rfr · H90WRFR5 · 2022-03-31 00:00:00 — As part of its suite of measures designed to stabilize US and international financial markets, the US Federal Reserve offered the Riksbank a US$ 60bn swap line on 19. The Riksbank in turn offered a US dollar lending facility to banks. In the event, only US$ 2bn was lent through this facility, and that was actually financed from the foreign currency reserves rather than from the Fed swap. 21 The swap line was extended on two occasions and continued to apply into 2021. 19Specifically the UK Treasury and 2012 Funding for Lending scheme designed to boost bank lending to households and to the private non-financial corporate sector ; the ECB’s 2014 Targeted Longer- Term Refinancing Operations (LTRO) designed to boost bank lending to households (other than for residential mortgages) and private non-financial corporates and the ECB’s 2019 introduction of tiered deposit rates for banks whereby each bank can avoid negative rates rates for some of its deposits at the ECB ) 20If onward lending to corporations was not achieved, a penalty of 20 (later 10) basis points applied. The banks retained the credit risk. Usage peaked at SEK 165bn in 2020, where it remained until early 2021, after which there was a substantial decline. 21The banks repaid these loans by 2020. There was no demand for dollars at the minimum price (OIS+25bp) in the three subsequent auctions offered by the Riksbank during April (cf. Gislén et al. CHAPTER 3 THE RESPONSE TO THE PANDEMIC The rapidly deepening financial market crisis during necessitated a swift and large-scale asset purchase response. QE purchases were greatly accelerated and extended to covered, municipal and corporate bonds. This broadening of the scope of asset purchase partly reflected the fact that the Riksbank already held close to 45 per cent of the total stock of government bonds. In addition, though, there was the fact that the yield spreads on these instruments relative to Swedish government bonds were widening.22 Thus, the package was intended to ensure that the disturbance would not increase term or risk premia across the yield curve. The initial expansion was to municipal bonds, and soon covered bonds (the largest segment) was added. Covered bonds became by far the largest segment of the purchases, followed in size by government and municipal bonds (Figure 14). The price effect was significant: risk spreads on covered bonds narrowed sharply to lower levels than had prevailed in 2019 (Alsterlind 2021). With spreads continuing to widen for corporate bonds, the Riksbank announced they would also purchase commercial paper and corporate bonds with the intention of calming markets and releasing liquidity to SMEs.23 The total amount of assets held by the Riksbank in its asset purchase programmes jumped by about 70 per cent to over SEK 600bn by end-year 2020 (Figure 14). Relative to the size of the economy this was a smaller rate of increase than engineered by and the ECB. The additional QE conducted by the Riksbank was also smaller, bringing the stock from about 18 per cent of GDP to 26; whereas the ECB’s stock reached 61 per cent of GDP and ’s 35 per cent of GDP. Increased asset purchases were employed by other central banks also, with an average increase in seven comparable smaller open economies, of about a third — from 39 to 49 per cent of GDP (Figure 15). 22Covered bond spreads peaked on 16; the municipal bonds on 20 and the corporate bonds on 27. 23The Riksbank limited its purchases to investment grade bonds and tried to be proportional in the portfolio of corporate bonds it purchased. Starting January 1st 2021 the Riksbank further limits its bond purchases to companies deemed to comply with international standards and norms for sustainability. CHAPTER 3 THE RESPONSE TO THE PANDEMIC Figure 14 Stock of bonds held by Riksbank as a result of QE Source: The Riksbank Figure 15 Scale QE Riksbank and selected central banks 2013-2021 Balance sheet totals as per cent of GDP Note: The shaded area represents the range of outcomes among the set of comparator small open econ- omies: , , , , , and . SOE is the average of these countries. Sources: , , , , Czech Statistical Office, , , Federal Reserve, , Japanese Cabinet Office, , of the , of , Statistics , Statistics , Statistics , Statistics , Swiss State Secretariat for Economic Affairs, the Riksbank and U.S. CHAPTER 3 THE RESPONSE TO THE PANDEMIC 3.2Implications of the 2020 Decision to Hold Repo Rate at Zero The decision not to reduce the repo rate was explained in several distinct ways. One important consideration discussed at was the fear that a return to negative repo rates might trigger a response by the banks to pass the rate cut on to depositors, thereby losing liquidity at a moment in the crisis where liquidity was already tight. Given the nature of the shock, it seemed more important to ensure that financial stability was maintained and that expanded liquidity demands were met (so that credit could continue to flow to households and firms) than to lower the wholesale cost of funds below what had prevailed pre-pandemic. A similar policy choice was made by most other comparable central banks. The Riksbank may have been also concerned that its credibility could have been damaged by reducing the repo rate so soon after rising it in . The depreciation of the krona at the beginning of the crisis, in spite of the interest rate differential vis a vis the ECB, also reduced the urge to cut the policy rate. However, the Riksbank have been at pains to stress that, under different circumstances, a negative rate would still be effective.24 The Governor and board members continue to stress that negative repo rate was not off the table: A sample of member statements on continuing potential for negative repo rates. “I would like to emphasize that I do not in any way exclude the possibility of a rate cut in the future” – (Minutes ). “Consequently, I do not rule out the possibility