rfr · H90WRFR5 · 2022-03-31 00:00:00 — The question arises whether the proposed new Riksbank Act, in taking a narrow view of the scope of monetary policy, could weaken the Riksbank independence in ways that could harm its ability to perform its role of maintaining price stability, support economic activity and employment and support financial stability. While, having read the draft legislation, we acknowledge that it attempts to avoid such problems, we do have some concerns, which we feel it is important to share.48 The draft legislation proposes to amplify the Riksbank’s explicit mandate to cover matters such as the level of economic activity which seem to have been hitherto taken into account as a kind of implied mandate. It will be helpful for the effectiveness of this independent institution if (as is currently proposed) the legislature clarifies the secondary objectives that have so far been implicit, but without too narrowly prescribing the policy measures that are to be used in delivering on its mandate. From this proposed amplification, as well as the decision that the definition of price stability should be subject to the consent of the Riksdag, it is clear that, without compromising the Riksbank’s necessary independence, the Riksdag is rightly keen to be closely involved. Of course this wish should not lead legislators to micromanage central banking. A trusted central bank, equipped with a full range of policy tools and the professional expertise to use them wisely in pursuit of its mandate over the long haul is what will serve best. Production and Employment in the Mandate The proposed expansion to the Riksbank’s mandate in the draft legislation is welcome, formalising, as it does, the de facto inclusion of production and employment as a secondary target. This change is in line with the legislation governing most central banks, which either has the level of activity as a secondary mandate or in a dual mandate. In practice, the Riksbank has already taken the real economy into account in formulating its monetary policy actions, recognizing that “permanently low and stable inflation” cannot be ensured in a weak economy. Nevertheless, the clarification is constructive in helping to remove any doubt as to the importance of such considerations. 48We have examined the draft submitted by the Government to . , 27 2021. We make no attempt to comment on the question of consistency of the draft legislation with the Treaty on the Functioning of Union. CHAPTER 7 IMPACT OF PROPOSED LEGISLATION Furthermore, the explicit addition of real economy and employment considerations into the Riksbank mandate may make it willing to lengthen the horizon over which inflation is brought back to target if this is necessary to support these additional objectives. For example, it is conceivable that if this had been the explicit mandate during 2018-2019, the return from negative interest rate would have been delayed as unemployment rate was trending upward since early 2018. Defining the Inflation Target There is a reasonable consensus in that the Riksbank has demonstrated a coherent approach to defining price stability and operationalizing the technical details. The Riksbank should keep under review the overall design of its inflation target, taking into account shifts in the strategy of other leading central banks notably in regard to the question of whether some overshooting of the target should be tolerated in order to compensate for undershooting attributable to having reached the lower bound of the policy rate. There is no pressing need for the Riksbank to revise its approach now, but it should not allow its targeting to deviate too far from the practice of the major central banks of ’s economic and financial partners. Under existing legislation, the definition of price stability and the choice of an inflation target is a matter for the Riksbank itself. In some other countries, the government or the parliament has a role in defining the inflation target, but this is not the case in the euro area or in the . In this respect the Riksbank’s autonomy is comparable to that of the ECB and Federal Reserve; greater than that of the original inflation targeter, the of , for which negotiation between Bank and Government is specified; and much greater than that of , which is given its inflation target by the British Government (Table C). The legislative proposal to require Riksdag consent for the Riksbank’s specification of the price stability target would somewhat reduce the autonomy of the Riksbank, but would leave it with greater autonomy on this matter than many other effective central banks. One potentially important drawback to this proposal, however, is the danger that this procedure could introduce a bias for inaction if at some future date the Riksbank, although regarding a change in the target to be desirable, could not easily find a satisfactory formulation that would command sufficient support in the Riksdag. This danger can be averted if the Riksdag continues in practice to defer on technical aspects of the design of the inflation target. CHAPTER 7 IMPACT OF PROPOSED LEGISLATION Segregating Financial Stability Policy The draft Riksbank legislation also makes separate provision for a secondary mandate on financial stability. In this respect also the Riksbank has not previously neglected an implicit mandate. But by separating the legislative authority for financial stability actions from that for monetary policy, the draft legislation introduces a somewhat artificial distinction which is likely to be impossible to maintain in practice. This is because the most important operational tools of liquidity support necessarily have monetary policy implications. There is in reality only a single toolbox: each of the tools that are being considered as either for monetary policy or financial stability policy can be used for each of the goals and indeed each tool will have effects on both. Experience in other