rfr · H30WRFR7 · 2016-01-19 00:00:00 — A complete list of those whom we met is set out in 4. 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. In so doing, we discuss in detail the views of members of as they evolved from meeting to meeting in the light of the information available to them. The plan of the Review is as follows. In Chapter 4 we describe the main features of the Swedish economy, and its experience during the financial crisis, prior to the beginning of the period of the Review. We then turn in Chapter 5 to a description of monetary policy in as it evolved over the period 2010-14, with comments also on developments in 2015. tive lies at the heart of our evaluation. It pays careful attention to the Monetary Policy Reports (which serve as the basis for the policy options considered and the decisions undertaken at the Monetary Policy Meetings) and to the Minutes of ’s Monetary Policy Meetings themselves which de- scribe the opinions of, and information available to, members as this difficult period unfolded. As requested in the terms of reference, Chap- ter 6 contains an evaluation of the forecasting performance of the Riksbank. Chapter 7 contains our evaluation of Swedish monetary policy during the pe- riod covered by the Review. Chapter 8 discusses the mandate of the Riksbank and considers the case for change. A central feature of our Review is the need to appreciate that policy is not made with hindsight, using data available today, but in real time. we place all the tables and figures after Chapter 8 so as not to distract the reader with data realized after the fact and undermine the experience that we want the reader to have in reading our text. Our recommendations are discussed and presented in the relevant chapters, and for ease of reference are also listed in Chapter 2. They contain a number of suggestions for the improvement of the conduct of monetary policy, the way in which the Riksbank is held accountable, and the division of responsibilities for monetary policy and financial stability. Those recommendations are di- rected not only at the Riksbank, but also at Riksdag itself, as well as the Government. We hope that they will be discussed widely before any decisions are taken. Our contribution is not to lay down a blueprint but to provide an independent and, we hope, objective basis for dis- cussion by all interested parties in . is the third such evaluation of the performance of the Riksbank. The first evaluation was made by Professors and Mishkin, and covered the period 1995-2005.1 The second was by Professors and , and covered the period 2005- 2010.2 We comment on the relationship between those Reviews and our own in Chapter 4. Three impressions stand out from our experience of conducting this Re- First, since first adopted an inflation target in 1993, the eco- nomic performance has been good in comparison with other industrialised 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 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 previ- ous 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. Second, 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. Finally, in conducting our Review, we were at all times impressed by the quality of intellect, experience, seriousness and open-mindedness of the people with whom we spoke, both at the Riksbank itself and elsewhere. can be proud of its central bank and the quality of people who choose to work for it. The qualities we observed reflect well, not only on the Riksbank and other public bodies, but on the country itself. 4 The Swedish Economy and Monetary Policy Prior to 2010 Prior to the global financial crisis of 2007-09, the Swedish economy appeared in good shape.3 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 (see Table 1). 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 strongly affected. GDP fell by from 2008/Q3 to 2009/Q3. But following the sharp downturn there was a strong rebound in 2010, more so in than in most other countries. The history of the period before our review period is well covered in the two previous evaluations of the Riksbank’s performance by Giavazzi and Mishkin and by Goodhart and Rochet, but we provide a brief overview of macroeconomic developments in prior to 2010, previewing briefly how macroeconomic conditions ultimately developed to 2015. During the earlier period there were important reforms involving the implementation of monetary policy. In particular, in February 2007 the Riksbank began to publish at each policy meeting its own expected future path for its official interest rate (the repo rate). We summarize briefly how the publication of the repo rate path worked in practice from 2007 to 2009. We then briefly review the record from 2006 through 2009 of reservations (dissents) entered by members of against the Riksbank's policy actions to provide perspective on the degree of contentiousness of policy actions on the Board prior to the period of our evaluation. 4.1 Macroeconomic Developments in GDP growth averaged around per annum from 2005 through 2007 and the unemployment rate fell from nearly to , although annual CPIF inflation (excluding the direct effects, through mortgage rates, of the Riksbank’s repo adjustments on CPI) was below the Riksbank inflation target, lying between and from 2005 through the first half-year of 2007 (see Figures 2 - 4). The Riksbank raised the repo rate (see Figure 1) steadily from in 2005 to in 2007, reaching on the eve of the crisis, as CPIF inflation rose from in 2007 to one year later and higher inflation expectations threatened to take trend inflation above the inflation target . 