually long six pages of comments critical of the main scenario in the Minutes (pp. 15-21), argued that the main scenario contained two problems. First, he argued that the Riksbank's repo rate path used in the main scenario was still much higher than market expectations. He worried that if it were to become credible, the policy stance would raise long-term interest rates in , strengthen the krona, stifle the recovery of exports and GDP, reduce inflation, and increase unemployment. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 pointed out that the exchange rate depends on the difference between long- term domestic and foreign market interest rates, and he argued that the lack of a greater appreciation of the krona in the main scenario was due to the assump- tion that the paths for market interest rates abroad were higher than implied by actual current market rates. “requested clarification from the staff as to whether the main scenario's forecast is really based on an assumption that interest rates in and the rest of the world differ from the actual observed interest rates, as maintained” (Minutes, p. , head of the Monetary Policy Department, replied that “[t]he analysis in the main scenario naturally takes account of current ob- served interest rates. He also said that 's picture of deviations be- tween actual interest rates and those on which the forecast is based proceeds from specific assumptions for translation of forward pricing to policy rate ex- pectations and the translation of policy rate expectations to long-term market In a model world with rational expectations it is difficult to take into account the fact that the monetary policy expectations of the market and of the Riksbank can differ. But the forecast in the main scenario is not a pure model forecast and it is possible there to use expert assessments in order to adjust for events that cannot be taken into account in models. The forecast of future in- terest rates use plenty of information apart from forward pricing, which led to an assessment that is close to the average for other forecasters' interest rate forecasts” (Minutes, p. immediately responded and “again explained that, as far as he could see, the main scenario is based on the credibility of both the repo rate path and the Riksbank's forecast of foreign policy rates--that is, that all market operators and other participants actually believe the Riksbank's forecasts for both the repo rate and foreign interest rates and that this belief is priced into market interest rates…However, these are questions that must be thoroughly sorted out ahead of the next monetary policy meeting” (Minutes, p. later proposed a basis for how monetary policy decisions could be improved by making forecasts based on implied forward rates and comparing the outcome with the proposed repo rate path (Minutes, pp. At the Monetary Policy Meeting, Swedish GDP growth in Q3 2010 was seen to be much stronger than thought at the October meeting. Once again, estimated GDP growth for all of 2010 was revised upwards, this time to from . Forecast GDP growth in 2011 was raised from Forecast unemployment rates fell slightly, and were now expected to average in 2013. CPIF inflation for 2011 previously forecast as was revised up to but expected to fall back to in 2012 when tem- porarily high electricity prices would fall back, and then return to in The unemployment forecast was changed from October and ex- pected to fall from in 2010 to in 2013 regarded as near the normal or long run sustainable unemployment rate. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 decided to follow through on its October forecast to raise the repo rate from to and continue with the same repo rate path decided in October, which was to raise the repo rate to by the end of 2013. decided to follow through with no more than the policy action expected in October, in spite of the surprise strength in GDP, saying “…even with the increases included in the Riksbank forecast, the repo rate will be relatively low for some time to come. This is justified by underlying inflationary pressures currently being low and resource utilisation being lower than normal” (MPU, p. As they did in October, and entered a common reservation against the majority decision. This time, however, they now accepted the October repo rate rise from to . But they argued against raising the repo rate further in , and as before they advocated a repo rate path that rose more gradually to over the forecast horizon. The discussion at the meeting largely followed the contours of the debate at the October meeting. and implicitly acknowledged the surprising strength in the Swedish economy since October by agreeing to raise the repo rate to . However, worried that “if the main scenario's repo rate path were to become credible, all else being equal, Swedish long-term rates would increase by about 70 points for a 5-year rate … This would mean a strengthening of the krona that would entail a further tightening in addition to the increase in long-term interest rates. The overall tightening