rfr · H30WRFR7 · 2016-01-19 00:00:00 — If household indebtedness began to increase significantly again for some reason, then those responsible for various policy areas in should discuss conceivable measures to limit risks in this area” (Minutes, p. The Swedish economy again showed surprising strength at the Monetary Policy Meeting. GDP increased by nearly at an annualized rate in the second quarter of 2012, fuelled by surprising strength in exports. Swedish GDP growth for 2012 was revised up since from to ; and exports were expected to grow in 2012 instead of -. But such strength was not expected to last and inflation and unemployment forecasts in the main scenario were changed from . One surprise was the sharp appreciation of the exchange rate since -- the krona rose as much as both against the euro and in trade-weighted terms to its strongest level in over ten years. A second significant surprise was a fall from to in the forecast of unit labour cost inflation for 2012, due to the upward revision of productivity growth for 2012 from to . Developments in the euro area continued to deteriorate as expected. decided to cut the repo rate to and keep it there until mid-2013 before planning to raise it gradually to at the end of the three-year forecast period. Swedish markets now expected the repo rate to be just over at the end of 2012, much as in . justified the lower repo rate saying: “Developments in countries important to are currently expected to be relatively weak. This means that GDP growth in will also be relatively weak in the coming year. It is therefore likely that the very rapid growth during the first half of the year will push up inflation, particularly as the high GDP growth has gone hand in hand with an unexpectedly high productivity growth. This, together with a faster appreciation of the Swedish krona than expected, means that cost pressures and inflation will be lower than was assessed in ” (MPU, p. entered reservations against the Monetary Policy Update, the decision about the repo rate, and the repo rate path. He advocated cutting the repo rate to , and a repo rate path that stays at from Q4 2012 through 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 Q4 2013 and then rises to by Q4 2014. He thought the Update's forecasts of foreign rates further ahead and foreign growth were too high. entered a reservation against only the repo rate path in the Mon- etary Policy Update. She advocated lowering the repo rate to during the autumn, this level through Q3 2013, and then increasing the repo rate to by Q4 2014. During the meeting, explained why given the concerns he ex- pressed at the meeting about the potential threat to financial stability that might arise from cutting the repo rate, he had now changed his mind. soned in terms of the inflation forecast in the main scenario: “…that the answer to the question of why he now thinks the repo rate should be cut, but did not think so earlier is quite simply that some deviation from the inflation target can be tolerated, but that one cannot aim for a future inflation that never quite reaches the target over the coming years. In 's view this could only be acceptable in very exceptional circumstances. circumstances did not exist” (Minutes, p. Later, asked why did not advocate an even lower repo rate right now and an even lower repo rate path in the coming period, given that the policy wished to conduct left inflation under his own judgement below the target for the entire forecast period (Minutes, p. replied that was correct and that “it would be better with a repo-rate path that gives a forecast for CPIF inflation that over- shoots the target in order to push down unemployment a more” (Minutes, Then, reiterated a point he had emphasized at earlier policy meetings that “it is difficult and that there are unfortunately not suffi- cient resources at the Riksbank to perform a thorough analysis of repo-rate paths and forecasts that lie far away from the main scenario” (Minutes, p. October 2011 Minutes, p. Growth in the and the euro area were changed at the October 2012 Monetary Policy Meeting. The Riksbank still assumed that sufficient measures would be taken in the euro area so that the crisis did not worsen dramatically. Unemployment in was forecast to rise in 2013 to from the estimate of because more people had entered the labour force than had found work and because it had been taking longer for job seekers to find vacant positions. The forecast for CPIF inflation for 2013 was revised down significantly from in to on falling energy prices. The main scenario still showed inflation rising to decided to keep the repo rate at and to lower the published repo rate path relative to by about 50 basis points to by late 2015, the end of the three-year forecast horizon. justified the policy action saying: “As monetary policy affects the economy with some time lag, an immediate repo-rate cut would probably have only minor effects on the low inflation rate 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 and economic activity in the coming year...[and] there is a risk that CPIF inflation would rise above 2 per cent in a few years' time. A lower repo rate could also further increase the risks linked to households' high indebtedness…[but a] lower repo-rate path means that household debts as a percentage of disposable income will not increase but remain at the current levels” (MPR, p. The market’s expected repo rate path changed from , with the repo rate going below by early 2013 and staying there through 2015. On this basis, the lower published repo rate path appeared to have actual effect on market expectations (MPR, p. dissented against the unchanged repo rate and the repo rate path, advocating instead a repo rate and a repo rate path lowered further to until the end of 2013, and then raised to . dissented against the , the unchanged repo rate, and the repo rate path, advocating a repo rate, and a repo rate path lowered further to from