rfr · H90WRFR5 · 2022-03-31 00:00:00 — 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 the concentration of wealth has increased. It is important to note that these low interest rates are only partly a consequence of the policies of the world’s central banks, let alone of Riksbank policy. Furthermore, 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. As with other central banks, it is only relatively recently that the Riksbank has begun to address the net impact of its expansionary policies on income and wealth inequality and on climate change. Quantification has proved elusive here, especially in relation to wealth (as distinct from income) and, despite recent policy statements on ecological sustainability, it may be that the Riksbank needs to explore these issues in greater depth. In particular, data on the distribution of wealth should once again be collected for . The Riksbank has recently (from 2021) taken a more forceful approach than before on climate change when it comes to selection of corporate bonds in its asset purchase programmes; such steps are important if the general public is to retain the trust in their central bank that is essential for its effectiveness. The Riksdag is considering a revision of the Riksbank Act. It will be helpful for the effectiveness of this independent institution if (as is proposed) the legislature clarifies the secondary objectives that have so far been implicit, but without narrowly prescribing the policy measures that are to be used in delivering on its mandate. We make no attempt to assess the consistency of the draft legislation with the Treaty on the Functioning of Union. The draft legislation proposes to amplify the Riksbank’s explicit mandate to cover matters such as the level of economic activity which indeed seem to have been already taken into account as a kind of implied monetary policy 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, it is advisable for legislators to avoid micromanage central banking or to be second-guessing the central bank on technical matters. Reliance on 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. As mentioned, in the current set-up, the Riksbank has no direct responsibility for many of the “macroprudential” policy instruments available to national policymakers for maintaining financial stability. Nevertheless, the rapid and extensive measures adopted by the Riksbank in 2020 reconfirms the importance to of being able to promptly deploy all of the instruments necessary to ensure price, macroeconomic 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 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. Even if the legislation does finally empower the Riksbank to take all necessary measures in circumstances that require urgent action, it will be important to ensure that the wording of the restrictions on the use of financial stability tools does not result in the Riksbank hesitating to act sufficiently early to prevent a disturbance metastasizing into a crisis that could have been avoided. It is vital that such inaction bias does not infect the Riksbank. The pandemic represented an extreme example of an 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 and climate impact, will tend to go into reverse. In this environment, it will be crucial for the Riksbank to retain the confidence of the Riksdag and other public bodies, of the financial markets and of the general public. 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.1 The terms of reference of our Re- view are set out in 1. started its work in 2021 and was submitted to the Riksdag in February 2022 for translation into Swedish. We are grateful to , and to of its Secretariat, for their help and cooperation in providing us with the facilities required to conduct this Review. We are particularly indebted to of the Riksbank who was seconded to work with us. Her intimate institutional knowledge, her command of the economics of central banking and her extensive network have been of great value. Despite the fact that so much of our work had to be done online and in videoconferences, she was able to arrange meetings with all of the counterparts with whom we felt it necessary to meet, she assembled and charted the data needed to analyse financial and economic developments and she helped source published and unpublished written material. (She should not, however, be held responsible for any of the observations and conclusions set out below.) We interviewed every member who served on during the period 2015-2021. Staff of the Riksbank provided extensive assistance in explaining their approach to formulating monetary policy options, their working arrangements and the econometric models that they use. We also interviewed members of (the Swedish Financial Supervisory Authority), a number of independent economists, both academic and representative of the different constituencies of social partnership, and others with views and experience of monetary policy in . A complete list of those whom we met is set out in 2. We are very grateful to all of these for helping us base our review on solid evidence. A five-year long episode of negative policy interest rates and two large waves of asset purchase (the so-called quantitative easing—QE) marked the period of ’s monetary policy under review. While there was a clear influence from somewhat parallel developments in the economies of ’s principal trading and financial partners, the timing and scale of these vigorous measures was calibrated to national conditions. They were effective in bringing ’s inflation close to target before the Covid-19 pandemic, and in protecting from financial market disruption in and and from an even deeper decline in economic activity due to the pandemic. 1The first evaluation was made by and , and covered the period 1995-2005. The second was by and , and covered the period 2005- 2010. The third was by and and covered the period 2010-2015. Some of the tools used and policy decisions remain somewhat controversial. The somewhat hasty decision to lift the repo rate out of negative territory at the end of 2019 – before inflation had been firmly anchored and with unemployment still rather high – points to the Riksbank’s discomfort with negative rates. Indeed, it did not choose to lower rates again when the pandemic hit, relying instead for its prompt reaction on a larger asset purchase programme, which entailed the controversial inclusion of mortgage covered bonds and corporate bonds. These additional asset could be justified in the height of the financial panic of and , and it is acknowledged that calm financial market conditions were quickly restored. But it is less clear that sustained purchases of corporate bonds over a longer period yields benefits commensurate with the risks involved, including the risks to the