rfr · H90WRFR5 · 2022-03-31 00:00:00 — Indeed, from the start of the euro and until the autumn of 2008, the SEK/EUR rate remained rather stable around the rate of EUR1=SEK9 (with a monthly standard deviation of only 0.3). During the following five years or so, it then embarked on a roller coaster, first depreciating to over 11 by 2009 and then recovering strongly and overshooting its previous high to reach about 8.3 four years later. From to , the SEK was as stable around a path, depreciating at a rate of about 4 per cent per annum against the euro, as it had been against a fixed rate against the euro pre-August 2008. This brought the rate close to 11 again by late 2019. The depreciation of the SEK against the euro continued even after repo was raised in late 2018 and also after it returned to zero at the start of 2020. This indicates that the Riksbank has some freedom of manoeuvre on its policy interest rates. CHAPTER 5 THE INTERNATIONAL CONTEXT Finally, the pandemic unleashed a new wave of appreciation, with the SEK/EUR rate returning close to 10 by the end of 2020. There are a number of striking points about these movements. is no evidence that these low-frequency movements of the SEK/EUR rate are influenced by the US dollar’s movements against the euro.41 The key reference currency for the krona is the euro and the movements we have described are How much attention should an inflation targeting country pay to the evolu- tion of the exchange rate beyond its role as a leading indicator of imported Despite the focus on inflation envisaged by inflation tar- , many central bankers, including those at the Riksbank, do consider the potentially damaging effect on different productive sectors of strong exchange rate movements (importers and those taking holidays abroad hurt by depreci- ation; exporters by appreciation). Furthermore, it seems that the 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 5.2 Contemplating Currency Intervention: a Closer Look at 2015-2016 The impact on Riksbank policy of exchange rate movements and of the environment created by monetary policy abroad, especially in the euro area, is well illustrated by developments at the beginning of the period under review. Recall that the Riksbank entered 2015 with a repo rate at zero and a stated expectation that it would stay at that rate for longer than had previously been indicated. It had allowed the USD value of the SEK to fall by almost 20 per cent since mid-year — even more than that of the euro. The turn of the year was marked by considerable expectation of a new relaxation of ECB policy and expectations of euro weakness. Indeed, in mid-January the , having already pushed its main policy rate below zero the previous month, suddenly abandoned the ceiling it had placed on the CHF/EUR exchange rate; this in turn prompted the to lower its policy rate to -0.75 per cent to discourage massive speculative inflows. The ECB’s public sector asset purchasing programme was announced on 22 January 2015 and the first purchases made in early . 41 Regressing monthly percentage changes in the EUR/SEK rate on changes in the EUR/USD rate gives an RSQ of 0.0, whereas regressing USD/SEK changes on those in EUR/USD gives an RSQ of 0.72. (Same result for 2001-2021 and 2015-2020) 42 An alternative, suggested by some, would be to peg the SEK/EUR rate, as is done in . Note, however, that this would not have avoided negative interest rates. Furthermore, capital flow management with such a peg might well have presented bigger problems (cf. CHAPTER 5 THE INTERNATIONAL CONTEXT Despite its expectation that monetary policy in the US and UK would be tightened in the course of 2015, it was the other European developments and , together with the still disappointingly low inflation, that dominated thinking. Indeed the Board appear to have reacted both to the anticipation of ECB QE (in 2014) and then again in response to its implementation in early 2015. They decided in mid-February to lower the policy rate gently into negative territory (-0.1 per cent) and to buy a modest amount of Swedish government paper. In the following couple of months, concerns were expressed about the danger of a strengthening of the krona against the background of monetary policy developments abroad.43 With inflation still expected to be well below target, the policy rate was lowered further to -0.25 per cent, and the promised amount of QE increased. With concerns about the krona still prominent in ’s discussion, the repo rate was lowered again to -0.35 at the meeting in , despite their expectation that inflation (CPIF) would have reached 2 per cent by endyear.44 With inflation expected to reach 2 per cent by the following year no further policy rate changes were made before the end of 2015, but concerns about exchange rate movements continued. Furthermore, the ECB continued to ease, lowering its deposit rate from -0.2 to -0.3 in early . On the first working day of 2016, the Riksbank surprised markets by announcing a new quick-acting procedure for currency intervention, whereby the Governor and First Deputy Governor were delegated to take such actions as a complementary monetary policy measure.45 The decision was taken at an unscheduled extraordinary meeting of , following an appreciation of the krona against both the US dollar and euro (and the KIX index) 43As Minutes put it: “In an environment where monetary policy abroad is out of step, it is difficult to assess exchange rate developments. The krona has weakened substantially, which supports inflation. If the krona were to appreciate rapidly or international developments were poorer than expected, there is a risk that the rise in inflation would come to a halt.” Governor Ingves was even more categorical: “He said that the exchange rate is currently a central factor as it is important to inflation, partly because it is affected by developments abroad. The ECB's asset-purchase programme will help to boost growth in the euro area, which is also positive for the Swedish economy. In the short term, however, there is a risk that the krona will appreciate as a result of the ECB's measures, which would hold back the upswing in inflation that the Riksbank is trying to achieve. In one way or another, the Riksbank must therefore address what is happening in the euro area. emphasised that this requires the Riksbank to be ready to act in several ways, even between the regular monetary policy meetings, if things seem to be moving in a direction contrary to that predicted in the forecasts.” 