rfr · H30WRFR7 · 2016-01-19 00:00:00 — Review of the Riksbank’s Monetary Policy 978-91-87541-39-1 Riksdagstryckeriet, , 2015 List of Recommendations.......................................................................... The Swedish Economy and Monetary Policy Prior to 2010...................... The Evolution of Monetary Policy 2010-2015 .......................................... Analysis of the Riksbank's Forecasting Performance................................ Evaluation of Monetary Policy in .............................. The Mandate and Governance of the Riksbank......................................... List of Tables and Figures .......................................................................... Tables and Figures...................................................................................... Terms of Reference of the Review ............................................................. in Swedish Monetary Policy 2010-2015 ................................. in Swedish Financial Stability Policy 2010-2015.................... Individuals and Organizations interviewed by the Evaluators.................... As part of the follow-up and evaluation by the Riksdag, commissions an external and independent review of Swedish monetary policy every four years. Two reviews have been carried out thus far. The first was performed by Professors and and covered the period of 1995–2005 (2006/07:RFR1). The second was performed by Professors and and covered the period of 2005–2010 (2010/11:RFR5). In 2014, decided to commission a new, third review of the monetary policy for the period of 2010–2014. In conjunction, the Committee appointed , former Governor of (2003–2013) and Professor of , to jointly carry out the evaluation. and have chosen to extend the period of evaluation to include the developments during most of 2015. The focus of the new review is on reviewing and analysing the setting of Swedish monetary policy during the relevant period, the balancing of various risks against one another, the work of , the formulation of the inflation target and the Riksbank’s forecasting activities (the directive is explained in greater detail in an annex to the report). and began their work in January 2015 and have visited several times over the last year to information and discuss Swedish monetary policy and financial stability with various persons involved. Among others they have met with representatives of the Riksbank, the , the Riksdag, (the Audit Office), the social partners in the labour market, (the Swedish Financial Supervisory Authority), academia and the banks. Economist acted as evaluation secretary for King and Goodfriend. The results of the review are presented in this report from the Riksdag. hopes that the review will further stimulate the already lively debate on Swedish monetary policy and provide a valuable contribution to the future setting of the monetary policy. will be circulating the review to various consultation bodies during spring and will thereafter present a report on the evaluation and the consultation responses to the Chamber of the Riksdag. , 19 January 2016 Deputy Chair of the Com- In 2014 we were invited by to conduct a Review of the performance of the Riksbank over the period 2010 through 2014. is wide-ranging, covering both monetary policy and financial stability, the structure, transparency and accountability of the Riksbank, and the relationship between the Riksbank and other official bodies concerned with economic policy, especially in the area of financial stability. Following the global financial crisis in 2007-09, the Swedish economy started to recover rather quickly. Interest rates, having been cut sharply during the crisis, were raised slowly in 2010 and 2011. Subsequently, this tightening of monetary policy proved highly controversial. That debate is at the heart of our Review. When assessing the rights and wrongs of monetary policy decisions, it is important not to make judgements with the benefit of hindsight. sets out to analyse and discuss the decisions that were made in the light of the information available to participants at the time. Following the traumatic experiences of the early 1990s, with the banking collapse and sharp depreciation of the krona, the subsequent period of monetary policy has been one of remarkable success under at times difficult circumstances. The Riksbank was asked to achieve stable prices, and in large part it has done exactly that. It is clearly a success compared with most previous policy regimes in . The fact that today small deviations of consumer price inflation from its target are seen as a failure is testimony to earlier success and evidence of a misplaced degree of hubris in expectations of the ability of any central bank to control the economy. During the period covered by our Review, there were serious divisions among . We comment below on the positions taken and their respective merits. The issues that divided the Board were major intellectual challenges thrown up by the global financial crisis and its aftermath, albeit it is fair to say that the Riksbank was confronted with even bigger challenges than were faced by other central banks. Around the world, central banks are debating the appropriate objective of monetary policy and no international consensus has yet been reached. The experience of is of importance to the rest of the world as well as to its own citizens. Prior to the global financial crisis of 2007-09, the Swedish economy appeared in good shape. Growth and inflation