that it can be motivated to lower the repo rate to negative levels once the economy has started to open up” - (Minutes ). “My view is that the conditions for repo rate cuts will improve when the rate of spread of the virus starts to decline and society gradually begins to open up” – Per (Minutes ). “[A lower repo rate] may however become relevant at a later stage, when we reach a recovery phase that needs support” – (Minutes ). “The repo rate can also be cut, if this is assessed to be a useful measure. At present, cutting the repo rate is not assessed to be the most effective tool to support the economic recovery. But this does not rule out such a possibility further ahead. There are several factors that are currently difficult to assess, 24For example, as discussed below, Riksbank analysis suggests that the pass-through from its policy rate to the lending rates to households and business is close to one-to-one (and 2021), despite the assertions of others to the contrary (cf. CHAPTER 3 THE RESPONSE TO THE PANDEMIC which will determine whether it is appropriate to cut the repo rate below zero once again. These factors include the development of the exchange rate, how fast the supply side of the economy recovers in relation to the demand side, and how a lower policy rate is assessed to affect interest rates in general and ultimately consumption and investment” – 2020. “If more monetary policy stimulus were to be required in the short term, the tools I see closest to hand are a negative repo rate and increased quantitative easing” (Speech by 23 February 2021). 3.3 Deliberations and Technical Preparedness Despite the sudden and intense nature of the early phases of the pandemic crisis, and the complexities of frequently having to operate without physical meetings, the decision-making of during 2020 was smooth and effective. held five ordinary meetings and five extraordinary meetings during 2020, and there were in addition eleven decisions taken ”by circulation” (written procedure). From the minutes of the Board meetings, it appears that policy discussions were much less confrontational than they had been in 2010-4; decisions during 2020 were taken with almost full consensus. While the Board members agreed that expanding the scale and the scope of the QE was an effective way to react to the crisis caused by the pandemic, there was some controversy over the composition of the asset purchases, and over the announcement of the extension of the programme. The broader consensus shows up in the absence of disagreements regarding the policy rate decisions in 2020; with just two members expressing some reservations in regarding the asset purchases. The crisis of 2020 served also as a real-time test of the Riksbank’s crisis preparedness. How did the Riksbank shape up to this decision theory perspective on optimal policy? Overall, it seems that the organization was adequately prepared for such an extraordinary circumstance. The legal framework provided the necessary authority and sufficient flexibility in the use of vital instruments, without imposing delays or procedural obstacles. Internal procedures were readily adapted to allow rapid decision-making. The skills and experience of and staff were sufficient to deal effectively with circumstances not envisaged in the standard models and analytical tools. Turning decisions into action was challenging, given the novelty of some of the measures, especially related to technical aspect of expanding the purchases to corporate bonds. This did require a lot of preparation but was accomplished, although with a delay of about half-a-year. While the credible announcement of the policy of corporate bond purchases was sufficient in to narrow spreads well ahead of actual implementation, this might not CHAPTER 3 THE RESPONSE TO THE PANDEMIC have proved sufficient.25 Six months is a very long time in the middle of a Considering that the ECB had been providing the example by purchasing corporate bonds since 2016, there would have been merit in the Riksbank preparing the operational requirements of such operations on a pre- cautionary basis in case they were needed — as indeed they were in 2020. 3.4 The Economic and Inflation Outcome in 2020 Did the Riksbank do enough in the crisis? It seems so. In spite of initial financial stress, actions taken by the Riksbank (as well as by the and the National Debt Office) helped alleviate the liquidity shortage and ensure the flow of credit at a low interest rate, and thus financial stability was maintained. experienced a more modest decline in GDP than most advanced economies in 2020. This surely reflects structural and fiscal and other policy differences, more than the working of the monetary policy measures, given that other central banks also adopted unusually vigorous measures. For example, analysts have pointed to the relatively modest economic importance of tourism in , to the relatively high share of the high-tech sector that enjoyed high demand during 2020, and to the somewhat less stringent restrictions imposed by the Swedish Government at the early stages of the pandemic, as well as to the effective fiscal and monetary policy response. Inflation as measured by CPIF dipped at the initial stages of the crisis, and was below target (and below the variation band ()) until the end of the year when it recovered to 1.7 per cent by January 2021. A similar path of an initial dip and a recovery towards the end of 2020-beginning of 2021 was observed in the major economies and in the comparator countries (SOEs). The CPIF excluding energy averaged 1.3 per cent in 2020 while other core measures of CPIF were around 1-2 per cent. It should be noted that some measurement issues arise in some CPIF segments of services that were not consumed during the pandemic (e.g. entertainment and recreation, restaurants, air etc.). Did the Riksbank perhaps do too much in the crisis, even threatening me- dium-term price stability? This would be hard to argue. important for medium-term price stability than the actual price developments in 2020 is the impact on inflation expectations. Reflecting the credibility established by the Riksbank in its ability to bring inflation back to target, financial market expectations of long-term inflation recovered from a sharp dip early in the year to end 2020 at around 1.7 per cent. While the purchase of mortgage-covered bonds will also have had a side-effect in maintaining upward pressure on housing prices, it went no further in this regard than returning to the conditions that had been prevailing pre-pandemic. 