44From Minutes: “Compared to the Riksbank's forecast in April, the krona has grown stronger, and its exchange rate thereby poses a risk to the upturn in inflation.” 45The decision was explained as follows: “The Riksbank does not have a target for the exchange rate. However, the value of the Swedish krona in relation to the most important currencies abroad is an important factor in assessing inflation. A rapid strengthening of the krona may therefore need to be counteracted by even more expansionary monetary policy. As a complementary monetary policy measure, the Riksbank may therefore need to intervene on the foreign exchange market.” (“Foreign exchange intervention – as a complementary monetary policy measure,” to the minutes of meeting of 4 January 2016) CHAPTER 5 THE INTERNATIONAL CONTEXT of about 2 per cent since the previous meeting of about three weeks earlier. Currency intervention is a tool which has been available to the Riksbank, but has not actually been used for many years (since 2002). It is conventional among the major central banks, and within Union, that one central bank’s intention to conduct currency intervention should be the subject of some prior consultation with other affected central banks. This is one of the “informal rules of the game”. While such intervention may be welcomed by partners when it is acknowledged that the exchange rate seems mispriced, in other circumstances it can often be poorly received. Actually, although the krona weakened on the day the intervention mandate was announced, and although the announcement may have stemmed an incipient strengthening, this date does not jump out from a plot of the daily rates. About six weeks later at the regular meeting, the repo rate was lowered to its all time low of -0.5 per cent. The following month the ECB lowered its policy rates again but this time there was no Riksbank policy response. (The ECB’s final policy rate reduction in was also not followed by the Riksbank). Further concerns about what proved to be transitory episodes of krona strength in 2017 and 2018 continued to exercise members, though no specific weakening actions were actually taken in that period. Allowing the special currency intervention delegation mandate to expire in 2019 was unlikely to unduly limit the Riksbank’s practical toolbox. Indeed, although the delegation authority was renewed several times until mid-2019, no use was made of it. All in all, this initiative seems to have been intended mainly as an announcement device. Swedish monetary policy is not and cannot be conducted without reference to the policy actions of the central banks of the main trading partners, especially the ECB. To neglect these would be to encourage volatile speculative capital flows and destabilizing exchange rate movements. While the exchange rate is not the objective of inflation targeting, the fact that exchange rate movements strongly influence prices and economic activity in has clearly been taken into account by the Riksbank on numerous occasions. It is less clear that the Riksbank has a fully worked-out formal strategy for incorporating the exchange rate into its deliberations. Chapter 6 Other Effects of Monetary Policy Given the wider set of policy instruments now being used by central banks, greater attention is being paid to their effects on aspects of economic performance beyond price stability. In the chapter we look at three important dimensions: financial stability, climate change and inequality. Monetary policy actions can have important financial stability consequences —not always in a helpful direction. For example, the low interest rate environment has clearly added to upward pressure on housing prices which could present stability risks. As is confirmed by long experience, low interest rates encourage risk-taking by financial institutions as well as by non-financial firms and households. And the risks that are taken often involve high leverage which makes the vulnerable to rate increases. The longer the maturity at which low yields prevail the larger these effects. Thus, the fact that the Riksbank has had to engineer low interest rates across the yield curve in order to deliver on its price stability mandate has increased the risk of financial instability. The purchase of sizable quantities of mortgage-backed covered bonds, and of some bonds of real estate and construction companies, may have acted in the same way. The public authorities as a whole have instruments at their disposal to mitigate these risks, including macroprudential tools, including capital requirement surcharges such as the “countercyclical buffer” and borrower-level rules such as ceilings on the ratio of loan-to-value for mortgage lending. In some countries some or all of these macroprudential tools are or partly under the control of the central bank, an arrangement that allows monetary policy and macroprudential policy to be decided as a joint package by a single agency. However, alternative institutional approaches, assigning macroprudential tools to the financial supervisory authority, to a government minister, or to a multi-authority stability council, are more frequent. Shortly before the period under review here, decided to allocate responsibility for macroprudential policy