were performing satisfactorily, there was a sound banking system, the fiscal position was strong, and in terms of conventional macroeconomic indicators there seemed no obvious problem on the horizon. But underneath this apparently calm surface, as with other major economies, tensions were growing. House prices and mortgage debt were rising rapidly at double digit rates, there was a growing maturity and currency mismatch in the banking system, and the trade surplus was unsustainably high. When the crisis intensified in the fall of 2008, was GDP fell from 2008/Q3 to 2009/Q3. sharp downturn there was a strong rebound in 2010, more so in than in most other countries. Since the start of our Review period in February 2010, monetary policy in has come full circle – from a repo rate of close to zero, rates were gradually raised as recovery took hold, and then were cut again as recovery disappointed until today the repo rate is actually negative. Our evaluation of this journey and the monetary policy conducted by the Riksbank from 2010 onwards leads to six main conclusions: First, the response of the Riksbank to the rapid recovery of the Swedish economy from the global financial crisis – which entailed raising official in- terest rates from to between 2010 and 2011 – was broadly accepted by all members of , and appears not unreasona- ble in the light of all the information available to the Riksbank at the time. Nevertheless, the need to accommodate the consequences for domestic prices of the sharp fall in the exchange rate could have justified a temporary over- shooting of the inflation target. Although the downturn of the Swedish econ- omy in 2008-09 was similar to that in other industrialised countries, the re- bound in the Swedish economy, particularly marked in exports, was more rapid than elsewhere and led to a shared view that it was justified to begin the process of raising rates. Moreover, although there were differences of judge- ment on the Board – and it would in the circumstances have been very surpris- ing if there had not been – those differences were small. view expressed in the minutes were well within the bounds of reasonable dif- of judgement about the outlook for the economy and for inflation, and the robust discussion helped to ensure that all possibilities were considered. Second, the situation started to change in late 2011 and 2012. second part of the period covered by our Review, the Riksbank was slow to realise the extent of the problems in the euro area and, especially during 2013, the majority was slow to cut interest rates. This problem was exacerbated not only by overoptimistic judgements about economic growth in the euro area but also by assumptions about the likely paths of interest rates overseas that were significantly out of line with expectations in financial markets. those assumptions was that the forecasts for future inflation were much higher than actual outturns. By far the most serious problem, however, was the grow- ing discrepancy between the future path for the repo rate forecast by the Riks- bank itself and the future path implied by prices in financial markets. divergence created problems for both the majority and minority positions on For the majority, the problem was that it was advocating a signifi- cant future rise in the repo rate and so a much tighter monetary stance than was actually being implemented, and yet inflation was falling below target. For the minority, there was a tension between the two different arguments that On the one hand, their rather aggressive criticism of the ma- jority position was based on forecast simulations using the assumption that monetary policy was actually described by the published desired repo rate On the other hand, the lack of market credibility in the Riksbank’s published repo rate path made it increasingly difficult to attribute bad outcomes to an overly tight monetary policy when market expectations were of a continuing lower repo rate. The one conclusion that can safely be drawn is that forecasts, and policy, should not be based solely on forecasts from a model that assumes full credibility in the stated policy path. There must be room for judgement about the credibility of the inflation target and the path of policy. Third, it is striking that all members of devoted so much time to thinking about the future path of the repo rate and to providing guidance as to their views on how it should evolve over the following three years. There is something surreal about the precision of the guidance provided by individual board members as to the future path of the repo rate when contrasted with the sheer uncertainty about the future and the fact that markets took rather notice of the published path in determining their own expectations. It became too easy to paper over major differences of view on the current stance of policy by expressing them in terms of differences of view about the likely future path of the policy rate. We recommend that the Riksbank should conduct and publish (i) a review of its experience with the announcement of a future path for the repo rate, and (ii) a post-mortem on the substantial deviation of market expectations from its published forecasts during the period covered by this Review. Fourth, there was heavy reliance, among both the majority of the Board and the dissenters alike, on forecasts produced by models developed by Riksbank staff. Although such models are useful in putting together consistent quantitative forecasts, inevitably they are based on strong