rfr · H30WRFR7 · 2016-01-19 00:00:00 — “One indication that monetary policy is effective is that inflation has stopped falling and that various measures of underlying inflation have begun to rise. This is despite the continued downward pressure from abroad on inflation. A further indication that monetary policy is working is…that the reporate cuts [to negative] have had the expected impact on market rates. Above all, banks' lending rates have fallen roughly as they usually do when the repo rate is cut” (Minutes, pp. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 also made known that even though he dissented against bond purchases in February, he supported bond purchases in and April. also expressed optimism noting that the three new monthly in- flation outcomes since February had in general been higher than the Riks- bank's forecast. He went on to describe promising survey evidence on infla- He reported that expectations of inflation five years ahead among participants in money markets were in January, in Feb- ruary, and about in and April (Minutes, p. Governor Ingves pointed to the fact that the actually gets paid for borrowing at maturities of just over five years as evidence of the ex- ceptionally expansionary stance of monetary policy (Minutes, p. At the 2015 Monetary Policy Meeting, GDP growth abroad largely developed as had been expected in April. The forecast of inflation abroad in 2015, dragged down by sharply lower oil prices earlier in the year, was also changed from April at in the euro area, and in the United Swedish GDP growth in 2015 was revised down from to but was forecast to average around in 2016 and 2017, slightly above its recent historical trend, with productivity expected to grow by around in 2017, and unemployment expected to average in 2015 and in 2017. Although also dragged down by sharply lower oil prices, CPIF inflation in 2015 was forecast to be , changed from April and significantly higher than in the euro area or the . CPIF inflation was forecast to average in 2016 and 2017. decided to cut the repo rate by 0.1 percentage points to -until the end of 2016 and then raise the repo rate to by Q3 Market expected repo rates conformed closely to the Riksbank's pub- path until the end of 2016, and then turned up more slowly to only about 25 basis points in mid-2018. also decided to extend the purchase of government bonds by billion until the end of the year. The purchases decided upon in April were expected to be concluded in , by which point the new purchases would be initiated. By the end of the year, the Riksbank was ex- pected to have carried out purchases of government bonds to a total value of This corresponds to around 20 per cent of the outstanding stock of nominal government bonds and around 4 per cent of GDP. continued to buy government bonds at the same pace, their purchases at the end of the year would correspond to around 7 per cent of the stock and 4 per cent of GDP. emphasised that it was prepared to lower the repo rate further and extend its bond purchases if inflation fell short of expectations. And among other options, the Board said it was prepared to intervene on the foreign exchange market if the upturn in inflation was threatened as the result of, for instance, a very problematic development of markets (MPR, pp. justified the additional easing of policy as follows: 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 “There is still considerable uncertainty, even though developments are heading in the right direction. Economic activity is strengthening in the euro area, but several countries are still being held back by high indebtedness and as-yet unresolved structural problems. The recovery could weaken again if confidence among households and companies were to fall for some reason. In this sensitive situation, the course of events in constitutes a tangible risk. If the situation deteriorates, unease may spread to other countries in the monetary union. Since the monetary policy meeting in April, the foreign exchange and fixed-rate markets have been characterised by continued high volatility. For example, interest rates and exchange rates are being influenced by the ECB's ongoing asset purchases and by uncertainty over the timing and pace of the approaching interest rate increases in the . The Swedish krona has appreciated against several currencies and the trade-weighted exchange rate is therefore stronger than in the forecast from April. Uncertainty and the relatively large fluctuations on the foreign exchange market are making it difficult to assess how the exchange rate will continue to develop. If the exchange rate were to become too strong in relation to the Riksbank's forecast, this would mean slower increase in prices of imported goods and lower demand in the Swedish economy” (MPR, pp. dissented against cutting the repo rate; he thought it sufficient to extend and prolong the purchases of government bonds in the current economic situation. At the policy meeting members considered evidence of the effectiveness of monetary policy in raising inflation, the risks to the forecast in the main scenario, and the feasibility and desirability of the various policy options available to ease monetary policy further if need be. Three key concerns, in particular, were discussed at the policy meeting as determining whether monetary policy would soon return inflation to and preserve the credibility of the inflation target. These concerns are summarized below. First, after having been reasonably well-anchored throughout the period of inflation targeting, and above since 2010, expectations of inflation fiveyears ahead in the Prospera survey had fallen below since mid-2013 (MPR, p. cited the two new surveys of inflation expectations since April. He noted that five-year expectations of both employer and employee organizations had increased, from 1.76 to 1.89 per cent and from 1.72 to 1.81 per cent, respectively. For all groups in the