to the (). Since the Riksbank’s mandate prioritizes price stability, it is up to the FSA to respond to stability risks that emerge as a side-effect of monetary policy, rather than having the Riksbank do so. Taking the current division of labour between the Riksbank and the FSA as given, the Riksbank can still advise on macroprudential policies that are not under its control. It is well equipped to do so, given its capacity for macroeconomic policy research and its independence from the kinds of short-term CHAPTER 6 OTHER EFFECTS OF MONETARY POLICY political pressures that have often resulted in an inaction bias in applying coun- ter-cyclical macroprudential policies in other countries. The Riksbank is represented on the (), which discusses such policies, but this is a forum for policy discussion, not a The Riksbank could adopt a more role by being prepared to suggest formally to the FSC specific macroprudential policy measures if it strongly considers them to be necessary. If the other FSC par- ticipants did not agree, it would be good for them to be expected to explain Some central banks have chosen to moderate the speed with which they aim to achieve the inflation target when housing and other asset prices seem to be Most (but not all) scholars consider that such a policy approach, sometimes termed “leaning against the wind”, is less advantageous than one which uses macroprudential policies to dampen asset price bubbles.46 To some extent this policy of “leaning against the wind” has been the practice of the Riksbank before 2014. It has not been in evidence during the period under On the whole, we think that the Riksbank’s more recent stance was The world’s main central banks have begun to assess in a more thorough the novel question of whether monetary policy should take explicit account of the problem of climate change. To be sure, there is relatively that any central bank can contribute to this vital policy challenge, but it is not nothing. First, there will be an increasing need to align with – and not undermine – the efforts of other central banks, when it comes to such matters as the composition of asset purchases. Market neutrality as a criterion for this composition is not evidently optimal when certain sectors and firms impose significant externalities through environmental damage. The trust in, and standing of, the central bank will also be at risk if it does not take explicit account of this important challenge, especially at a time when it is receiving extensive public attention in view of the irreversible nature of climate change and the fact that the globe appears to be nearing a tipping point. An international Network of Central Banks and Supervisors for Greening the () was established in 2017 to develop recommendations for central banks’ role in climate change. The Riksbank joined this initiative – which now has 95 members and 15 – in its first year. Climate change has somewhat influenced Riksbank asset purchases and the composition of its external reserves in recent times. From 2021, it will, in line with the recommendations of the Task Force for Climate-related Financial 46 Some Swedish scholars argue that, at low interest rates, the Riksbank should pay more attention to asset prices (especially housing prices) which can at present be more easily influenced by central bank policy than can the aggregate of consumer prices (cf. and 2020). CHAPTER 6 OTHER EFFECTS OF MONETARY POLICY Disclosures (TCFD), disclose the carbon foot-print of its corporate bond holdings. Nevertheless, the policy deserves further development and transparency. A decision was taken in to adopt a “sustainability strategy for the Riksbank”. This is to include a negative screening whereby the Riksbank will not buy bonds of companies which do not comply with international sustainability standards (and 2021). As described in Breman (2021), the Riksbank is in effect limiting its monetary policy purchases of corporate bonds to firms that are following relatively good climate policies. It is also moving away in its foreign reserves from the purchase of the bonds of governments whose countries may be regarded as more “brown”. The Riksbank’s actions on climate change are now broadly in line with those of the more of central banks around the world. It is acknowledged that clear global standards for measuring greenness are necessary to ensure that these policies are as effective as they can be: such standards are being worked on, but are not yet well developed. They may not materially influence the progress of decarbonization, but will have a necessary symbolic role. It is unlikely that this will materially interfere with the Riksbank’s ability to achieve its primary price stability goal. Another issue of general importance which central bank policy influences is inequality of income and wealth in society. The impact on inequality of the lengthy period of low nominal and real interest rates has attracted attention all over the world. Low interest rates are clearly associated with high asset prices and it is evident that these prices have increased the concentration of wealth. Among the assets affected are homes; their prices have been rising for most of the period under review and accelerated in 2020. Beyond their effect on household indebtedness and thus on financial stability, the rising prices made housing less affordable especially for the lower income segments of society. However, although low interest rates have surely contributed to the demand for housing, the chief policy measures for addressing housing lie within the domain of government structural and tax policies. Furthermore, low interest rates were needed to ensure adequate aggregate demand to bring economies back to full employment after the global financial crisis, thereby reducing income inequality. A tighter monetary policy in during this period of relatively weak aggregate