assumptions and can act as no more than a starting point for a discussion of the challenges facing monetary policy at any particular juncture. They cannot be used mechanically. At no time was this note of caution about the use of models more relevant than in the immediate aftermath of the global financial crisis. Models that not only didn’t, but couldn’t by their nature, predict the crisis were unlikely to tell the whole story of the difficulties facing economies during the recovery phase. A greater degree of humility about those models would have been appropriate. The minutes of the Monetary Policy Meetings reveal remarkably challenge to the results from model simulations from either the majority or minority members of the Board. One important failing of the models used was the assumption of complete credibility in the willingness and ability of the Riksbank to hit the inflation target. The forecast of inflation always returned to over the medium term. The presumed credibility of the inflation target gave a false sense of confidence in its own strategy which encouraged a belief that persistent departures of inflation below could not undermine credibility in the target. By 2015 that confidence was being sorely tested. An important role for members of is to challenge the assumptions of models used to generate quantitative forecasts so that there can be a full discussion of all relevant aspects of the outlook before members reach their policy judgements. Fifth, tensions among members of , while not leading to significant differences in policy judgements in 2010 and 2011, grew in 2012 and spilled over in 2013 into disagreements not only about the setting of inter- est rates but also, and significantly, about the objectives of policy. that by 2012 the majority on were sufficiently concerned about developments in house prices and the growth of household credit to set the repo rate at a level higher than was justified by a strict application of tar- inflation two years ahead. All central banks have struggled to reconcile the inflation targeting framework used before the crisis with the existence of economic and financial “imbalances” in the economy which both contributed to the crisis and also affected the recovery from it. From our conversations it is clear that the majority on were concerned about the impact of rising asset prices and indebtedness on the economy and felt that if no-one else was going to do something about it then they should. that they would be damned if they did and damned if they didn’t. bank, therefore, took it upon itself to allow concerns about financial stability to affect decisions on monetary policy. The dissenters on the Board took a much narrower view of the commitment to price stability which reflected a particular view of how the economy worked. They believed that policy should aim to set interest rates in order to meet the inflation target looking 18 months to 2 years ahead based on forecasts of inflation generated by a particular set of As a result, the two sides talked past each other. particularly Swedish about this debate. At the international level, the two views represented in by the majority and minority on the Executive Board are reflected in the positions of (BIS) and the Federal Reserve, respectively. Neither side has a monopoly of wisdom. difficulties that beset policy at the time was the failure of the Government to decide which body should have the responsibility for financial stability. concerns of the Riksbank were reinforced when in the spring of 2015 Finansin- spektionen withdrew proposals to make households amortise their mortgages because, although accepting that such proposals were necessary, they felt they did not have a sufficiently clear legal mandate to proceed. The Riksbank’s task has been made much more difficult by the dithering of the Government in introducing a clear regime for macro-prudential policy. Sixth, the success of the decision-making process in the Riksbank is heav- ily dependent on the willingness of Board members to respect each other’s viewpoint and to use the Monetary Policy Meetings to further a collective un- derstanding of developments in the economy and the appropriate response of Differences of view and judgement are an important part of this process, but they must be expressed in a conducive to the collec- tive venture on which the Riksbank is embarked. A key part of the structure of is that each individual has one vote and is enti- tled, indeed required, to express clearly their own view on the stance of mon- This is a strength of the process. A healthy debate benefits from such differences of view. Explanations of those differences are essential to the promotion of greater understanding among the wider public of the challenges facing monetary policy. It is evident from the minutes and public comments made by members of the Board that respect for others’ viewpoints was not always present during the period covered by our Review. The extent of divisions, and in particular the way they were expressed, was damaging to the reputation of the Riksbank. Members of the Board must remember that their role is to present coherent arguments in a reasonable and persuasive fashion. If they use language which is designed to attack other members of the Board the public standing of the Board is damaged. It was not helpful that minutes and interviews by Board members displayed a degree of brusqueness uncharacteristic of normal public debate in . Compared with the early years of Monetary Policy Meetings, the minutes during much of the Review period became extremely long and contained mainly the views of dissenters, the majority view being expressed in the regular Report. The minutes no longer represented a to-and-fro between different viewpoints on the Board, and did not reflect the balance of discussion. It is not helpful for the majority and minority to express their views in differing formats. There needs to be a degree of collective discipline in how the minutes are produced. The minutes should cease to be a detailed and uneven record of submissions by individual members and should contain a more balanced explanation of the decision reached by the majority and the arguments against that put forward at the meeting by the dissenting minority. The full list of our fifteen recommendations is contained in Chapter 2. 