rfr · H90WRFR5 · 2022-03-31 00:00:00 — Evaluation of the Riksbank’s Monetary Policy 2015–2020 List of Figures and Tables .............................................................................. List of Acronyms ............................................................................................ Chapter 1 Price Stability: Converging to the ........................................ Fulfilling the Mandate: Price Stability and Macroeconomic Inflation Relative to Target 2015-2020 ................................................ Measurement of Inflation ..................................................................... Reviewing the Inflation Target............................................................. Chapter 2 The Operation of Monetary Policy 2015-2019............................. Phase A 2015-2018 .............................................................................. Phase B 2019........................................................................................ Conduct of Deliberations...................................................................... Accuracy of Forecasts .......................................................................... Chapter 3 The Response to the Pandemic..................................................... Measures in Phase C............................................................................. Implications of the 2020 Decision to Hold Repo Rate at Zero ............. Deliberations and Technical Preparedness ........................................... The Economic and Inflation Outcome in 2020..................................... Persisting with the Purchase Programme ...................... Chapter 4 The Impact of ...................... Zero and Negative Interest Rates.......................................................... Chapter 5 The International Context............................................................. Exchange Rate Movements and Monetary Policy ................................ Contemplating Currency Intervention: a Closer Look at 2015- Chapter 6 Other Effects of Monetary Policy................................................. Chapter 7 Impact of Proposed Legislation.................................................... Terms of Reference for Evaluation of the Riksbank’s Monetary Persons interviewed by the evaluators .......................................................... List of Figures and Tables CPIF inflation and CPIF excluding energy Inflation rates in and selected countries 2013-2021 Riksbank inflation fan chart as of early 2015 GDP annual growth rate and selected countries Unemployment rate, and selected countries Unemployment rate, domestic and foreign-born 2005-2021 Household debt as percentage of disposable income Real house prices 2015-2021 monetary policy rates in and selected central The Riksbank’s repo rate forecasts 2007-2021 Forward guidance on the repo rate Stock of bonds held by Riksbank as a result of QE Scale QE Riksbank and selected central banks 2013-2021 Yield spreads relative to Swedish Government bond Bank lending rates – spreads over repo 10-year Government bond yields, and selected Monthly exchange rate for the Swedish krona against US dollar and euro, and KIX index Measures taken by the Riksbank during the Covid-19 crisis Measures taken by the Riksbank and other central banks during the Covid-19 crisis Consumer Price Index with fixed interest rate Financial Supervisory Authority (in Swedish, ) Harmonized Index of Consumer Prices Krona Index (a weighted average of currencies in 32 countries that are important for ’s international trade) Quantitative Easing (asset purchases) Since the introduction of ’s inflation target policy in the mid-1990s, and the Riksbank gaining a more independent status in relation to the Riksdag and the Government in the late 1990s, has conducted regular external and independent reviews of ’s monetary policy. To date, three reviews have been conducted. The first was performed by Professors and and covered the period 1995–2005 (2006/07/RFR1), the second by Professors and for the period 2005–2010 (2010/11:RFR5) and the most recent for the period 2010‒2015 by , former Governor of , and , Professor at (2015/16:RFR6). In 2020, decided to commission a new, fourth review of ’s monetary policy for the period 2015–2020. In conjunction with this, , former Governor of and member of the of , and , former Director of the Division of Financial Stability at the US Federal Reserve, were appointed to perform the review. In January 2021, was replaced by Karnit Flug, Professor at and former Governor of , when was offered a top position in the . The focus of the new review is on examining ’s monetary policy during the – from a historical perspective – exceptional monetary policy period 2015‒2020, characterized by low inflation, a negative repo rate and heavily expanding central bank balance sheets (the terms of reference are accounted for in greater detail in an annex to the report). Economist acted as Evaluation Secretary for Flug and Honohan. Flug and Honohan commenced their work in 2021, and the findings of the review are now presented in this Report from the Riksdag. hopes that this review will further stimulate the already lively monetary policy debate and contribute to the future setting of ’s monetary policy. During the spring of 2022, will be circulating the review to various consultation bodies before holding a public hearing on the review and comments of the consultation bodies in 2022. Chair of the Committee Deputy Chair of the Covering the period 2015-2020, this is the fourth in a series of reviews of Swedish monetary policy carried out at the invitation of over the past two decades. The Riksbank’s monetary policy has been energetic and expansionary in recent years. Its actions helped bring inflation close to target and, in 2020, helped limit the impact of the Covid pandemic on ’s economy and financial system. Contrasts with Previous Period In