25 For example, taming the panic in the US Treasury market in 2020 required actual purchases, and was not accomplished by the announcement alone (Vissing-Jorgensen 2021). CHAPTER 3 THE RESPONSE TO THE PANDEMIC 3.5Persisting with the Purchase Programme The complexities of internal processes in order to implement a programme of corporate bond purchases meant that purchases in that segment were delayed until . By that time, spreads were already back to their pre-crisis levels, but the Riksbank felt the need to make good on its promise and go ahead with the corporate bonds purchases to maintain its credibility (Figure 16). Figure 16 Yield spreads relative to Swedish Government bond Covered bond, 5 year Corporate bond, 5 year Municipal bond, 5 year Sources: Bloomberg, Macrobond, and the Riksbank. In a Press Release on , the Riksbank announced that it would expand the bond purchases and extend the purchasing programme until the end of 2021 “To give further support in an uncertain time, improve the conditions for a recovery and help inflation rise towards the target of 2 per cent.” In the Monetary Policy Account 2020, that decision is explained: “monetary policy would need to continue to be expansionary for a long time to facilitate the economic recovery and enable inflation to rise towards the target”. Yet, with risk premia on corporate bonds down to below their precrisis level, the need to provide continuing support for this segment of the market was much less clear than it had been earlier in the year. Chapter 4 The Impact of Unconventional This chapter considers the effect that negative interest rates, asset purchases (QE) and forward guidance – the so-called “unconventional” policy instruments – have had on the Swedish economy. 4.1 Zero and Negative Interest Rates Previously known only in , negative policy interest rates have been adopted in recent years by several European central banks, starting with in mid-2012. The ECB moved to a negative deposit rate in 2014 and its further expansionary measures in subsequent months pushed first and then into negative territory also. The banking and financial systems of these countries are clearly linked, with the euro area a predominant influence; even the early move by (long before the ECB went negative) can be seen as a reaction to developments in the euro area in 2012, as mobile funds sought safer havens. Thus, the Riksbank’s decision to go negative cannot be fully understood without this international context in mind. This point is further considered in Chapter 5 below. Nevertheless, the Riksbank is clearly not absolutely constrained in its interest rate policy by conditions in the euro area. It is therefore relevant to know how the negative policy rate has transmitted itself through ’s financial and economic system. Did negative interest rates have a strong effect on the supply of credit to SMEs? How effectively was the policy rate passed through to borrowers? Did reluctance to push deposit rates negative impede the transmission, or did lowering rates below zero have a bigger effect than a comparable lowering of rates when they are positive? To what extent were bank responses seen more in higher risk than in increased lending? For other countries, data-based answers to these questions has been emerging, for example in detailed econometric studies such as the bank-by-bank analysis of risk-taking for the largest euroarea banks reported in Bubeck et al. (2020), the loan-by-loan analysis of bank lending in in Bottero et al. (2021) and the firm-by-firm analysis from twelve other euro area countries in Altavilla et al. (2020). Most of this evidence confirms that the hoped-for expansionary effect did materialize (cf. Schnabel 2020; et al. 2021; Brandão-Marques et al. Studies of comparable granularity do not appear to have been completed for during the period under review, but there is no strong reason to expect the results to be materially different. We would therefore concur with the conclusion of an article in the Riksbank’s 2019 Account of Monetary Policy — published just as the period of CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS negative rates was coming to an end — that “the negative policy rate [had] had an expansionary effect and contributed to inflation being close to the target”.26 Nevertheless, several aspects remain controversial: how well did repo rate reductions pass-through to other interest rates and bond yields? Could a negative policy rate have been prolonged without growing adverse side-effects? How strong was the impact of the various transmission effects of interest rate declines on aggregate activity and inflation? Assigning additional research resources to the econometric analysis of microeconomic data on loans and business investment under negative interest rates would likely have been worthwhile in confirming and quantifying the effects on business and household generally allocating more of the Riksbank’s research effort to loan- by-loan, customer-by-customer, and transaction-by-transaction micro-data would yield enhanced insights into the working and effectiveness of monetary policy measures. Impact of Negative Repo Rate and its Movements International experience suggests that pass-through of interest rate movements when the policy rate is negative can be sluggish (et al. The Swedish case