Q1 2013 to Q1 2014, and then raised to . He thought the Report's forecasts of foreign policy rates further ahead and foreign growth were too high. At the meeting, Board members debated the extent to which the euro area would work through its banking and other structural problems without significantly worsening its economic . There was also much debate about the extent to which it was necessary, feasible, or desirable to take account of housing prices and household indebtedness in the monetary policy decision. According to , the argument for doing so comes down to this: “[He] found it hard to ignore the fact that so many countries had run into problems with excess indebtedness in one way or another, and that so many had previously been certain that this indebtedness would not be a problem. [He thought] this called for a precautionary principle to be applied” (Minutes, p. argued that it was not necessary, feasible, or desirable for monetary policy to take household indebtedness into account at all. expressed some sympathy for doing so, but thought that under the circumstances it was more important according to model simulations to lower the repo rate path in order to bring inflation back to target faster and unemployment down to a sustainable rate more rapidly. During the discussion supported the majority decision saying that “[i]nflation being below the inflation target for a certain period of time is a ‘cost’ that can be accepted if it means that the risk of a really bad development of household debt can be reduced a ” (Minutes, p. 's comment is interesting for two reasons. First, it is implicitly an argument against choosing the repo rate path by looking solely at deviations of inflation and unemployment from target over a conventional forecast period of around two years, as continually advocated. Second, both sides in the debate accept the veracity of the main scenario and alternative model forecast simulations presented in the . 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 sides have confidence in the model forecast simulations and are willing to make their arguments in terms of the model forecast simulations. Of the three, only worried about the credibility of the inflation forecasts, observing that: “given the fact that average inflation has been below 2 per cent since the introduction of the inflation target…it is unfortunate that this tendency will now be reinforced in that inflation will be below the target [in the main sce- nario] until into 2014 [and] this may reduce confidence in the inflation target” (Minutes, p. She was also sceptical of the assessment that the effect of a repo-rate cut would be delayed saying that “[m]uch probably depends on how the exchange rate is affected and on how much of an impact exchange rate fluctuations have on inflation -- and this impact can occur relatively rap- idly…[b]ut if the effect of repo rate changes is delayed, this would suggest that the repo rate should already have been lower today. Because then, a long period with inflation below target could have been avoided” (Minutes, p. Growth in 2013 were marked down again in the euro area from to -at the Monetary Policy Meeting. growth in the euro area and 's QE3 stimulus led monetary policy expectations in the long term in both economies to fall closer After showing strength throughout , GDP growth in slowed in Q4 2012. Private consumption in 2013 was now forecast in the main scenario to grow by instead of ; GDP growth in 2013 was revised down from to ; unemployment was forecast to average in 2013 revised up from . 2013 was revised down from to , but still forecast to rise to by cut the repo rate to and published a repo rate path through 2013 before raising it gradually to at the end of 2015. ing on Swedish money markets indicated that the Riksbank was expected to cut the repo rate to by the end of 2013. Explaining its policy action admitted that weak devel- opments abroad were now having a greater impact on growth in than was previously expected. It mentioned that households' debts as a percentage of their incomes were at a relatively high level, over , and added that the debt ratio was expected to remain at approximately this level during the fore- cast period (MPU, p. supported the decision to cut the repo rate to , but she dis- sented against the repo rate path, advocating instead lowering the repo rate to at the beginning of 2013 until Q1 2014, and then raising it to by the end of 2015. dissented against the Monetary Policy Update, the repo rate decision, and the repo rate path, advocating a repo rate, and a repo rate path lowered further to from Q2 2013 to Q1 2014, and then raised to by the end of 2015. He thought the Update's forecasts of foreign policy rates further ahead, foreign growth, and Swedish inflation were too high. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 assessment was that his lower repo rate path would not noticeably affect any risks associated with household indebtedness since monetary policy normally has very small short-run effects on household indebtedness and with low and stable inflation no long-run effects either. A new element in the debate on the Board was a questioning of the inflation forecast in the main scenario. From 2010 onwards CPIF inflation forecasts had systematically overestimated CPIF inflation for 2012. The forecasts rose fairly quickly to 2 per cent while actual outcomes show a downward trend since 2010 from to below . In light of this, asked “whether it is worth missing bringing inflation up to around 2 per cent and bringing down unemployment to some form of sustainable long run level, to try to influence household debt with the repo rate. [She] did not think it was. She said that it entails considerable economic costs in exchange for something that is highly unlikely [to be] attained using the repo rate. All of the calculations made by the Riksbank so far imply that the repo rate has very effect on households' indebtedness…At