rfr · H90WRFR5 · 2022-03-31 00:00:00 — est rates went negative: in this case by expanding their lending to households, including unsecured lending offering higher interest spreads, as well as by cost However, there is international evidence that, as the period of nega- tive interest rates was prolonged, it began to have an impact on bank profits in affected countries, and there are some indications that the Swedish banks were not exempt from this path (). Several transmission channels of monetary policy are seen to be operating during the negative interest rate period. The credit channel is illustrated by survey results on available credit terms. While these surveys still showed that most respondents considered credit conditions to be tight, the balance was much less adverse from 2014 than it had been since the GFC. true after mid-2017, but there is an evident tightening around then not long before some of the members of began to argue for a rate The cash-flow channel is important in because of the prevalence of floating rate mortgages. This channel relates not to the cost or availability 30 As mentioned, by 2018 banks in were considering whether to apply negative in- terest rates to household deposits: this could have undermined public support for the negative interest rate policy. CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS of new borrowing but to the squeeze on liquidity-constrained existing borrowers from the increased servicing charge they have when interest rates increase (and vice-versa). To the extent that the repo rate has transmitted to mortgage interest rates, this cash flow mechanism has had a fairly quick impact on borrowers, given that, until recently, more than half of mortgage finance in was at adjustable rates (2020; Flodén et al. The present-value mechanism, whereby a lower cost of funds makes certain projects more profitable in net present value terms, thereby increasing spending on investment projects, will also have been present. Evidence can be sought by inspection of capital formation by firms, by price effects on Swedish financial asset markets and by price and volume effects in housing. Reliably isolating the effects of this mechanism from data is, however, inherently difficult. Housing price inflation did accelerate during 2015, but slowed into 2016 and by mid-2017 house prices were falling. This time pattern at least is thus in line with the other channels. Other channels, including the asset price effect on collateral and the exchange rate channel have also been found to be significant in empirical work on the effectiveness of monetary policy. In particular, the growing levels of indebtedness in seem to have enhanced the effectiveness of low interest rates in boosting aggregate demand (Di Casola and 2019). All in all, there is ample evidence to confirm that, as they dipped below zero, low interest rates have continued to work in the intended direction to increase aggregate demand without damaging the workings of the banking system. The generally expansive monetary policy stance was supported by outright purchases of government bonds (both nominal and real index-linked) in sizable amounts in 2015 and 2016, continuing on a smaller scale in 2017. These purchases began at the same time as the ECB greatly expanded its asset purchase programme to include public sector securities. The Riksbank’s purchases were at first on a much smaller scale – just billion in and April of 2015 whereas more than billion in that period would have required to be proportionate to what the ECB was buying.32 Purchases during 2015 and 2016 continued to be low relative to what the ECB was doing. By mid-2016 the Riksbank was reducing its monthly pace of purchases even as the ECB expanded, and further reductions relative to the ECB occurred in 2017 at which point the Riksbank was buying at a proportional of only about 32This calculation applying the Riksbank’s share of the ECB capital key to the €95 billion purchased by the ECB produces €3.6 billion or about billion. For to the same calculation would produce billion, compared with the billion announced by the Riksbank in April. CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS one-sixth of what the ECB was doing. There is no implication that this was a mistaken policy, but only to point out that the Swedish QE was on a much smaller scale than that of the ECB. No doubt this can be partly explained by the fact that the ECB was also facing a bigger inflation undershoot relative to Another factor was the lower stock of outstanding government debt in in relation to GDP – after all, the Riksbank’s holdings reached about 45 per cent of government debt—much higher than occurred in the euro area. A sense that, at this size, the Riksbank’s holdings could be challenged in terms of the Treaty prohibition on monetary financing was relevant.33, 34 Still, no explanation seems to have been offered for the precise choice of volume of Net purchases ended for the time being in 2017, though maturing bonds and interest receipts were reinvested and early reinvestments resulted in some small transitory increase in holdings. Purchases of medium and long-term bonds is normally considered as a means of flattening the yield curve when the short rate is close to the lower Inspection of the yield curve slope in 2015-2017 does not show a strong effect after February 2015.35 Indeed a persistent flattening of the yield curve (proxied in Figure 19 by the difference between bond yield and repo) is only seen after mid-2018, a development we have already linked to euro area de- Several scholars have sought to quantify the expansionary impact of the yield-curve flattening resulting from asset purchase programmes in terms of an additional lowering of the (negative) policy rate (without QE) were that Estimates of this so-called “shadow” policy rate have been made by De Rezende and Ristiniemi (2020). They conclude that each unanticipated billion of asset purchases equates to about 3.3 basis points of a cut in During the negative interest rate period, QE is estimated to have gener- ated a shadow rate of between ½ and ¾ per cent below actual repo. approach and the Riksbank’s model, these authors calculate that inflation in early 2019 would have been about ½ per cent lower, and unem- ployment ¾ per cent higher had QE not been introduced in early 2015. estimates appear plausible. 