seems to confirm this. In particular, the official statistics on bank interest rates do seem to make it clear that Swedish bank deposit rates bottomed out at close to zero by the time the repo rate had reached -0.25 per cent.27 Indeed, by that point deposit rates had fallen by less than 150 bp compared with 225 bp of the repo. As such, the repo downward moves did not pass through one-for- one to deposit rates even before the repo went negative. This should not be a surprise. Indeed, we can see it as an example of the way in which bank-based economic systems tend to insulate the retail and mid-market from the extremes of volatility in financial market yields. Banks in most countries have tended over the years to smooth the impact on retail rates of high-fre- quency wholesale money market rates. (Note that deposit rates had not risen to match repo in the rate increase period up to 2011) (Figure 17). 26Side-effects of negative (as distinct from low) interest rates were also reviewed in that paper. 27Eggertson et al. (2020) argue that passthrough was strong until the repo rate reached about -0.25, but then stalled, suggesting that a de facto floor of many deposit rate contracts around zero limited the effectiveness of repo reductions beyond that point. However, and (2021) have rebutted this argument with data showing that, albeit somewhat slowly, lending rates did continue to experience pass-through for most categories, although “passthrough appears to have been somewhat slower and weaker for lending rates to households”. 2021/22:RFR5 CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS Figure 17 Bank deposit rates Sources: Statistics and the Riksbank Pass-through to Swedish bank lending rates seems to have been more complete. Spreads of bank lending rates above repo have been very affected by the fall in repo rates. If anything, spreads have fallen since repo was at 2 per cent in 2011 – though spreads are indeed higher than they were before 2008 (Figure 18). No evidence, then, that a particular negative policy rate is a floor for pass-through. Some of this is explained by the importance of market financing of the main Swedish banks through the use of mortgage (covered) bonds.28, 29 As far as securities markets is concerned, it appears that pass-through to yields was quite complete. The yield curve slope (2 years less repo) showed no tendency to increase at low repo rates – indeed it was on average almost flat at least until 2018. Around this average there have clearly been some quite significant fluctuations. Notable in the figure is a degree of ratcheting around the dates of pre-announced repo rate changes: the repo rate changes were often implemented some days or weeks after announcement, whereas the impact on longer term market rates of the policy announcement would tend to be almost immediate (Figures 18 and 19). 28A recent paper by Onofri, Peersman and Smets (2021) shows that negative interest rate policy need not be rendered ineffective by a zero floor on deposit rates if there are other assets in the household portfolio and other sources of financing by banks. 29The entry of new mortgage players and increased competition might also have played a role: gelska/2020/new-challengers-on-the-mortgage-market--increased-competition-and-possi- ble-pressure-on-interest-rates.pdf CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS Figure 18 Bank lending rates – spreads over repo 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sources: Statistics and the Riksbank Figure 19 yield spreads Per cent and percentage points 10 year government bond-repo 5 year government bond-repo Note: The vertical lines indicate the announcement of purchases of bonds in February 2015, , and . Sources: Statistics and the Riksbank The movements in bond yields on the six monetary policy announcement days in 2015 have been analysed closely by De Rezende (2016). He notes that the sum of the one-day responses of Swedish 10-year bond yields to these was about 40 basis points (0.4 per cent). Of this, 27 bp is not explained by the CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS response to repo rate movements, and can presumably be attributed to the asset purchase component of the announcements. (The term premium fell by 26 bp of which 18 bp cannot be explained by the response to repo rate movements.) Interestingly, the 10-year mortgage bond did not move as much – a decline of only 22 bp. Furthermore, the increase in repo from early 2019 did not result in a rebound in medium or long-term Swedish yields, whether for government or Instead, these yields drifted further downwards in sympathy with German Federal Government bonds. Indeed, it is striking how long-term Swedish bond yields seem to have followed those of the into more negative territory despite the return of the (short-term) repo policy rate to zero, thereby confirming that Swedish financial market conditions are far from be- ing fully under the control of the Riksbank. International developments do, in this recent period, appear to have had a more important effect on bond yields than did Riksbank policy (cf. Figure 20). The main Swedish banks finance a sizable share of their mortgage port- folios through covered bonds, whose yields can go – and have gone – negative. Accordingly, bank profitability may have been less adversely affected by low and negative interest rate policy and their reluctance to impose negative de- posit rates on depositors than has been the case in some other countries (Madaschi and Pablos 2017).30 This is also suggested by the relatively high ratio of their stock market price to book value of equity during the negative For example, during 2017 three of the main Swedish banks ranked highest in Europe in the ratio of market price to book value (among banks with total assets of above €100bn), with the other coming in fifth place.31 Smaller Swedish banks have also retained and even improved profitability when inter-