would lead to even lower inflation and even higher unemployment than in the main scenario” (Minutes, pp. After a full year of post-crisis tightening of Swedish monetary policy, it is worth quoting in full Governor Ingves’ case for continuing to withdraw monetary stimulus: “The data that has come in shows that growth is higher and unemployment lower than in earlier forecasts, and that the current account surplus remains. GDP will shortly have reached the same level as before the crisis and resource utilization will normalise during the forecast period. Business tendency data indicate continued strength in the economy. Inflationary expectations are rising even though the forecast inflation will be quite close to the two per cent target. All in all, according to this means that it is now appropriate to raise the interest rate and continue to do so in the future”. “According to , needs less expansionary monetary conditions. This can be achieved via two channels; via interest rate increases and/or via the exchange rate. Exchange rate assessments are genuinely difficult and it is hard to base monetary policy on an assumption that the low interest rate in the rest of the world will contribute to a strengthening of the exchange rate. The discussion of the role of the exchange rate in monetary policy is reminiscent of the discussion of a ‘monetary conditions index’ in the 1990s, which did not lead to any clear conclusions, but on the contrary led to the abandonment of this kind of index ”. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 “The repo-rate path proposed in the Monetary Policy Update is a reasonable compromise, according to . By gradually raising the interest rate monetary policy will be less expansive. If developments in the exchange rate should differ dramatically from those forecast, this must be dealt with when it Governor Ingves also remarked that “[h]ousehold debt continues to in- crease and it is too early to judge what effect 's loan ceiling To avoid problems in the future it is also appropriate in view of this to raise the interest rate and indicate interest rate increases in the future as specified by the repo-rate path. The monetary policy transmission works via expectations and the repo-rate path steers expectations” (Minutes, p. By the end of 2010, the battle lines in the debate over the stance of monetary policy were drawn. One side worried about the surprisingly buoyant recovery of the Swedish economy, and also about the implications of rising house prices The other had a narrower focus on forecasts of inflation and were concerned that current forecasts had overestimated the likely path of overseas interest rates and, as a result, had taken insufficient account of the impact of a stronger krona on pushing down inflation. Ongoing strength of the Swedish economy was confirmed again at the Feb- ruary 2011 Monetary Policy Meeting. In the main scenario, Swedish GDP was expected to grow by in 2011 and slow to around in 2012 and Unemployment was expected to average in 2011 and to average CPIF inflation was expected to be in 2011, in 2012, and in 2013. voted to raise the repo rate from to and to steepen the repo rate path slightly to from by early 2014. expected repo rates shifted upward from and now conformed to the Riksbank repo rate path until early 2012. justified its policy action saying: “The real economic for and abroad are roughly in line with the forecasts published in . Resource utilization is currently slightly lower than normal, but it is estimated that it will be normal or slightly above normal towards the end of the forecast period … To stabilize inflation around the target of 2 per cent and to avoid a too high level of resource utili- zation in the period ahead, the Riksbank's assessment is that it is appropriate to continue the sequence of increases in the repo rate that was initiated last year” (MPR, p. As they had done in October and , and entered a common reservation against the majority decision. accepted the increase in the repo rate at the previous () mon- etary policy meeting; but they argued against raising the repo rate, now , However, this time they revised upward the endpoint of the repo rate path from the that they had favoured since October 2010 to at the end of 2014. Their modest departure from the majority decision 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 implied a commensurate improvement in inflation relative to the target and a faster reduction of unemployment towards its sustainable level. In spite of the narrowing of difference among Board members evident above, there was nevertheless the usual extensive discussion in the monetary policy meeting. The following comments serve to capture the mood: observed that “[w]ith regard to the repo-rate path, however, his assessment still was that it will be necessary to increase the repo rate by 0.25 per cent at each of the year's six meetings. reminded the meeting that the repo rate is still very low. The market's repo rate expectations have shifted upwards and he noted that an increasing number of bank economists