the same time, it has substantial effects on inflation and resource utilization”. “…[I]t was in the years before the financial crisis that the growth rate in lending to households reached double figures. Then there really was a wind to lean against. Now, however, credit growth is below 5 per cent at an annual rate and has been so for most of this year. It appears that housing prices have been rather stable over the last two years. So why pursue such a leaning against the wind policy now?” (Minutes, p. , who had joined in January 2012, thought that “it was unfortunate that so much of the focus of today's discussion had been on household indebtedness. Now that is facing a serious downturn she believed that the international outlook and domestic demand were the most important issues to evaluate. It was important to keep the discussion focused on how different scenarios would affect the development of the economy and on what monetary policy alternatives are available … to attain credibility it is important that monetary policy is seen in the perspective of a focus on the inflation target” (Minutes, p. Phase 4: Another Pause for Thought, February 2013-October 2013 At the February 2013 Monetary Policy Meeting economic developments in and abroad were largely in line with the assessment and the main scenario forecasts remained more or less unchanged. Swedish GDP contracted in Q4 2012, unemployment was still expected to exceed in 2013, and a second consecutive year of CPIF inflation was forecast for 2013. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 decided to keep the repo rate at until early 2014 and then expected to raise it gradually to , much as expected in 2012 (MPR, p.17). The repo rate path expected in money markets in early 2016 rose by about 50 basis points from to around (MPR, p. explained its policy action as follows: “Since , the Riksbank has lowered its interest rate from 2 to 1 per cent. Monetary policy affects the economy with some time lag, which means that the effect of these cuts has not yet made a full impact on economic activity and inflation. Cutting the repo rate further in the present situation would probably have very minor effects on the low inflation and economic activity in the short run, but as monetary policy is already expansionary, there is a risk that CPIF inflation would be above 2 per cent towards the end of the … With regard to the labour market, the relatively high un- employment rate is partly explained by structural factors. This means that it would be difficult, even with a more expansionary monetary policy, to attain a significantly lower rate of unemployment in coming years. policy would also risk contributing to an even higher indebtedness and make households more vulnerable to shocks. The latter in turn entails greater risks of large fluctuations in resource utilization in the future” (MPR, p. dissented against the decision to maintain the repo rate at and also against the repo rate path, advocating a repo rate and a repo rate path at through Q1 2014 rising to around by early 2016. dissented against the , the unchanged repo rate, and the repo rate path, advocating a repo rate, and a repo rate path that would stay at through Q1 2014 rising to by early 2016. His reasoning was identical to his dissent. The discussion at the meeting was again taken up with debate about house prices and household indebtedness in in relation to monetary policy. The following comments are of particular note. observed that it was “unclear what it is that will drive inflation up to 2 per cent given the weak situation on the labour market throughout the forecast period and the forecast that the exchange rate will remain largely un- changed” (Minutes, p. also expressed concern that the high rate of unemployment might become entrenched. And she reiterated that it was “important that inflation does not remain far below 2 per cent for too long in order to prevent a loss of confidence in the inflation target” (Minutes, p. Asked by to clarify which part of the inflation forecast she did not agree with, pointed out that “growth in unit labour costs is expected to fall from just over per cent to below 2 per cent in 2014 and 2015. With falling growth unit labour costs and an in principle un- changed exchange rate, which means that there is no inflationary impulse from import prices, what is it that will make inflation rise?” (Minutes, p. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 Governor Ingves had earlier expressed concern about just the opposite risk, worrying that “[k]eeping the repo rate very low in this situation could contribute to inflation overshooting the target. There is a risk that the inflation target will lose its role as anchor. can one disregard the significance of risk linked to low interest rates for over-indebtedness in various sectors” (Minutes, p. Forecasted 2013 GDP growth in the euro area was marked down slightly again to -at the Monetary Policy Meeting compared with February. And forecasts in the main scenario were largely in line with those from February with two notable exceptions. First, after having levelled off in 2011, household debt as a percentage of disposable income was now forecast to grow from the current to just over at the beginning of 2016, revised upward from expected growth in February (MPU, p. 5 and p. Second, the CPIF inflation forecast for 2014 was revised down sharply from to ; nevertheless, CPIF inflation in the main scenario was still forecast to average in 2015 and CPIF inflation was still forecast at for 2013. The Monetary Policy Update explained the lower inflation forecast for 2014 as follows: “Inflation in 2012 was lower than expected by the Riksbank and other forecasters. The Riksbank's interpretation of this, as presented in the report Ac- count of Monetary Policy 2012, is that it was mainly due to the international economic activity weakening to an extent that surprised both the Riksbank and other analysts. The