reputation of the central bank as an impartial manager of monetary and financial conditions in the public interest. The exceptionally low global real interest rate environment against which Swedish policy decisions had to be taken boosted the market prices of real and financial assets--thereby aggravating the concentration of wealth. Nevertheless, by supporting the level of employment, the expansionary stance of Riksbank monetary policy protected average incomes in the lower part of the distribution thereby likely avoiding an overall worsening of income inequality. The experience of this remarkable period 2015-2020 again demonstrates the wide range of monetary policy tools that need to be deployed in the face of shocks in the highly leveraged and volatile financial world of recent years and the importance of bringing them to bear with speed and flexibility. Communicating these complexities remains challenging, especially considering the complex side-effects on wider economic policy goals, including the functioning of banking and financial markets in general, financial stability, economic inequality and climate change. The Riksbank has been communicating its policy, and the rationale behind it, to the various stakeholders in a clear and effective way. However, the thrust of some recent legislative proposals suggests that the Riksbank needs to be more effective in persuading legislators of the value to of it retaining its freedom of action in independently deploying all its available tools to ensure, in appropriate collaboration with the other agencies of the State, that it can be effective in delivering on its mandate. The body of the report is organized as follows. •Reflecting the primacy given to price stability in the Riksbank’s current mandate, Chapter 1 discusses the target used and the overall achievement relative to this target. •Chapter 2 describes the measures taken during the first five years of our review window 2015-2019, during which the main policy interest rate was negative. Given the commentary by our predecessors on the conduct of deliberations in earlier years, we look at how things have 2021/22:RFR5 INTRODUCTION changed in that respect as well as on the communications and forecasting performance of the Riksbank and the degree to which it has been effective in anchoring market expectations. •Chapter 3 deals separately with 2020, and the special measures adopted early in that year to deal with the financial market and economic disruption caused by the pandemic. •Chapter 4 considers the effectiveness of three major features of monetary policy, sometimes thought of as “unconventional” and which have been used both in and in several other relevant central banks since the Global Financial Crisis, namely negative interest rates, outright asset purchases and forward policy guidance. •Monetary policy in a small open economy such as is strongly constrained by external factors. Chapter 5 focuses on these, looking in particular at the impact of exchange rate movements on monetary policy decisions over the review period. •Monetary policy tools can have important effects on financial stability as well as on non-financial aspects of economic performance such as inequality and climate change. Chapter 6 assesses the degree to which these have been relevant in the Swedish context. •Chapter 7 turns to the question of new legislation and the importance of ensuring that the modifications to the Riksbank Act are crafted in such a way as to enable the Riksbank to deliver effectively and promptly on the mandate given to it. •This is followed by some Concluding Remarks. The recommendations derived from our analysis are presented immediately following this Introduction. They deal with the mandate of the Riksbank and the choice of target; the role of negative interest rates and asset purchase in the implementation of monetary policy, including the planning of exit from the use of exceptionally expansionary policy; the role of exchange rate movements in determining monetary policy; communications and forward policy guidance, and the transparency of deliberations; and on side effects of monetary policy on inequality and climate change. We address the subtle challenges that arise in the interaction between monetary policy and financial stability, and have felt it appropriate to warn about some problems that might arise from proposed legislative reform. It strikes us that has been well-served by the monetary policy of the Riksbank in the period under review. Its skilled and dedicated staff have delivered more effectively than in earlier years on the mandate which the Riksdag has given it. We echo the assessment of previous reviewers that can be proud of its central bank and the quality of people who choose to work for it. R.1 The Mandate of the Riksbank for Monetary The proposed expansion to the Riksbank’s mandate in the draft legislation is welcomed, formalizing, as it does, the de facto inclusion of production and employment as a secondary target.2 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. Moving from CPI to CPIF as the measure of inflation used by the Riksbank in its target has been a success. By avoiding the perverse mechanical impact of interest rate movements on the target that was present when CPI was the target, clarity of the policy stance is promoted. 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. The +/- variation band around the target can be exploited in this regard within the current framework. Under existing legislation, the definition of price stability and the choice of an inflation target is a matter for the Riksbank itself. In this respect its autonomy is comparable to that of the ECB and Federal Reserve and 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. The proposal to require Riksdag consent for the Riksbank’s specification of the price stability target somewhat reduces the autonomy of the Riksbank, but leaves it with greater autonomy on this matter than many others. One potentially important drawback to this proposal, however, is the danger that this procedure could introduce a bias for inaction if the Riksbank, though regarding a change in the target to be desirable, could not easily find a satisfactory formulation that would command sufficient support in the Riksdag. 2It is important to note that we make no attempt to assess the compatibility of the draft legislation with the Treaty on the Functioning of Union. 