33 See, for example, this passage in a recent Riksbank QE decision: “The purchases included in this decision shall be implemented with such an allocation and according to such terms and conditions that they can be assessed as compatible with the appropriate provisions re- garding the prohibition of monetary financing, in accordance with the instructions in the Ex- ecutive Board decision dated 9 February 2021 (ref.no. This means that the pur- chase programme will continue to be designed based on the principle that the Riksbank should not hold a predominant share of the total outstanding stock of securities issued by the Swedish state, Swedish municipalities and regions, as well as Kommuninvest i and publicly-owned companies.” 34 We do not consider here whether having the central bank hold such a high share level of total Swedish Government bonds outstanding might have an adverse effect on the liquidity and price discovery function of the bond market in . 35 As noted above, De Rezende (2016) calculated a net impact of QE in 2015 at 27bp for the 10 year bond yield or 18 bp for the 10 year term premium. (For the 5 year maturity the figures were 29bp for yield and 18 bp for term premium). CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS It should also be noted that asset purchase by other central banks, especially the ECB, have had expansionary spillover effects on during the period under review (Di Casola and Stockhammer 2021). One can think of this happening not only by increasing aggregate demand (albeit potentially appreciating the SEK which would have an offsetting contractionary effect) but also by helping to induce an asset purchase response by the Riksbank. Figure 20 10-year Government bond yields, and selected countries Note: SOE is an average of , , , , , and . Sources: , , , of and U.S. The Riksbank’s policy response to the pandemic from 2020 involved greatly expanded asset purchases, which were also extended into covered, municipal and corporate bonds and commercial paper, etc. Although the scale of the purchases was smaller (relative to GDP) than in several other leading central banks, it was substantially above the rate at which bonds had been bought in 2015-2016 (Figure 14).36 The biggest share of these new purchases was mortgage covered bonds. The Riksbank already held such a high proportion of the outstanding stock of government bonds that, in an abundance of caution with respect to the prohibition on monetary financing, further purchases were at a slower pace. In addition, municipal bonds were acquired in sizable quantities (and Birging 2021). The extension to other categories also reflected the fact 36The Riksbank did not, however, attempt to anchor long-term rates through yield-curve control (as in ). And rightly so: such a policy could involve extremely large bond purchases. In addition, exiting from such a policy is likely to be difficult. CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS that, although all bond yields were impacted by the purchase of government bonds, the pass-through to non-government bonds was imperfect in 2015.37 Only a relatively small amount of corporate bonds and commercial paper was bought – almost all of the latter category in the second quarter of 2020. The corporate bonds were heavily weighted to the real estate sector — a curi- ous feature given the desirability of not adding to what many saw as an over- Because of the various complexities involved in starting up the programme, the purchase of corporate bonds was not commenced until Sep- Arguably, purchases were not needed by then, as the crisis in the financial market had passed, but the Riksbank felt that it had to follow through on the commitment it had made to purchase. This phase of QE differs from that in 2015 inasmuch as it happened without a lowering of the repo rate. This wave of purchases can be best seen as measure to stabilize financial markets rather than to influence the yield curve and thereby aggregate demand. The extension of purchases into other categories also points in the same direction, though the continuation of purchases well beyond the initial financial panic stage of the pandemic casts some doubt on Indeed, the continued purchases into late 2020 and beyond are less easy to rationalize. The continued purchase of private bonds after the immediate panic was over began to raise some tough questions. First, there is the question of credit risk: the number of firms whose bonds have been acquired is very large, though the Riksbank has limited itself to bonds of investment grade.38 It is understood that a broad market neutrality approach is adopted (with certain negative criteria, relating to climate change, recently introduced). an adequate basis for ensuring economic efficiency? If not, could political pressure be brought to bear on the Riksbank to focus purchases on specific sub-sectors or firms in a way that drags the Riksbank into quasi-fiscal activ- ities?39 Even if the Riksbank successfully resists any such pressure, there is a clear danger that its bond purchase activities could become politicized and the cause of some adverse reputational effects.40 When it comes to covered (mortgage) bonds, these may be considered somewhat more safe given the double default protection that is entailed (even though the default of the ultimate debtors and the issuing bank are likely to be positively correlated). But the very direct impact of such purchases on the cost 37 De Rezende’s (2016) calculations suggest that 10 year mortgage bond yields fell by about half as much as 10 year government bond yields. The gap was smaller at shorter maturities. 