several respects, policy has been markedly different from that of previous years. Just before the period under review 2015-2020, the stance of monetary policy had changed rather sharply, as the Riksbank moved significantly from its cautious stance in coping with aftershocks of the Global Financial Crisis (GFC). Leaning against the wind of rising housing prices, the Riksbank had previously been slow to lower interest rates, resulting in an undershoot of inflation, appreciation of the krona and unduly high unemployment. From mid- 2014, however, the policy rate was lowered more aggressively, reaching zero following the October meeting of , before going even lower in the face of the more expansive stance of the ECB. In addition, since 2015, seems to have been much less sharply divided than before in their assessments of appropriate policy. The frequency of dissents dropped and differences were mainly over timing of movements rather than on the general thrust of policy. Vigorous application of what had become thought of as unconventional measures characterized Swedish monetary policy in this period. These measures, which partly paralleled similar actions being adopted in the euro area, were adopted first to bring inflation back up from the too-low level where it seemed to have got stuck in 2012-4 and subsequently as a response to the global financial market panic and the sharp contraction of economic activity associated with the outbreak of the Covid-19 pandemic. The main policy interest rate was pushed below zero and remained there for five years. While the negative policy interest rate was the most vivid distinctive policy tool used in this period, it was not the only one. The Riksbank moved quickly and decisively in 2020 in response to the Covid crisis, and the main measures adopted were appropriate. The Riksbank lowered long-term bond yields by expanding its balance sheet through outright purchases of government, and later other, bonds. The scale of these purchases was greatly increased in 2020. In the same year, concerned to ensure that small businesses would not be deprived of bank credit because of a lack of bank liquidity, the Riksbank enhanced the access of credit institutions to liquidity through a “funding for lending” type scheme. Another significant, albeit technical, innovation related to the treatment of housing costs in the measurement of inflation for the target; this was designed to ensure that interest rate movements did not mask the underlying trends in All of these initiatives seem to have been well-judged and effective. With these measures, the Riksbank succeeded much better in its main statutory objective, namely price stability, than in the previous five years. Inflation returned to within the Riksbank’s variation or tolerance band of +/- 1 per cent around its target of 2 per cent per annum by 2016 and stayed there until the pandemic shock. Although inflation averaged about ½ per cent in 2020, by the end of that year there were signs that inflation would soon return to the variation band before long. (Indeed, subsequent events pushed inflation much higher in 2021—after the end of the period under review). The general macroeconomic performance of was moderately good. Average annual GDP growth 2015-9 was 2.6 per cent, better than the euro area, but not as good as , for example. Adding 2020 brings the average down to 1.7 per cent. There were occasional patches of weakness in 2016, 2018 and 2019. Unemployment averaged 6.8 per cent 2015-2019 and fell by less than 1 percentage point during that period – much less than the fall in the euro area, but about the same as the fall in (where, however, the average rate of unemployment was just over 4 per cent). Persistent high unemployment among recent immigrants was a contributory factor in slowing the reduction of the average unemployment rate. Financial markets were functioning well during 2015-2019, and risk spreads were low. The turmoil in financial markets that broke in and with the outbreak of the Covid-19 pandemic was short lived, and calm was quickly restored to the financial markets. Interest Rates: the Return to Zero It is evident that negative interest rates would not have been employed by the Riksbank had it not been for the exceptionally low interest rate environment worldwide and especially in the euro area. It was more than six months after the ECB moved its key deposit rate below zero before the Riksbank followed suit, bringing its main policy rate (repo) into negative territory in early 2015, and lowering it further later that year and in 2016. This expansionary stance appears to have had the desired effect in pushing inflation up towards target. By the end of 2018 the Riksbank had decided to bring the repo rate back up, with a first increase taking effect in early 2019 and a return to zero in January 2020, whereas the ECB (with lower inflation rates) remained much more accommodative. The Swedish rate increases occurred even though inflation had only recently reached the 2 per cent target and indeed dipped below it again. Furthermore, inflation expectations which had only moved slightly above 2 per cent, were heading down again. Unemployment too was trending upward, and – although the labour market was still strong for Swedish-born participants – unemployment among these was also increasing somewhat. The two increases in repo 2019-2020 represent a rather prompt tightening of policy which contrasts with the approach of the other central banks that have used negative interest rates, and can only with some difficulty be rationalized as a necessary response to actual or expected inflation or other conjunctural indicators at the time the decisions were taken. Instead, it seems more reasonable to interpret these moves as influenced by the attraction of discontinuing the use of an unconventional instrument, seen as not having delivered results that would justify its continuation, given the risk that adverse side-ef- fects