4 THE SWEDISH ECONOMY AND MONETARY POLICY PRIOR TO 2010 The global financial crisis led to a sharp fall in the demand for Swedish exports. After growing at a annual rate from 2005 through 2007 and early 2008, exports fell at a annualised rate in the fourth quarter of 2008 and at a annualised rate in the first quarter of 2009, and ultimately contracted by around in 2009 over 2008. As a result, GDP fell by in 2008 and at an astounding annualised rate in the last quarter of 2008. In the first quarter of 2009, GDP continued to fall at a annualised rate and contracted by in 2009 over 2008. The consequence was that the unemployment rate rose from in mid-2008 to nearly by the end of 2009. Nevertheless, CPIF inflation averaged around for 2009, in part due to the sharp depreciation in the exchange rate precipitated by the international crisis and the aggressive easing of monetary policy in . The krona had fallen some against the euro by early 2009 before settling around /euro after mid-year and it depreciated by against the US dollar. In terms of the trade-weighted (KIX) index, the krona depreciated by close to between mid-2008 and 2009 (see Figure 5). The Riksbank cut the repo rate aggressively from to in a series of five steps starting with an 8 October 2008 intermeeting action (in concert with , , , , and the ), reaching in February 2009, and concluding with a cut to in 2009. The Riksbank, other Swedish authorities and the Government, responded to help offset the negative effects of the financial crisis on liquidity and credit spreads in . The Riksbank offered loans in Swedish krona from three months to one year to facilitate banks’ longer-term funding. Swedish banks had become heavily dependent on short-term US dollar wholesale funding of longer-term assets. Private dollar funding contracted sharply in the wake of the crisis. The Riksbank responded by lending US dollars to the banks partly funded by the Riksbank's foreign currency reserves and more importantly by a US dollar loan facility unprecedented in breadth and scale offered by to the Riksbank and other central banks. The demand for Swedish exports bounced back remarkably in 2010, growing by due to the resurgence in global activity and world trade, and the effect of the krona depreciation. Stimulated by the strength in exports, Swedish GDP reversed its contraction in 2009, expanded by in 2010, and pulled the unemployment rate down from to . CPIF inflation continued to run near the inflation target in 2010. The strong recovery in conjunction with inflation at the target led the Riksbank to raise the repo rate in seven steps from in 2010 to in 2011. During the summer and autumn of 2011 concerns over sovereign debt in the and particularly in the euro area caused trade and growth to deteriorate in . Swedish GDP growth slowed to in 2011 as growth of exports slowed to . Unemployment bottomed out at . And CPIF inflation fell sharply below the target during 2011, to 4 THE SWEDISH ECONOMY AND MONETARY POLICY PRIOR TO 2010 around at year's end. , the Riksbank in reversed direction and began to cut the repo rate from its peak of in 2011. In 2012 annual Swedish GDP fell by but then increased by in 2013 as the unemployment rate hovered around in 2012-13. growth recovered somewhat to around in 2014 and helped Swedish GDP to grow in 2014 near its average annual rate since 2000, while the unem- ployment rate remained close to . However, CPIF inflation fell further in 2013-14, eventually stabilizing at , and the Riksbank continued to cut the repo rate, to zero in October 2014, and eventually to minus in 2015. 4.2 Dissents by Members of Disagreements among were common prior to the period covered by our review. Although there were no dissents in 2006, there were six in 2007, eight in 2008, and no fewer than fourteen in 2009.4 In 2007, one member of the Board dissented five times and another dissented once, both voting to tighten monetary policy more aggressively than the majority. From February to two members dissented on three occasions each, and a third member dissented twice, all voting for easier monetary policy than the majority. The greatest challenge to the majority led by the Governor during the entire period from 2006 through 2009 was in and when three members of the Board voted for easier policy and the majority carried the day only because the Governor exercised his casting vote. acted unanimously to ease monetary policy aggressively following the crisis at the four meetings from October through February 2009. But the disagreements reappeared in . One member dissented for easier monetary policy at all five remaining meetings in 2009, wishing in April to cut the repo rate by 75 instead of 50 basis points and then to hold the repo rate at 25 basis points until mid-2011, and in wishing to cut the repo rate to zero instead of 25 basis points and keep it there for one year. Another member dissented on four occasions in 2009 and a third member dissented on three of those occasions, both voting for the repo rate to be raised sooner than expected by the path described in the Monetary Policy Re- port. Even though 2009 saw 14 dissents against majority compared to only eight in 2008, the challenge to the majority was never as great