demand would have resulted in higher unemployment, which in turn would have had an adverse effect on income inequality. Balancing these two opposing forces is essential if we are to understand the impact of monetary policy on inequality. Three other considerations need to be borne in mind if we are not to exaggerate the scale of redistribution that is truly attributable to Riksbank policy. First, low interest rates in are not simply due to central bank policy. It is true that monetary policy has had an expansionary thrust for over a decade now across most of the globe and that the Riksbank’s policy has also been CHAPTER 6 OTHER EFFECTS OF MONETARY POLICY However, it is important to note that these low interest rates are only partly a consequence of the policies of the world’s central banks (and even less of Riksbank policy per se). Indeed, real interest rates across the world have shown a very long downward trend which has been pronounced in the past quarter century and is variously attributed to demographic developments, movements in inequality, and the rise of high saving economies in , for example (See Mian et al. 2021 and Schmelzing 2020). Thus, a sizable part of the rise in the price of financial assets must be attributed to non-monetary fac- Still, the Riksbank’s monetary policy has had some autonomous contri- bution to the low interest rates prevailing in and as such to the distri- Second, monetary policy does not always act to lower interest rates. inflation is above target, the Riksbank has acted – and will surely act again – to increase interest rates above their long-term trend level. tional impact interest rate reductions have will tend to be reversed by such Lifetime distributional effects of monetary policy on inequality can thus be expected to be rather low. A third point relates also to lifetime calculations. who have already accumulated financial assets do benefit, when interest rates fall, from the higher capital value of a given stream of interest or dividends from their accumulated assets. But they will earn less from new savings. lifetime perspective needs to be kept in mind in assessing the policy relevance of wealth changes resulting from interest rate movements (cf. Quantifying the distributional effects of monetary policy has been a focus of considerable international attention over the past decade or so. an easy task, as it requires micro data in order to identify the scale of impact on income and wealth on individual households, and also needs a robust coun- terfactual, to assess what would have been the case under an alternative mon- etary policy sufficient to achieve the price stability goal. For example, there might be a trade-off between QE and lower policy interest rates inasmuch as QE likely has a stronger effect on long-term bond yields thereby generating larger wealth effects; but evidence to confirm such a hypothesis is lacking for The empirical research that has been carried out internationally suggests that the effects of monetary policy on inequality have not been very large, and have varied depending on the state of the economy when the policies were Thus, most studies for the suggest a moderate increase in inequality from the use of QE, whereas the ECB’s QE, which was adopted at a time of higher unemployment, seems to have resulted in lower inequality This issue seems to have been addressed significantly in writing by the Riksbank only towards the end of 2020, and there is only limited available Estimates based on administrative data suggest that in- come effects of an expansionary monetary policy are strongest at the bottom and (if realized capital gains are included as income) the top of the distribution. CHAPTER 6 OTHER EFFECTS OF MONETARY POLICY The gains at the bottom arise mainly because of employment effects (Amberg et al. Data to analyse the effects of QE and low interest rates on the distribution of wealth are not available in , since the abolition of wealth tax in 2007. The flattening of the unemployment response to monetary easing in 2017-2018 may have meant that the regressive impact through wealth effects began to dominate the progressive effect through unemployment reduction. Given the wider range of tools being used by the Riksbank, there is some potential for trade-off between inequality impacts and other side-effects of the mix of policies used to achieve price stability.47 The likelihood that some of these policy tools will continue to be used in the future argues that the Riksbank should continue its somewhat belated research on the topic. However, it is important to stress that the main tools to deal with income and wealth distribution lie within the domain of the Government, and to the extent that monetary policy conducted so as to achieve price stability has some redistributive side effects, those could be counteracted by government policies. 47For example, it is often noted that a policy of “helicopter money” i.e. a broad distribution of grants from the central bank to the general public, would have a different distributional impact to that of QE for an equivalent impact on aggregate demand and inflation. Of course, having the central bank decide, and implement, such a distribution independently of government policy would be highly controversial. (Furthermore, helicopter money could not be put into reverse when monetary policy has to be tightened.) For the moment, such a policy remains at the level of academic contemplation, though a fiscal expansion of social benefits combined with QE would have de facto similar effects on aggregate demand and inequality. Chapter 7 Impact of Proposed Legislation The broad consensus that exists regarding the desirability of central bank independence reflects the generally held view that the primary objective of price stability is best served by a fully independent institution with a precise definition of its mandate.