could increase with prolonged use. Several types of side-effects of negative rates were considered, especially those affecting the functioning of the banking system, the supply of credit, risk-taking and asset price movements, though precise quantification was lacking. A particular concern at the Riksbank was the fear that trust in, and support for, the Riksbank itself by the general public could be damaged if bank deposit rates for households were to go negative; banks were understood to be making plans in that direction. Furthermore, the persistent weak trend in the external value of the krona had led to a public perception (in some circles) of wider economic weakness which, despite the fact that this was not the case, was seen by some as weakening public support for the Riksbank’s policy stance. The decision not to return to negative repo when the pandemic struck, and the explanations that were offered for this, point in the same direction, though the tools that were used were well-adapted to the particular nature of that crisis. However, in its policy statements during the pandemic, the Riksbank did emphasize that it does not rule out future reduction of the policy rate into the negative territory if the conditions will merit such a move – though it seems that the potential impact on the krona would be a prominent factor in such a decision. Asset Purchases (QE) Two episodes of asset purchases represented the other major initiative of the period under review. Having previously experimented on a small scale, the Riksbank was ready in 2015 to combine its move into negative interest rate territory with a programme of government bond purchases. This was on a smaller scale than that operated by the ECB and was gradually tapered. The much stronger 2020 expansion of asset purchases, both in quantity and in range of asset types, was a response to the impact of the pandemic on finan- As was the case for other central banks, decisive and speedy ac- tion was certainly needed in this situation. The Riksbank rose to the occasion, displaying a good degree of crisis-preparedness, decisiveness and collegiality in arriving speedily at policy solutions. Nevertheless, action on such a scale also raises important issues of effectiveness and side-effects which have not yet fully received the analytical attention they deserve. The largest part of the asset purchases was of mortgage-backed covered bonds (rather than the gov- ernment paper mainly used by other leading central banks). helped fuel housing price appreciation. Two main reasons for not buying more government bonds were the limited liquidity left in that market following previous Riksbank purchases and con- cerns that a continued increase in the share of the stock of outstanding govern- ment debt held by the Riksbank could eventually raise questions about con- sistency with the Treaty prohibition on monetary financing. The purchase of private sector bonds and commercial paper was much smaller in scale but, by drawing the Riksbank into direct financing of firms, presents some new challenges. The Role of Housing Costs in Monetary Policy Having loomed large in the previous five-year evaluation, when both policy action (leaning against the wind) and measurement (whether a price index with a different treatment of owner-occupier housing costs should be used) were important features, housing played a smaller role in the period since 2015. As had been recommended in the previous review, the Riksbank did adopt the CPIF index (which removes the direct impact of changes in mortgage rates) from late 2017; but this did not make much difference in practice, since interest rate movements were not very pronounced in the period. Housing prices peaked in 2017, before resuming the previous upward trend in 2020; household debt as a percentage of disposable income followed a similar path. While members of were concerned with the potential impact of low interest rates on housing prices, and felt the need for macroprudential policy measures, there was or no explicit consideration of monetary policy actions to lean against upward house price movements in this period. The Riksbank’s purchases of covered bonds will also have added to demand in the housing sector by preventing an increase in bond yields and therefore in mortgage interest rates. It must be noted, however that, albeit small, the purchase of the bonds of construction and development companies will also have helped increase the supply of new homes. With Swedish short-term interest rates constrained (by prevailing world conditions) to be close to zero, communication of policy intentions becomes especially important (for example when it is desired to lower long-term interest rates in order to bring inflation back up to target) inasmuch as market expectations will influence the slope of the yield curve. While the Riksbank’s approach to communication has remained in general excellent, its forward guidance has long come in for some criticism. The fact that outcomes have not closely followed the forecast repo rate path may partly explain why the forward guidance appears not to influence market expectations as much as might have been expected. This is even more so when future policy being signalled also has QE and other important components. The Riksbank itself attached less importance than in the past to these forecast paths, seeing them mainly as an exercise in transparency (given that the Riksbank’s macroeconomic forecasts should be consistent with the expected rate path). It may be time to reconsider the methodology around the announcement of an expected rate path, making it clear when (as at present) it does not entail a commitment, and that rate decisions will depend on how economic conditions evolve. A particular instance of forward rate guidance creating some frictions relates to the intention to bring repo back to zero, clearly signalled from 2018. As mentioned, by late 2019 the macroeconomic