38 Ratings from the big three international agencies and two smaller ones are accepted. limitation to investment grade parallels the practice of the ECB in its corporate bond pro- gramme which began in 2016. About half of the listed bonds in are not rated, so the investment grade restriction is quite tight. By comparison, the has adopted a much less strict criterion for its corporate bond purchases. 39 Though it is recognized that, like other EU central banks, the Riksbank must not “seek or take instructions from [European] Community institutions or bodies, from any government of a member state or from any other body.” 40 Transparency of the programme was high at the start, but has become somewhat less trans- parent as it was considered necessary to limit the publication to protect commercially sensi- CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS of funding for house purchase means that purchases of covered bonds at a time when over-indebtedness in an overheated property market is a source of concern. After all, by choking-off an increase in bond yields and thereby avoiding an increase in mortgage lending rates, they supported the demand for housing (Alsterlind 2021). Thus, such purchases might have needed to be offset be a tightening of macroprudential policy measures which are not under the control of the Riksbank and which are likely to have unattractive distributional consequences. (a) On Policy Rates The Riksbank introduced forward guidance on its policy rate already in 2007, i.e. in pre-crisis conditions. The policy rate forecasts were intended to represent the policy consistent with the rest of the Riksbank’s macroeconomic forecast, rather than declaring an intention to adhere to the announced path. It is, however, important to distinguish between guidance that merely indicates an expectation, and guidance that involves some degree of promise. Ma- jor central banks, including , , and , introduced forward guidance on policy rates after the crisis with a different intention, namely as a commitment to holding rates low. The Riksbank has not adopted such “Odyssean” guidance. Although commentators have often criticized the wide gap between forecast and realized policy rates over the past decade, it cannot fairly be accused of failing to deliver on a commitment, as no commitment is implied by the forecast. As mentioned already, the Riksbank has not used this (“Odyssean”) form of forward guidance. Instead, the Riksbank’s rate path falls into the (“Delphic”) category of being merely a forecast. In that way it is somewhat analogous to the “dot plots” used by members of the US FOMC to indicate where they expect the US policy rate to be. An important difference vis-à-vis the Fed dot plots is that the dots are provided by the individual members of the FOMC and have no obligatory relationship with the overall macroeconomic projections published by the Fed, whereas the Riksbank’s forecast is designed to be consistent with the rest of the macroeconomic projections. The usefulness of Odyssean forward guidance depends on its credibility, but this is not necessarily the case for a forecast offered merely as a the path of policy rates which the Riksbank envisages as being appropriate if the rest of its macroeconomic forecast becomes a reality (“Delphic” forward guidance). Thus, the challenge to the Riksbank’s policy rate future path by some (for example and 2019) should be seen more as a critique of the Riksbank’s overall forecasting success rather than being strictly targeted at the rate path. Still, it may be sensible for the Riksbank to further de-emphasize the forecast path for the policy rate. For example, statements CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS such as “the first rate increase is not expected to be made until the middle of 2018, which is the same assessment as in April” or “and revising the repo-rate path down substantially in relation to the [previous meeting’s] decision,” ap- pearing in the Summary page of minutes, may be more mis- leading than useful. The accompanying fan chart, which (as already suggested above) is too wide to be of much use, could also be downplayed. But could it be useful for the Riksbank to move in the Odyssean direction of turning elements of its policy rate forecasts into a commitment? the practice of the major central banks has legitimized such a usage and even created an expectation that it could be useful in some circumstances. bank would need to make such a shift in the use of forward guidance very explicit if it is to have the desired impact on market expectations. the Riksbank could end up paying a price for such a policy of tying its own In order to preserve its credibility, it might have to stick by its commit- ment to what had become a sub-optimal policy, if conditions that have not been foreseen when the commitment was made were to emerge. One way of providing forecasts while maintaining the