rfr · H90WRFR5 · 2022-03-31 00:00:00 — In this respect also the Riksbank has not previously neglected what was seen as an implicit mandate. But, by separating the legislative authority for financial stability actions from that for monetary policy, and by identifying a limited number of tools that are to be considered as monetary policy tools, the draft legislation introduces a somewhat artificial distinction which is likely to be impossible to maintain in practice, as the most important operational tools of liquidity support necessarily have monetary policy implications. Experience in other countries shows that attempting to maintain a separation between tools that are focused on price stability and those focused on financial stability can result in sub-optimal measures for both objectives. The last few years have demonstrated that the range of tools needed to ensure achievement of the monetary policy mandate is indeed a wide one; this reality is not reflected in the narrow focus proposed in the draft legislation. The most practical implication of the proposed separation relates to the requirements (in Section 11 of the draft legislation) for cooperation with other authorities of the State. In many instances, such cooperation should indeed be expected when structural policy changes are being planned. However, it should not become routine that the Riksbank is expected to consult on its use of liquidity tools. The final paragraph of Section 11 as worded is intended to ensure that speedy action in an emergency such as that of 2020 need not be delayed. But the wording of this paragraph may not be strong enough to insulate the Riksbank’s monetary policy discretion from procedural obstacles and delays. Thus the requirement for pre-consultation may lead to inaction bias by the Riksbank when the grounds for policy action may not be clearly separable between financial stability and price stability objectives, and when the determination whether the circumstances merit operation under “a crisis mode”. Monetary policy actions can have important financial stability consequences — not always in a helpful direction. For example, the expansionary policy environment has clearly added to upward pressure on housing prices which could present stability risks.4 The textbook response to such conflicts includes the use of macroprudential tools to dampen unwarranted asset price movements. Most of these tools are at present under the control of (). Taking the current division of labour between the Riksbank and the FSA as given, the Riksbank can (and does) still advise on macroprudential policies that are not under its control, 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 reluctance to adopt macroprudential policy in other countries. The FSA and other relevant governmental authorities should, if they are not willing to act in line with such advice, be expected to explain why. R.10 Side-Effects of Monetary Policy on Environmental, Social and Governance Aspects The broader toolkit being used by central banks since the GFC and the extremely low interest rates that have recently prevailed have drawn attention to hitherto neglected side-effects of monetary policy. In particular, the questions of whether monetary policy should take account of (i) climate change and (ii) inequality have come to the fore both in and abroad. In practice, the extent to which climate change can be influenced by monetary policy actions is small, but the Riksbank should clearly play its part. 4The link between monetary policy and housing prices in has been the subject of academic econometric studies, e.g. (2019). 2021/22:RFR5 RECOMMENDATIONS will be manifested mainly through its policy on asset purchases. The Riksbank’s new policy statement on this matter, which took effect from the start of 2021, seems to be well crafted.5 Its reports to the Riksdag on implementation of this policy should be detailed and transparent. The effects of monetary policy on income and wealth distribution are complex. The general direction of the effects is clear: expansionary policy reduces income inequality through its effect on labour income distribution, while it increases wealth inequality through its effect on asset valuations. However, quantifying these effects has been challenging in all countries: the expansionary path of monetary policy since the GFC may have had net favourable effects on income distribution in the euro area, but may have been slightly negative in the US. Wealth effects may have been worse. In the case of , the necessary data for assessing wealth distribution changes has not been collected for some years. This is an omission that should be corrected. It would be desirable to have more studies on the effects of monetary policy on income and wealth distribution. In cases where a variety of monetary policy tools are available to ensure price stability, such studies could help make the Riksbank aware of choices that could have unnecessarily adverse effects on inequality. generally, there is much to be gained from greater use of microeconomic data in the Riksbank’s research programme. The main tools for affecting income and wealth distribution are, however, within the domain of government redistributive policy. Furthermore, even if expansionary policy increases wealth inequality the opposite will likely be true of contractionary policy, so these effects will average out over the business cycle. 5It can be compared with somewhat different approaches recently announced by such comparators as the ECB, and . The ECB’s position is the most relevant since it too has been a purchaser of corporate bonds for monetary policy purposes. Chapter 1 Price Stability: Converging to the 1.1Fulfilling the Mandate: Price Stability and Macroeconomic Side-Effects We begin with inflation. After all, the Riksbank’s current statutory mandate for monetary policy is exclusively directed to price stability. This is unusual for a modern central bank. At one level it could imply that an evaluation such as the present one could focus exclusively on the Riksbank’s achievement relative to this target. Yet policymakers’ speeches make it clear that relevant de- cision-makers are also concerned about wider conjunctural performance and about side-effects. In practice, the Riksbank has always 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. Indeed, draft legislation now proposes an expansion to the Riksbank’s mandate formalizing the de facto inclusion of production and employment as a secondary target. The draft Riksbank legislation also makes separate provision for a secondary mandate on financial stability. This area too has been a vital part of Riksbank thinking and influencing its actions. This chapter focuses on the Riksbank’s overall success in relation to its price stability mandate and also summarizes the performance of the real economy in the period under review. It discusses decisions about the measurement of inflation for policy purposes and the choice of inflation target. Later chapters will look in greater detail at the policies employed by the Riksbank and their impact on the Swedish economy. 