2 List of Recommendations We list below our recommendations under four subject headings: 1.The Riksdag, on a recommendation by the Finance Minister, should specify the inflation target, in terms both of its definition and its numerical value, and should delegate that objective to to achieve. At present, we recommend a target of a year as measured by CPIF. The target should be reviewed every ten years unless the Riksdag legislates to change the target earlier than the next due review date. 2.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 , 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 . 3.The Riksbank should re-examine its methods for producing forecasts for both the world economy and overseas interest rates to help focus on the big issues surrounding the outlook. should explain in more detail the basis for the assumptions about overseas growth and interest rates. 4.The Riksbank should conduct and publish (i) a review of its experience with the announcement of a future path for the repo rate, and (ii) a postmortem on the substantial deviation of market expectations from its published forecasts during the period covered by this Review. 5.As a matter of course the Riksbank should publish in its Monetary Policy Reports an analysis of why in its view there is a divergence between its published repo rate path and market expectations of the repo rate path, and what implications it believes any such divergence has for the setting of monetary policy. 6.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. 2 LIST OF RECOMMENDATION 7.The Government should ensure without further delay that has the legal powers and range of macro-prudential instruments appropriate to its role in promoting financial stability. 8.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. 9.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. 10.In 2020 the Government should ask a small group of experts to carry out a review of the allocation of responsibility for macro-prudential policy between and the Riksbank. Accountability of the Riksbank: 11.The Finance Committee of the Riksdag 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. 12.The minutes should attempt to record the differing points made at the meeting and not a sequence of individual formal presentations. Longer analyses by particular members should be made available publicly in speeches. 13.The Riksbank should augment the current minutes with minutes of the meetings where the is decided – at the First or Meetings and also Forecast Meeting. Those minutes could then be released to the public together with the current minutes two weeks after the Monetary Policy Meeting. 2 LIST OF RECOMMENDATIONS 14.The Executive Board 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. 15.The Finance Committee of the Riksdag should invite to submit recommendations for amendments to the Riksbank Act. In 2014 we were invited by to conduct a Review of the performance of the Riksbank over the period 2010 through 2014. The terms of reference of our Review are set out in 1. As the Review progressed, and we took evidence from a large number of witnesses, it became clear that we could not ignore developments in the period immediately prior to 2010, which included the global financial crisis, nor to overlook the significant developments in monetary policy during 2015. is wide-ranging, covering both monetary policy and financial stability, the structure, transparency and accountability of the Riksbank, and the relationship between the Riksbank and other official bodies concerned with economic policy, especially in the area of financial stability. started its work in January 2015 and was submitted to the Riksdag at the end of for translation into Swedish. We are grateful to , and to of its Secretariat, for their help and cooperation in providing us with the facilities required to conduct this Review. We are particularly indebted to of the Riksbank who was seconded to work with us during 2015. His help in guiding us through the maze of documents relevant to our Review and in organising our visits to in order to interview the relevant participants went beyond the call of duty. His wise guidance, good humour and counsel were immensely valuable, but he should not be held responsible for any of the observations and conclusions set out below. We visited three times for several days each in order to conduct interviews with all the relevant participants both at the Riksbank and elsewhere. We interviewed every member who served on during the period 2010-15. We also interviewed members of (the Swedish Financial Supervisory Authority), a number of independent economists, and others with views and experience of monetary policy in .