circumstances were less obviously pointing to the final move, but the prior signalling created strong market expectations which the Riksbank felt reluctant to disappoint. A somewhat different forward guidance hiccup occurred in 2020 when it took several months from the time the Riksbank announced its intention to buy corporate paper to prepare implementation of that policy. By the time the preparations were complete, the need for purchases had arguably vanished, yet the Riksbank felt compelled for credibility to go ahead with the purchases, seemingly a captive of its earlier forward guidance. A more nuanced announcement could have avoided this time-inconsistency trap. Influence of International Factors The conduct of Swedish monetary policy is inevitably constrained by strong international links, not just to the euro area and to other members of Union, but also to US dollar financial markets and the wider international economy. The impact of this influence is evident in the way in which interest rates were lowered ahead of the ECB’s expanded QE programme launched in early 2015. It was also true in 2020, when financial market stresses hit most economies more or less simultaneously both directly from the pandemic shock and also as international flows transmitted shocks from country to country. Successful monetary policy in such an environment requires close attention to international flows and good relationships with other central banking partners, as have been exemplified in the swap arrangements with the US Fed- eral Reserve and the ECB as well as with other countries for which would be more the provider of funds than taker. After a five-year long experiment, the Riksbank has, like land and , decided that it can best deliver on its mandate without going to negative policy rates. Nevertheless, it is striking how long- term Swedish bond yields seem to have followed those of the German Federal Government into more negative territory despite the return of the (short-term) repo policy rate to zero, thereby confirming that Swedish financial market con- ditions are far from being fully under the control of the Riksbank. The average exchange rate of the SEK against major currencies at the end of the period under review was changed from its position at the start. However, this is the net result of a four-year period of steady depreciation against the euro, followed by a strengthening from 2020. That the SEK is not pegged to the euro or any other currency might have allowed a somewhat greater degree of monetary policy autonomy than is sometimes supposed (though whether a different policy would have been more effective is less clear). Indeed, it may be that a partial insulation of from the constraints of international financial integration can best explain the Riksbank’s abandonment of negative policy rates as an expansionary tool. Compared with the Danish krone (which has a quasi peg to the euro) and the Swiss franc, the SEK is not as vulnerable to capital inflows when its short-term interest rates move above those of the ECB. After all, weakness of the SEK against the euro continued even after repo returned to zero at the start of 2020. As such the Riksbank has more freedom of manoeuvre on its policy interest rates. How much attention should an inflation targeting country pay to the evolution of the exchange rate? Certainly, it is important as a leading indicator of imported inflation. Despite the single-minded focus on inflation envisaged by inflation targeting, many central bankers, including those at the Riksbank, have an eye to the potentially damaging effect of strong exchange rate movements on different productive sectors (importers and those taking holidays abroad hurt by depreciation, exporters by appreciation). It is not clear, however, that this is based on a fully thought-out strategy for integrating the exchange rate into Swedish inflation targeting: this would benefit from further systematic analysis. As mentioned, public opinion in , as interpreted by some Riksbank decision-makers, also attaches symbolic importance to not seeing the krona as weak — even independent of any true economic effects. Undue emphasis on such considerations could in the end result in losing the anchor of the inflation target, though this has not happened. Additional Side-Effects of Expansionary Monetary The use of a wider range of monetary policy instruments, including negative interest rates and QE, to deliver on their price stability mandate has resulted in central banks being drawn into unfamiliar territory as far as side-effects are concerned. Side-effects of this wider set of policy tools, whether in relation to the functioning of the banking system, excessive risk-taking resulting from easy finance, direct financing of carbon-intensive industry, or adverse effects on income and wealth inequality, have become more salient. While such side-ef- fects, and other long-considered ones such as those affecting macroeconomic outcomes including growth and employment as well as financial stability, are not explicitly referenced in the existing Riksbank Act, they are clearly of public concern (and may be added in forthcoming legislation), as well as to Riksbank decision-makers, as evidenced by public statements — and rightly so. Not having been granted a more central role in the formation of financial stability policy in , the Riksbank is in charge of only a limited subset of the available policy tools that can be used to offset undesired risk-taking in housing and other asset markets. The Riksbank can still advise on other such policies, and is well equipped to do so, given its capacity for macroeconomic policy research and its independence from the kinds of short-term political pressures that have often resulted in a reluctance to adopt macroprudential policy in other countries. The relevant agencies of government should, if they are not willing to act in line with such advice, be expected to explain why.