share the assessment that the Riksbank will need to increase the repo rate to 2.75 per cent by the turn of the year” (Minutes, p. was referring to the fact reported in Figure 3.4 of the MPR showing that since , market expectations of future repo rates had largely converged on the Riksbank's published repo rate path. During the meeting, Board members took some time to discuss and compare the reliability of alternative measures of resource utilization. concluded that his “own preliminary assessment of the sustainable rate of unemployment is at 5.5 per cent after having read some papers on the subject and discussed it with several labour economists” (Minutes, p. Later, he argued that the Riksbank's model might overstate the forecast of inflation at the end of the forecast period because it is “calculated using a standard assumption of a sustainable unemployment rate of 6.5 per cent, which he believes is too high” (Minutes, p. noted that “[o]ne complicating factor in this recession is that reforms were implemented at the same time, which could be expected to lower what can be considered a sustainable rate of unemployment” (Minutes, p. Returning to familiar themes, pointed out that “[t]he forward rate curve has shifted upwards, and is now quite close to the Riksbank's reporate path, at least for the next 12 months or so. This seems to have taken place without any major inhibitory effect on the Swedish economy, via a rapid appreciation of the Swedish krona. This shift seems to reflect the international rise in forward rates” (Minutes, p. (and separately) acknowledged during the meeting that “[t]his time there [were] no significant differences between … implied forward rates and the main scenario's assumptions about foreign policy rates in the first two years” (Minutes, p. At the Monetary Policy Meeting, the recovery in the global economy was judged to be continuing at a good pace, the forecast for 2011 global GDP was changed from February despite a natural disaster in , political unease in North and the Middle East, and public finance problems in the euro area. Rising energy prices, in particular, pushed the 2011 forecast for global inflation slightly above . In the main scenario Swedish GDP was forecast to grow by in 2011 before falling back toward its trend as the unemployment rate fell. The 2011 CPIF inflation 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 forecast was revised down from to , but still forecast to reach decided to follow its February repo rate forecast and raise the rate from to , leaving the remainder of the repo rate path unchanged from the February meeting to reach in early 2014. The Monetary Policy Update reported that “[a]ccording to market pricing, monetary policy expectations in are more or less in line with the Riks- bank's forecast for the repo rate one year ahead…For longer horizons, how- ever, they are lower than the Riksbank's forecast. Expectations of the repo rate according to surveys are in line with the Riksbank's forecast in the long run, Both surveys and market pricing point to expectations of an increase in the repo rate in April, and three further increases this year” (MPU, p. justified its policy action with much the same reason- ing as in February 2011. As they had done since October 2010, and entered a common reservation against the majority decision. Again they accepted the increase in the repo rate at the previous (February) monetary policy meeting; but they argued against raising the repo rate, now , further to And again, they revised upward the endpoint of the repo rate path-- from the that they favoured in February to by early 2014, advo- cating a slower rate rise at first and a faster rise later on. est departure from the majority decision implied a commensurately faster in- crease of inflation toward the target and a faster reduction of unemploy- ment towards its sustainable level. Among the main points made during the meeting were the following. and assessed the increase in the ECB policy rate to in April (and that the rate increase triggered an increase in forward interest rates in the euro area). thought the move was intended only as a signal to show that the ECB prioritizes inflation in check, unlike Mr who thought it might mean higher policy rates in the future (Minutes, pointed out that two elements of uncertainty in European finan- cial markets had been removed. had requested and received assis- tance from the IMF and EU; and the new government in had moved to address the problems in its banking system. He added, however, that problems in and remain (Minutes, p. argued that two new estimates by the and sustainable rate of unem- ployment supported his view that it was close to instead of the Riks- bank’s assumed in the main scenario. considered that there was one issue that did not require so much attention as previously, namely household debts. The growth rate in house- hold debt had clearly slowed and house prices had levelled off. was prepared to place this concern to one side, at least temporarily (Minutes, 5 THE EVOLUTION OF MONETARY POLICY 2010-2015