as in 2008 because there were dissents for both easier and tighter monetary policy relative to the majority. Giavazzi and Mishkin evaluated the first period of inflation targeting in , which began in January 1993 shortly after floated the krona in the fall of 1992. Fortunately for , underlying economic conditions were relatively benign during the initial period of inflation targeting, coming as it did after the Swedish banking crisis in the early 1990s and before the 4 THE SWEDISH ECONOMY AND MONETARY POLICY PRIOR TO 2010 global financial turmoil in 2007-09. Giavazzi and Mishkin assessed the implementation of inflation targeting in in large part from the perspective of the academic literature, in terms of its success in stabilizing inflation, and in light of the Riksbank Act of 1999 which gave the Riksbank the independence to maintain price stability. Covering the period of the global financial collapse, the second evaluation by Goodhart and Rochet described in detail the nature of the financial crisis itself, ’s vulnerability to the crisis, and the variety of extraordinary measures taken by the Riksbank to stabilize the Swedish economy in response to the crisis. Rochet and Goodhart assessed the capacity of the Riksbank and other government authorities in to maintain financial stability in light of the crisis. Their predominant concern was that the Riksbank’s responsibility for financial stability in the 1999 Act was unclear; and moreover, the Government had not authorized the Riksbank or other financial regulatory agencies to pursue macro-prudential policies needed to guarantee financial stability. Our review differs from the earlier ones in that by 2010 the global financial crisis had passed and Swedish exports began to recover rapidly. Moreover, the Riksbank had accumulated two decades of experience with inflation targeting and with that a degree of confidence in its management of monetary policy. Nevertheless, a number of difficult underlying economic conditions would test severely the framework within which the Riksbank conducted monetary policy. First, Swedish housing prices and household indebtedness continued to rise throughout the period of our evaluation (see Figures 6 and 7), posing a threat to financial stability. And the Government failed to remedy deficiencies in the regulatory framework to secure financial stability. Second, sluggish growth in the and especially in Europe, slowed the expansion in and forced inflation significantly and persistently below the target. Third, by the end of our evaluation period, the Riksbank was forced to deal with the zero lower bound constraint on its official short-term interest rate. There was no road map for how the Riksbank should have handled these nearly unprecedented circumstances. and the Monetary Policy Department were learning by doing, so to speak. So we base our evaluation of the Riksbank’s monetary policy during the period on how handled these unexpected developments in real time as recorded in the Monetary Policy Reports and Minutes of the Monetary Policy Meetings. 5 The Evolution of Monetary Policy 2010- Chapter 4 described the performance of the Swedish economy during the crisis and in the run-up to the period of our Review. The combination of rising asset prices and debt, on the one hand, and the weakness of the world economy, on the other, posed major challenges to economic policy in general, and to monetary policy in particular. As we stressed in the introduction, it is sensible to judge policy not with the benefit of hindsight but in terms of the information that was available at the time. It is important not to be misled by any subsequent attempt to rewrite history. So now we turn to an analysis of what the Riksbank knew meeting by meeting and how the reasoning for its monetary policy actions evolved over time. Before that, however, we describe the monetary policy framework – both the strategy (section 5.1) and the process (section 5.2) – governing the Riksbank’s decisions on monetary policy. 5.1 Monetary Policy Strategy The monetary policy strategy includes the objectives of policy and the judgements about the economy which determine decisions on official interest rates and other policy instruments. The Riksbank's publication Monetary Policy in (2010, pp. 5-6) summarizes its monetary policy strategy as follows (quotations taken from the document): “According to the [1999] Riksbank Act, the objective for monetary policy is to maintain price stability. The Riksbank has specified this as a target for inflation, according to which the annual change in the consumer price index (CPI) is to be 2 percent”. CPI inflation includes the impact of changes in interest rates on the imputed cost of owner-occupied housing. A measure of inflation excluding this impact of changes in interest rates is described as CPIF inflation. When interest rates rise to dampen demand and ultimately inflation, the initial impact is to push up CPI inflation. To counter this perverse effect, in its policy deliberations, consistently employs CPIF rather than CPI as the measure of inflation guiding policy. Monetary policy also aims “to support the objectives of general economic policy with a view to achieving sustainable growth and high employment”. So in addition to stabilising inflation around the inflation target, the Riksbank also tries to “stabilise production and employment around long-term sustainable paths. The