countries shows that attempting to maintain an artificial separation between tools that are focused on price stability and those focused on financial stability can result in sub-optimal measures for both objectives. The most practical implication of the proposed separation relates to the requirements in Chapter 3, Section 11 of the draft legislation for cooperation with other authorities of state. In many instances such cooperation should indeed be expected when structural policy changes are being planned.49 However, it should not become routine that the Riksbank is expected to consult on its use of liquidity tools. The final paragraph of Chapter 3, Section 11 states that the requirement for prior consultation shall not apply “if a decision is urgent or if its effect is jeopardised.”50 As worded, this provision intends to ensure that speedy action in an emergency such as that of 2020 need not be delayed. But the wording of this paragraph may not be strong enough to insulate the Riksbank’s monetary policy discretion from procedural obstacles and delays. Instead, the requirement to consult with the FSA and other relevant authorities before implementing policy tools aimed at financial stability as in the proposed law may lead to inaction bias by the Riksbank when the grounds for policy action may not be clearly separable between financial stability and price stability objectives, and when the determination whether the “decision is urgent or if its effect is jeopardised” may be difficult in an evolving situation that may turn into a crisis. The extensive measures adopted by the Riksbank in 2020 reconfirm the importance to of being able to promptly deploy all of the instruments necessary to ensure price, monetary and financial stability. Central banking tools for monetary policy and financial stability are not clearly separable. In a crisis, no sharp distinction can truly be drawn between the central bank’s tools of monetary and financial stability policy. In its final decisions on 49For example, the 2015 swap arrangement through which the Riksbank made US$0.5bn available for six months to provides another example (cf. Gislén et al. While the technical and legal aspects of this arrangement were carefully designed at the Riksbank, such actions have wider diplomatic and political implications and need to be decided in the context of wider national policy. 50In such a case, the Riksbank is to notify the relevant authorities of the decision without delay. CHAPTER 7 IMPACT OF PROPOSED LEGISLATION the wording of new legislation, the legislature will do well to avoid introducing ambiguous procedural requirements that could hamper the speed and discretion that have proved in 2020 – as also in 2008 – essential for effective use of monetary policy instruments to combat sudden deteriorations in financial conditions threatening price and economic stability. broadly, a well-functioning financial system is a necessary condition for an effective transmission of monetary policy. Therefore, instruments aimed at safeguarding or restoring its functioning are, in our view, an integral part of monetary policy, and the Riksbank should maintain the full autonomy in applying them. Having tackled with considerable energy first the problem of below-target inflation, and then the disruptive effect of the pandemic, the Riksbank can look back at the period 2015-2020 as one of monetary policy success. This has also been a period that required extreme policy measures with negative interest rates for much of the period and a remarkable increase in the size of the Riksbank’s balance sheet. It is not surprising that some of this has generated controversy, especially in regard to potential side-effects, and has prompted a focus on the role and powers of the Riksbank. Our overall assessment is that the Riksbank’s inflation-targeting monetary policy in this period has been well-judged and more successful than it had been in the previous few years. The measures adopted were consistent with what is internationally considered as good central banking practice. Naturally there is scope for small differences of opinion as to such matters as timing of interest rate movements and the purchase of some types of security. However, we consider that has been fortunate to have a central bank able and willing to take quick and well-designed action to stabilize economic and financial conditions. The side-effects of what are still very low interest rates and a very large balance sheet do, however, deserve more analytical attention than they received up to 2020. The extent of the policy toolkit being used by the central banks including the Riksbank these days means that consideration of side-ef- fects (including on risk-taking in financial asset markets, on income and wealth distribution and on climate-change relevant finance) needs to play a more prominent role in the analytical work of the Riksbank. Its increased attention to these aspects in recent months is welcome. Legacy of the Global Financial Crisis and the Covid Pandemic The Riksbank was not alone among central banks in facing broader than usual challenges, and more public scrutiny, in the aftermath of the Global Financial Crisis. Indeed, as is so often the case in a small open economy, many of the problems faced by the Riksbank over the past decade have been external in origin and its room for manoeuvre constrained by international market pressures. inflation close to target – the primary goal – required steps to boost aggregate demand by ensuring low interest rates. At the same time the massive increase in uncertainty following the Global Financial Crisis generated financial fragility and a widespread reluctance to engage in capital formation (investment). These headwinds too had to be countered by the actions available to central banks if they were to meet their secondary objectives of supporting general economic policy goals including financial stability and sustainable employment