quarterly survey, five-year expectations rose from 1.73 to 1.78 per cent. But five-year expectations of money market participants remained stable at 1.85 per cent (Minutes, p. Second, the pointed to the depreciation of the krona since the start of 2014 as an important factor contributing to the recent upturn in inflation. According to the trade-weighted (KIX) nominal exchange rate, the krona depreciated by a more than 10 per cent since the start of 2014 to early 2015 as the repo rate was cut from in to below zero. But since early 2015 the KIX had given back around 3 per cent 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 of that depreciation (MPR, Figure 4:6, p. 26; see also Figure 5). to the risk to the main scenario of an appreciating exchange rate, noted that “[f]or a small, open economy like 's the exchange rate chan- nel is always of major importance. Furthermore, in a situation where domestic and real economic conditions have not impacted inflation as expected, the ex- change rate channel is even more significant. Bearing this in mind, [he said it was important] that the krona exchange rate does not appreciate further in the months ahead but instead weakens somewhat from its current level, as is also predicted in the draft monetary policy report” (Minutes, p. Third, the noted that “collective agreements for almost 3 million employees expire in 2016, as early as the end of 2016 for more than half of these including sectors such as manufacturing, construc- tion, and retail trade. Towards the end of 2015, negotiations between trade unions and employer organisations will begin within major parts of the indus- Since the Industrial Agreement was first signed in 1997, wage formation in has been marked by a high degree of compliance between different contractual areas. The industrial sector has set the norm for the level of percentage wage increases in the collective agreements, and other contrac- tual areas have normally signed agreements with basically the same percent- age wage increases” (MPR, p. observed that judging by various statements put out by em- ployee organisations, there was now a risk of the inflation target not forming the basis of next year's wage negotiations, and that that would make it much more difficult to keep inflation on an upward curve. He blamed the problem, in part, on the fact that many continue to focus blindly on the current CPI inflation rate, which is forecast for 2015 to be an exceptionally low largely because it takes account of the Riksbank's own repo rate cuts. pointed out that CPIF inflation (which excludes the repo rate effect from CPI) is forecast to be about in 2015, and that CPIF inflation excluding energy prices is forecast to be , and that both are better measures of inflation in this context than CPI inflation (Minutes, p. On the whole, the main scenario at the Monetary Policy Meeting showed much the same forecast profile for growth abroad and in as in , though great uncertainty still prevailed concerning devel- opments abroad, especially with regard to . CPIF inflation in 2015 was revised down to from in , but still was expected to reach in 2016; and CPIF inflation excluding energy was forecast exactly as in to be in 2015 also rising to in 2016. unanimously decided to hold the repo rate unchanged at -, to follow through on purchases of government bonds until the end of the year as decided in , and not to start slowly raising the repo rate until the second half of 2016. justified continuing its highly expansionary monetary policy much as in . 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 , who had joined the Board in 2013, began the meeting by pointing out that “the underlying inflation rate measured as the CPIF excluding energy ha[d] risen from about 0.5 per cent in the spring of 2014 to 1.5 per cent in the latest outcome from ” (Minutes, p. supported maintaining the monetary policy stance decided in with the fact that the inflation outlook had improved. In particular, he announced that “recent outcomes for longer-term inflation expectations confirm that the downward trend in confidence that the Riksbank will meet its inflation target has been broken. After having shown a low-frequency downward trend for several years, longer-term inflation expectations turned upwards or stabilised over the spring and summer. Expectations are still a few tenths of a percentage point below 2 per cent but the important point is that the downward trend has now been stopped” (Minutes, p. He credited the Riksbank’s highly expansionary policy as having a beneficial effect on the krona saying “the krona exchange rate has weakened since last year, which has contributed towards higher prices for imported goods and services. This provides an important explanation for the recent rise in inflation…” And he also mentioned that “[i]n recent years, unit labour costs--which are usually a good indicator of underlying inflationary pressures--have increased more or less at a historically normal rate” (Minutes, p. However, also acknowledged that there were good reasons for making monetary policy more expansionary than in . These were linked to international developments and risks, associated with the collapse of oil and commodity prices, which could further push down both actual and expected inflation. In particular, he worried that “the Chinese economy [is] slowing down and successively being readjusted away from the commodity-heavy industrial sector. This is one explanation for the fall in value of currencies in many emerging market and developing economies that are dependent on commodity exports to . This development may also be significant for and the ECB. It cannot be ruled out that will react by postponing its policy-rate increases slightly and that the ECB will communicate an intention to further increase its purchase of securities. As current interest rates and exchange rates are determined by expectations of the future, this could rapidly lead to tighter monetary conditions in the Swedish economy” (Minutes, pp. Toward the end of the meeting, chose to respond as he put it to an increasing number of commentators suggesting that the Riksbank should be satisfied with the current development, i.e., low inflation and reasonably good growth, and either reduce the inflation target or be more tolerant of an inflation rate that is lower than the target for a prolonged period. With the lower inflation target, he continued, it is argued that the Riksbank could immediately raise the repo rate back into positive territory and hence ensure that households and pension fund managers receive sufficient return on their investments, instead of enticing them to make riskier investments by having negative interest rates. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 “The current development, with low inflation and reasonably healthy growth, is of course not independent of the monetary policy pursued by the With tighter monetary policy, inflation would be even lower and And if we also reduced the inflation target, either permanently or temporarily, inflation expectations would probably decrease. contribute to even lower inflation and could also lead to further falls in already low nominal long-term rates” (Minutes, p. Later, continued “It is also important to note that the negative interest rate and asset purchases thus far seem not to have given rise to any clear disruptions on markets…Households can read about negative rates in the newspaper but have, as before, zero interest on their bank accounts and posi- tive interest on their mortgages…For example, the demand for cash has not And, according to the Riksbank’s assessment, the rather extensive purchases of government bonds have not led to poorer liquidity on the market. There are participants who are being negatively affected by low interest rates, for example pension fund managers who have pledged a certain minimum But their main problem is the fact that long-term interest rates are low, something which can be explained by low expectations of future in- flation and growth. The aim of the pursued monetary policy is, of course, to push up inflation and inflation expectations, as well as to contribute to healthy growth, which will also lead to higher long-term rates. A lower inflation target or tighter monetary policy would in no way benefit these participants”. added that the problem “with the low repo rate is the continuing rise in house- hold indebtedness and the fact that this may be happening with unreasonable expectations of future interest rate levels. Bearing in mind what and had just said, as well as a great many previous statements from the Riksbank, [he] emphasised that this is a problem that can and should be dealt with by the Government, the Riksdag and other authorities using macroprudential tools” (Minutes, pp. Most notably, the main scenario at the October 2015 Monetary Policy Meeting showed 2016 US GDP growth slowing to from forecast in , and US growth falling to from in 2017. in was now expected to reach only in 2016 instead of fore- cast in , and in 2017 instead of . energy in 2016 was also only forecast to reach instead of the forecast in and to reach only in 2017 instead of . decided unanimously to extend the government bond purchasing program by an additional billion so that purchases will amount to billion by the end of 2016. The repo rate was left unchanged at -0.35 per cent but an initial rise in the rate would be deferred by approximately six months to the first half of 2017. As it had done repeatedly since the February 2015 Monetary Policy Meet- ing, emphasized its readiness to do more expansionary monetary policy if need be. The October 2015 MPR reiterated that the Board 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 was prepared “to quickly make monetary policy even more expansionary if inflation should deteriorate, even between the ordinary monetary policy meetings. The repo rate can be cut further, which is reflected in the repo rate path, and the Riksbank can purchase more securities. The Riksbank also stands ready to intervene on the foreign exchange market if the upturn in inflation were to be threatened, for example, by a problematic development in the markets. In addition, there is scope to launch a lending programme to companies via the banks should this be necessary. The measures taken already and the readiness to do more underline the Riksbank’s aim to safeguard the role of the inflation target as a nominal anchor for price setting and wage formation” (MPR, p. The Riksbank again warned in the October MPR (pp. 12-13) that the risks associated with household indebtedness, especially in combination with the low level of interest rates, must be managed by the Government, the Riksdag, and , echoing reasoning and recommendations spelled out in detail in the Riksbank’s latest 2015:1 Financial Stability Report. explained the further easing of monetary policy as follows: “Financial markets interpreted the ECB’s most recent communication as a signal that the current asset purchasing program may be extended and continue past . In addition, the expectations of a first rate increase by have been put on hold. International interest rates are therefore expected to remain very low in the period ahead and Swedish monetary policy needs to take this into consideration. If this does not happen, the krona exchange rate risks appreciating earlier and at a faster rate than forecast. This would then lead to the prices of imported goods and services increasing more slowly and demand for Swedish exports would fall. Such a development would make it more difficult for the Riksbank to push up inflation and stabilise it around the target…Since the upturn in prices of more domestically produced goods and services is still relatively cautious, it is the Riksbank’s assessment that slightly stronger demand will be needed before inflation stabilises around 