Riksbank therefore conducts what is generally referred to as flexible inflation targeting”. To meet its objectives the Riksbank sets official interest rates at its regular monetary policy meetings (held six times a year). The official interest rate is known as the repo rate or “reporäntan”. The repo rate is the interest rate at which banks can borrow or deposit money for a period of 7 days with the 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 By altering the level of the repo rate the Riksbank can exercise influence over the interest rates that banks apply to loans, mortgages and savings accounts, and so on the amount of money and credit in the economy. recently, when the repo rate had fallen to zero, and in 2015 turned negative, the Riksbank has bought securities in financial markets in order to inject more money into the economy. Because it takes time before monetary policy has its full impact on inflation, monetary policy is guided by forecasts for the economy and inflation. In addition, the Riksbank publishes, among other things, its own assessment of the likely future path for the repo rate and the degree of uncertainty surrounding that path. This interest rate path “is a forecast, not a promise”. In connection with every monetary policy decision, “makes an assessment of the repo-rate path needed for monetary policy to be well-balanced. A well-balanced monetary policy is normally a question of finding an appropriate balance between stabilising inflation around the inflation target and stabilising the real economy”. The Riksbank began to publish after each monetary policy meeting its own expected repo rate path over a three-year forecast horizon in February 2007. It also began to prepare its forecasts on the basis of its own published expected repo rate path, rather than conditioning them on forward short-term interest rates derived from the money market yield curve. At the same time, it renamed its Inflation Report the . In a 17 January 2007 speech, Deputy Governor , explained that “…the primary reason for publishing one's own interest rate forecast is that it makes it easier for the central bank to steer expectations. With this assumption for the interest rate, the central bank can explain more clearly to the general public and the financial markets how it envisages future interest rate developments and how it reasons when making monetary policy”. As we discuss below, the question of how successfully the published repo rate path steered market expectations proved to be a highly problematic factor in making forecasts and setting interest rates. A major challenge facing any central bank is how quickly it tries to correct any deviation of inflation from target. In , “[t]here is no general answer to the question of how quickly the Riksbank aims to bring the inflation rate back to 2 per cent if it deviates from the target. A rapid return may in some situations have undesirable effects on production and employment, while a slow return may have a negative effect on confidence in the inflation target. The Riksbank's ambition has generally been to adjust the repo rate and the repo rate path so that inflation is expected to be fairly close to the target in two years' time”. According to the Riksbank Act, the Riksbank tasks also include promoting a safe and efficient payment system. During the period covered by the Review, the Riksbank also became concerned about developments in house prices and household debt. Official responsibility for such matters lay primarily with the regulatory authorities and not the Riksbank. We describe below how such concerns affected monetary policy and comment in Chapters 5 THE EVOLUTION OF MONETARY POLICY 2010-2015 7 and 8 on the implications of financial stability policy for the setting of mon- etary policy in . The Riksbank “endeavours to ensure that its communication is open, fac- tual, comprehensible and up-to-date”. The objective is to make it easier for economic agents to make economic decisions by reducing the uncertainty as- sociated with the conduct of monetary policy. 5.2 The Monetary Policy Decision-making Process The Riksbank holds six “Monetary Policy Meetings of ” each year at which it makes decisions regarding the repo rate. A is prepared for the February, /, and October meetings, which includes a main scenario for monetary policy favoured by the majority of the Board and a variety of alternative scenarios; a Monetary Policy Update without alternative scenarios is produced for the other three meetings.5 The interest rate decision is announced at 9:30 am the following day, along with the votes of individual members of , and the or Update is posted on line to provide more detail on the policy decision. The Governor also hosts a press conference. Minutes of the Monetary Policy Meetings with attribution (ascribing all statements and comments to individual members of the Board) are published about two weeks after each policy meeting. According to and Tägtström (2009), the material for each Monetary Policy Meeting of is produced in a series of premeetings that usually takes about six weeks (the time line of the process that culminates in the Monetary Policy Meeting is shown in Figure 8).6 Board members already participate in the first pre-meeting, which begins to develop alternative scenarios based on different views for economic growth abroad, productivity growth, oil prices, and/or other conditioning variables.