and output growth. As ’s financial system had been less severely affected than most others, and with house prices rising relatively rapidly, the Riksbank decided in mid-2010 to reduce the degree of monetary expansion ahead of most others. Equally, it was slow in lowering interest rates during 2012-2013 despite inflation starting to undershoot the target; this period was associated with considerable disagreement in the Riksbank’s , as was discussed in the previous report in this series (King and Goodfriend 2016). By mid-2014, however, in the face of persistent undershooting of the inflation target, and with the increasingly expansionary stance of the ECB affecting the external environment, the Riksbank changed course and reduced the gap between Swedish interest rates and those in the euro area. Consistent with the new approach, the first five years of the period under review saw the Riksbank maintain negative interest rates to help edge inflation back up to target (a policy which had the effect of reversing the previous strength of the SEK in international currency markets). Inflation did eventually reach the target level, prompting the Riksbank to bring its main policy interest rate back up to zero (perhaps a sooner than would have been ideal). No sooner was this done than was plunged, like others, into the uncertainty and economic downturn generated by the Covid pandemic. This led the Riksbank (like other central banks) to greatly expand the scale and scope of its asset purchases to help stabilize the financial system and the economy. Could an Alternative Policy ? While the Riksbank’s overall approach to monetary policy was in line with that practiced in other highly regarded central banks in recent years, a spectrum of opinion exists in on the degree to which the best course was chosen. Given the close links with the euro area, it was almost inevitable that the Riksbank would respond to the ECB’s increasingly expansionary policy from 2014, involving negative policy rates and asset purchases, by pushing its policy rate into negative territory also. Indeed, we share the view of some that the easing of policy that marked the early years of the period could have been sustained for longer, allowing the economy to run “hot” in order to make further inroads into long-term unemployment. Even if this involved a temporary overshoot of the inflation target, that would be welcome given the previous experience of undershoot. Besides, the variation band of +/- 1 per cent would have allowed a temporary overshoot. An interesting alternative view starts from the observation that the effectiveness of low interest rates in stimulating inflation seems weaker than in the past. If so, could exchange rate and overall financial stability have been protected better by avoiding a negative policy rate, without suffering too low an inflation rate? We are less convinced by this alternative view, noting for example that the previous five years of positive interest rates was marked by more exchange rate volatility and by inflation greatly undershooting the target. With sharp movements in asset prices and the prices of some of goods and services, the monetary policy landscape at the time of writing has several unfamiliar features. The price of such assets as equities and housing are very high, so policymakers need to be ready to deal with the consequences of any sharp falls that might occur. Meanwhile supply restrictions and shifting patterns of demand have resulted in very large relative price movements and in a surge in the overall consumer price level. Ensuring that this does not somehow spillover into continuing inflation (as happened in the 1970s with the first energy price shock) will be a key challenge for monetary policy. Based on what we have seen for the period 2015-2020, the Riksbank is well-equipped to respond to these emerging challenges: – Its monetary policy decision-making process is robust and it uses mainstream modeling approaches. Still, it should continue to develop its analytical tools, especially to ensure that it keeps up with developments in modelling and econometric data analysis, for example in estimating the effectiveness of its asset purchases programmes. – Its communication with stakeholders is clear and transparent, though more could be done to present its perception of the varying scale and nature of the uncertainties that can make unforeseen policy adjustments necessary. In particular, the impact of forward guidance on future policy actions would be enhanced by making explicit the conditional (state-dependent) nature of the guidance. The pandemic represented an extreme example of an unexpected exogenous shock – but there have been others. Since economic forecasting is not a precise tool, the policy regime should be not only well attuned to the central macroeconomic projection but robust to deviations from that central projection. The Riksbank has passed this test well. It will be important to ensure that it continues to have the toolbox and the freedom of action to respond to unpredictable shocks in the future. The time will come for a less expansionary stance of monetary policy in . Given the range of tools that has been deployed over the past decade, and the accumulation of assets on the balance sheet of the Riksbank, there will, as in other countries, be a range of complex decisions to be considered around this exit. The communications challenges will be considerable. Potential effects on financial stability will have to be taken into account. Some of the sideeffects of expansionary measures, as with inequality, will tend to go into An additional element of complexity will be associated with the introduction of e-krona, the central bank’s digital currency. In this environment, it will be crucial for the Riksbank to retain the confidence of the Riksdag, of other public bodies, of the financial markets and of the general public. 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