flexibility to adjust policy to changing circumstances is to stress the fact that the forecast of policy path (interest rate and QE) is conditioned on the realization of the main ele- ments of the forecast. Another way deal with the problem of time inconsistency of policy fore- cast/commitment especially in times of high uncertainty is the use and presen- tation of alternative scenarios. The Riksbank used to present different policy rate scenarios in the past, but has not done so since 2015. This could be an effective way to convey uncertainty regarding economic developments and therefore also regarding the future policy path. A particular instance of forward rate guidance creating some frictions re- lates to the intention to bring repo back to zero, clearly signalled from 2018. As mentioned, by late 2019 the macroeconomic circumstances were less ob- viously pointing to the final move, but the prior signalling created strong mar- ket expectations which the Riksbank felt reluctant to disappoint. (b) On QE It seems that, in regard to elements of Swedish QE, the shift to a commitment has already occurred. The existence of QE certainly complicates the provision of forward guidance whether on rates and purchases, especially considering the extent to which they are substitutes, and especially in times of heightened uncertainty. Still, there is a presumption that announcements on the future path of QE have more the character of a commitment than a mere forecast, though this does not appear to have been made explicit by the Riksbank. After all, such announcements appeared to be decisions to actually buy a particular volume over periods of six months or so. This is a point that needs to be clarified. Taking this commitment element into account, it does seem clear that, even more than is the case with rates, the fan charts (published from February 2021) CHAPTER 4 THE IMPACT OF UNCONVENTIONAL POLICY INSTRUMENTS are an insufficient tool to convey the nature and extent of the uncertainty that is involved in future asset purchases and of the contingencies that will influence this. An example of the time-inconsistency problem created by an early announcement of bond-purchases 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-consistency trap. Forward guidance is especially difficult when the policymaker does not have a clear plan. For both negative interest rates and QE it does appear that the policies were embarked upon without having much regard to the exit plan. Under what circumstances would negative interest rates end? Should interest rates be normalized before or after re-investment of maturing bought securities was ended? Such questions were left, both in 2015 and in 2020, to be resolved later. This was understandable, especially in 2020 when decisions had to be taken in a hurry, but more attention should probably have been given to ensuring that systematic thinking about these issues was prioritized. Even now, at the time of writing, these sequencing issues do not seem to be settled. Chapter 5 The International Context It is natural to look at Riksbank policy mainly in terms of its domestic actions and the impact on inflation and other domestic economic indicators. But monetary policy in as open an economy as is strongly influenced by international developments and has an important impact on the exchange rate for the Swedish krona. Looking primarily through this alternative international lens, this chapter offers a complementary insight into the workings of ’s monetary policy in the period under review. 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 Federal Reserve (mentioned above) and the ECB as well as with other countries for which is more the provider of funds than taker. 5.1 Exchange Rate Movements and Monetary Policy Even though, unlike its neighbour the , the Riksbank does not try to peg the exchange rate, movements in the SEK/EUR rate are both strongly influenced by, and in turn influence, Riksbank policy actions. A higher policy rate tends to be associated with a strengthening krona and vice versa. When ECB acted to lowering its policy rate and adopt other expansionary policies, the Riksbank knew that, were it to ignore these actions, the krona could be expected to appreciate against the euro. Thus, although not a target of monetary policy in , the external value (exchange rate) of the krona is an important variable in the determination of price inflation and other macroeconomic conditions. How the Exchange Rate Moved During the period under review, in addition to daily and weekly fluctuations which can be expected for any freely floating currency in a market system, the exchange rate has experienced a significant low frequency (slow) oscillation. CHAPTER 5 THE INTERNATIONAL CONTEXT The net change in the (KIX-weighted) average effective exchange rate of the krona against the currencies of ’s main trading partners between January 2015 and was only about 1 per cent (Figure 21). However, selecting these two months masks a large low-frequency oscillation from strong to weak and back again. Broadening the temporal scope gives a more coherent picture within which our study period can be better understood. It is clear that, as between the US dollar and the euro, the krona has been more stable against the latter, both over the long-haul and in subperiods. Figure 21 Monthly exchange rate for the Swedish krona against US dollar and euro, and KIX index SEK and Index, = 100 KIX (RHS) Note: The KIX (krona index) is a weighted average of currencies in 32 countries that are important for 's international trade. A higher value indicates a weaker exchange rate. Source: The Riksbank