2 per cent” (MPR, pp. “In the short term, market expectations according to forward pricing are basically in line with the interest rate path and continue to indicate some likelihood of a lower repo rate (see Figure 2:1). In the longer term, the Riksbank’s new repo rate path will be lower than interest rate expectations according to forward pricing. According to the Riksbank’s forecast, an initial rise will take place in the first half of 2017, while forward pricing indicates an interest rate rise towards the end of 2016” (MPR, p. reminded the meeting “of an important starting-point for today’s monetary policy decision, namely that inflation had been low for a long time. the last five years, CPI inflation has on average been 0.8 per cent, 1.0 per cent excluding the effects of lower mortgage rates and 1.0 per cent excluding mortgage rates and energy prices…One risk is that economic agents have assumed an inflation rate of two per cent when setting prices, concluding wage 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 agreements or taking out fixed-interest loans…A second related risk is that…pension funds and insurance companies, who guarantee a certain aver- age nominal return, or banks and other companies, whose owners expect a certain nominal return on equity…[will find it ] to generate a high nom- inal return without taking on more risk...if the fall in inflation expectations pushes down long-term rates…A third risk is that persistent low inflation un- dermines the credibility of the inflation target...” (Minutes, pp. noted “that the trend increase in inflation that had been under- way since the start of 2014 had continued…We could then feel pleased that inflation in , measured in terms of the CPIF and CPIF excluding energy prices, amounted to 0.94 and 1.54 per cent respectively. The most recent in- flation outcome for shows that this development is continuing. CPIF inflation, the outcome was 1.00 per cent. Excluding the volatile energy prices, the outcome was 1.81 percent. We have to go back to 2010 to find such a high inflation figure…continued by pointing out that the Riksbank’s short-term inflation forecasts have demonstrated a high level of accuracy in recent months and have been better than the market’s forecasts. This is particularly noteworthy, he thinks, because the market constantly up- dates its short-term inflation forecasts, giving them a heavy informational ad- vantage over the Riksbank’s assessments…The development of inflation ex- pectations is also emphasising that monetary policy is having an effect, Mr Expectations of inflation one and two years ahead have successively increased over the year for most groups included in the surveys. As regards more long-term inflation expectations, there is now a stronger im- pression that the downward trend has been stopped” (Minutes, pp. Nevertheless, “one important purpose, according to , for making monetary policy more expansionary at present is to counter an excessively rapid appreciation of the krona and to clearly demonstrate that the Riksbank has not thrown in the towel by any means as regards defending the inflation target, as some have speculated” (Minutes, pp. Later in the meeting, pointed out that “as the Riksbank increas- ingly lowers the repo rate and extends its purchases of government bonds even further, the likelihood that it will also become necessary to intervene on the foreign exchange market will obviously increase if there continues to be a need to make monetary policy more expansionary…[But] if anything, a decision by the Riksbank to intervene on the foreign exchange market is now considered to be less likely than earlier in the year. … [o]ne further possibility is, of course, that the market is not really taking the Riksbank seriously, but believes that we would rather give up the defence of the inflation target than resort to interventions on the foreign exchange market…If the latter is the case, we ob- viously have some lessons to learn as regards communication—because the point of writing in the , for the fifth time in a row, that we are prepared to intervene on the foreign exchange market can be that foreign exchange interventions should not be taken seriously as a conceiv- able monetary policy measure” (Minutes, pp. 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 Nevertheless, it is understandable that Riksbank foreign exchange interventions may lack credibility in the market in light of the discussion at the monetary policy meeting in . and both agreed then that foreign exchange intervention would be an effective means of returning inflation to the target, but they were reluctant to use it. Several members of again emphasized the urgent need for to adopt a variety of measures to manage problems in the Swedish housing market and to prevent further increases in household debt. 6 Analysis of the Riksbank's Forecasting As we described in Chapter 5, members of placed considerable weight on the forecasts provided to them by the Riksbank staff. is a small, open economy so forecasts of the Swedish economy depend importantly on expectations of international economic activity and inflation, and also on policy rates abroad, particularly in Europe and the . Many of the discussions on the Board concerned the international forecast and assumptions made about overseas interest rates. In this chapter we focus on the international forecast before turning to the overall performance of the Riksbank in forecasting inflation and economic activity in . In preparation for every monetary policy meeting, the Riksbank employs a macroeconomic model of the Swedish economy to make an assessment of the repo rate path needed for monetary policy to deliver forecasts for inflation, production, and employment that are judged to be “well-balanced”. As a rule, the Riksbank has tended to adjust the repo rate and the repo rate path so that inflation is forecast to be fairly close to the target in two years’ time.