unusually weak international economic activity probably had a direct effect on inflation, but may also have had an indirect effect. There are signs that companies raised their prices less than normal in relation to costs and demand. the past two years, unit labour costs have increased by around 2 per cent per year, at the same time as CPIF inflation has been around 1 per cent. This supports the assessment that companies now have more limited opportunities to pass on their higher costs to consumer prices”. “Given this, the Riksbank now assess that prices will also be raised slightly more slowly in the coming years, in relation to costs. Other factors pointing to lower inflation are the forecast for the exchange rate, which is now stronger for the entire forecast period than it was in February. All in all, the forecast for inflation in 2014 has been revised down, despite domestic cost pressures remaining roughly unchanged since the assessment made in February” (MPU, pp. decided to keep the repo rate at , and expected to begin increasing the repo rate in the second half of 2014, about one year later than in February, to at the beginning of 2016. justified the policy decision as follows: “…Since , the Riksbank has halved the repo rate from 2 to 1 per cent and monetary policy is currently very expansionary. There are now signs of an improvement in economic activity, at the same time as housing 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 prices and debt are increasing more quickly. However, the Riksbank now as- sesses that it will take longer before inflation begins to rise and that CPIF in- flation will not reach 2 per cent until 2015. Although an even lower repo rate would mean that inflation approached the target more quickly during the fore- cast period, it would further increase the risk of imbalances up. imbalances can become particularly difficult to manage if developments were to move towards a strong upwards trend in both housing prices and debt. important to prevent this from happening. A number of measures have been taken by various authorities in recent years, such as the introduction of a mort- However, there is great uncertainty over the effects of these measures and whether they are sufficient. Swedish authorities and other par- ticipants should therefore consider carefully whether further measures are needed to ensure that developments in the Swedish economy are sustainable in the long run” (MPU, p. again dissented against the decision to maintain the repo rate at and against the repo rate path, as she had done in February, advocating a repo rate and a repo rate path at through Q3 2014 rising to only by early 2016. dissented against the Monetary Policy Update, the unchanged repo rate, and the repo rate path, advocating a repo rate, and now a repo rate path that stayed at from Q3 2013 through Q3 2014 rising to by early 2016. He reiterated his reasoning from and February, add- ing this time that the Update's CPIF forecast exaggerated inflation pressure, and that his lower repo rate path might increase the household debt ratio by a couple of percentage points within a couple of years, but not in the long term, and that it would not have any noticeable effect on any risks associated with The divisions between the majority and the minority on the Executive Board intensified considerably and became more evident at this policy meet- and explained at length why they thought taking household indebtedness into account was a mistake. son said that the Riksbank had been holding back the recovery in fol- lowing the global financial and debt crisis in “an ineffectual and misguided attempt to limit household debt,” and that as such “monetary policy conducted in recent years was a clear and serious failure” (Minutes, p. referred to the abovementioned reasoning given for the Executive Board policy decision in the Monetary Policy Update as “among the most con- fusing and vague pieces of reasoning that he had encountered during his almost six years at the Riksbank” (Minutes, p. The following paragraphs summarize 's views on the matter, and to a great extent reflect those of as well: noted that the substantial downward revision of the inflation forecast put the Riksbank “more in line with other forecasters, who did not believe in a rapid rise in inflation to 2 per cent”. She asserted that “arguments 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 against cutting the repo rate in the near term were not tenable,” as “[t]he starting point was already that inflation is expected to be below the target level for most of the forecast period, and unemployment is expected to be fairly high above what can be considered a long-run sustainable level”. She added that “[w]hen making a substantial downward revision to the forecast for inflationary pressures, it ought to be fairly self-evident that the repo rate needs to be cut…” and that “failing to cut the repo rate in this situation…could make external analysts more convinced that the Riksbank has abandoned the inflation target as the basis for its monetary policy decisions” (Minutes, p. She argued that “given the emphasis put on the potential increase in risks connected with household debt if the repo rate were cut, one would expect a thorough analysis of what these risks are and how monetary policy affects them. But in her opinion there were only fairly loose claims that a lower repo rate would increase the risk of imbalances up, and that such imbalances would be difficult to manage if there was an upward trend in housing prices and debt. There is no explanation of what the imbalances consist of nor how monetary policy is expected to influence them. There is merely a claim that they would be difficult to manage if there was an upward trend in housing prices and debt. An upward trend has been noted for a fairly long time since the mid-1990s, and this does not appear to have been particularly strongly linked to the repo rate” (Minutes, pp.