2021/22:RFR5 RECOMMENDATIONS This danger can be averted if the Riksdag continues in practice to defer on technical aspects of the design of the inflation target. R.3 The Toolkit – Interest Rates Negative interest rate policy should remain part of the toolkit. Experience has been generally positive with close to full pass-through from the main policy rate to lending and other key interest rates. Subsidized lending or deposit rates have been used by and the ECB among others, though only for broadly defined segments. The Riksbank’s “funding for lending” scheme introduced in the panic of 2020 was broad in scope – banks’ access was dependent only on the funds being on-lent to companies. On the other hand, the scale of subsidy involved was limited given that pricing of these collateralized loans was at the repo rate. One can imagine future circumstances under which such measures might be needed again. While this was appropriate given the special conditions of the time, see advantage for the Riksbank to go further in introducing such distortions: subsidies for preferred economic sectors are better channelled through the government’s budget. R.4 The Toolkit – Asset Purchase Asset purchase (QE) has proved to be a valuable tool both in and in other countries where short-term policy interest rates have approached their lower bound. Now that the processes for such purchase programmes have been tried and tested, they should remain part of the toolkit and can be useful in influencing the slope of the yield curve even when the policy rate is above its lower limit. Going beyond Swedish government bonds in asset purchase can be less desirable from an economic impact point of view; it is understood that the Riksbank has been influenced by concerns that substantial further purchases of Swedish government bonds could be thought of as falling foul of the monetary financing prohibition of the Treaty. Even though only investment grade bonds are acquired, the potential drawbacks, political and economic, of becoming entangled in the reallocation of financing towards larger firms, together with the credit risks that may be involved, suggest that purchase of corporate bonds and commercial paper should only be considered at times of acute market disruption. Purchase of mortgage covered bonds – which has formed the largest part of the asset purchase programme – clearly involves a preferential tilt of financing towards residential property; when contemplating further purchases of covered bonds, the Riksbank should carefully consider whether this important side-effect is desirable or acceptable. R.5 Exiting from Expansionary Measures The Riksbank should devote more attention to scenarios in which QE and the other exceptional measures introduced during the pandemic can be rolled back and provide greater clarity about its plans. In particular, it should clarify the sequence in which it will roll back the purchase of the various asset . The first steps should be to curtail and then stop purchase of corporate bonds. Does the Riksbank intend (as is the case with several other central banks) to move interest rates higher before stopping reinvestment? generally, the sequence of steps in unwinding exceptional policy measures should always be planned for and publicly communicated. It has been suggested by some critics that refocusing monetary policy on ensuring a more stable exchange rate for the SEK is desirable. As long as there is no decision to join the euro, we believe that the Riksbank already pays sufficient attention to this rate within the context of maintaining price stability. This seems to have been sufficient to avoid sharp changes in the external value of the currency that might seriously affect competitiveness or financial stability. Conveying the distinction between its repo rate forecast and policy commitments remains challenging for the Riksbank as for other central banks. Al- though the Riksbank has repeatedly stated that the repo path is a projection and not a commitment, it seems that it is not perceived by the public as a mere forecast. This challenge of forward policy guidance deserves greater attention in the Riksbank’s communication, with a view to clarifying what is a forecast, what is a conditional commitment (and what the conditions are), and what is an unconditional commitment.3 As is well-known this is not a simple task, as economic and financial market conditions can change in unforeseen ways, and future members of may not feel themselves to be fully constrained by commitments entered into by their predecessors. But that only serves to emphasize how important it is to plan communications around forward guidance to reduce the associated risks. For example, that the repo path is not a commitment tends to jar with other aspects of the Riksbank’s forward policy guidance. Indeed, the fact that the Riksbank felt obliged to go ahead with activation of the corporate purchasing program when it was ready in , even though corporate bond spreads had already narrowed, reflects the fact that the announcement of this programme in 2020 was seen, both within and outside the Riksbank, as a commitment and not just a projection dependent on market conditions. 3At the very least, it should be stressed that the repo rate and QE forecast path (interest rate and QE) is conditioned on the realization of the main elements of the economic forecast. 2021/22:RFR5 RECOMMENDATIONS Riksbank felt that it had to make good on the commitment to implement the programme (in order maintain credibility), even though the conditions that had motivated it no longer prevailed; this might not have been necessary had there been an indication at the outset of what conditions would be required to justify activation of the programme when it was ready. There is much to be said for forward guidance on QE less specific especially for the longer horizon (e.g., asset class, quantities). Here there is a need to weigh the possibly reduced effect of reduced specificity on shaping expectations, against the benefit of maintaining flexibility for policy decisions when the outlook changes. Another way to deal with the problem of time inconsistency of policy forecast/commitment especially in times of high uncertainty is the use and presentation 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. R.8 Transparency of the Deliberations of the The published minutes provide a fairly detailed statement by each member about the economic outlook and the arguments for the desirable policy path. In this sense it is very transparent and provides the public with the information of how each member of the board forms his or her view about the desired policy action. However, as the minutes are not organized around issues, they do not give a clear sense of the debate or internal discussions. It would be desirable to annex to the minutes a more detailed analytical section that would focus at greater length on the main issues that were discussed (especially those where different views were expressed) and summarize the different views expressed on these issues. R.9 Secondary Mandate on Financial Stability The draft Riksbank legislation makes separate provision for a secondary mandate on financial stability.