1.2 Inflation Relative to Target 2015-2020 The years before the period under review were marked by a stagnation of the price level which only began to be rectified after the Riksbank’s mid-2014 policy shift. By the end of 2014, CPI inflation in had hovered around zero for more than three years — well below the Riksbank’s target inflation rate of 2 per cent. Among the reasons for this sluggish rate of increase in prices, it is easy to see the part played by Riksbank policy. Its main policy tool, the repo interest rate6 was increased during the second half of 2010 and the first half of 2011, thereby dampening economic demand and slowing inflation (Figure 1). Even though the Riksbank started to lower the repo rate again shortly after the 6The main policy rate of the Riksbank is the repo rate. It manages its fine-tuning operations involving the sale of certificates of deposit to the banks to ensure that the volume of bank deposits remunerated at the Riksbank’s lower deposit rate is small. Therefore, even when bank liquidity is plentiful, the Riksbank’s deposit rate has relevance. This contrasts with the situation in the euro area, where the ECB’s deposit rate is the most relevant policy rate during periods of excess liquidity such as have prevailed now for over a decade. CHAPTER 1 PRICE STABILITY: CONVERGING TO THE CPI started to actually fall (just before the end of 2011), the interest rate reductions were too slow to bring inflation back up to the target promptly.7 Figure 1 CPI inflation Note: This is the former target measure CPI, which was replaced in 2017 by CPIF which removes the transitory effect of interest rate changes on measured inflation. With the much more expansionary Riksbank policy stance from mid-2014, inflation soon picked up. Indeed, the average of CPI inflation 2016-2019 was, at 1.8per cent, close to target; and it even exceeded 2 per cent for parts of 2017 and 2018. This was closer to the 2 per cent target than in most countries including the euro area (and most of the comparator small open economies (SOEs) (Figure 3)).8 Thus, while the Riksbank’s fan chart of expected inflation as of early 2015 may have looked over-optimistic in the speed with which it forecast a return of inflation to target, it proved to be quite prescient (Figure 4). Indeed, using the alternative CPIF inflation data (as explained later, CPIF was adopted as the formal target variable in October 2017) inflation was well within the Riksbank’s +/- 1 per cent “variation band” throughout . The drop to an average of 0.5 per cent inflation in the pandemic year 2020 evidently reflects unusual economic conditions in that year — so much so that 12-month inflation was briefly negative in early 2020. 7Admittedly, because the target variable (CPI inflation) was mechanically affected by a lowering of mortgage rates, the declining repo rate itself had a somewhat misleading effect of reducing measured inflation in this period. Nevertheless, inflation measured by the alternative series CPIF, which is free of this artificial effect, fell as low as zero in early 2014 (Figure 2). 8To show relevant international comparisons, we have included simple average data for all of the countries with populations between about 5 million and 20 million, and with per capita GDP of at least US$ 40,000 PPP, namely , , , , , and . (’s population is 10.4 million and GDP per capita about US$59,000 nominal and US$56,000 PPP.) CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Figure 2 CPIF inflation and CPIF excluding energy Note: This is the new target indicator CPIF. Figure 3 Inflation rates in and selected countries 2013-2021 Note: Targeted inflation. The shaded area represents the range of outcomes in comparator small open economies: , , , , , and . SOE is the average of these countries. Sources: Czech Statistical Office, , , Japanese Cabinet Office, Statistics , Statistics , Statistics , Statistics , Swiss State Secretariat for Economic Affairs and U.S. CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Figure 4 Riksbank inflation fan chart as of early 2015 Note: The uncertainty bands are based on the Riksbank’s historical forecasting errors. The CPIF is the CPI with a fixed mortgage rate Source: February 2015 The relatively satisfactory inflation record 2015-2019 took place against a relatively stable overall macroeconomic environment. Average annual GDP growth 2015-9 was 2.6 per cent, (best in 2017), with employment growing at about half that rate (Figure 5). Per capita GDP growth averaged about 1½ per cent; this was better than the euro area, but not as good as , for example, or for the average of the comparator small open economies. (Adding 2020 brings the average down to 1.7 per cent.) There were occasional patches of weakness in 2016, 2018 and 2019. CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Figure 5 GDP annual growth rate and selected countries 2013-2021 Note: SOE is the average of the set of comparator small open economies and consist of , , , , , and . The red dotted lines represent the maximum and minimum outcomes of these countries. Sources: Czech Statistical Office, , , Japanese Cabinet Office, Statistics , Statistics , Statistics , Statistics , Swiss State Secretariat for Economic Affairs and U.S. Unemployment averaged 6.8 per cent 2015-2019 and ended that subperiod less than 1 percentage point lower than at the start, there having been some reversal in 2019. This was a much slower reduction than in the euro area, and less than the average of the small open economy comparators, but about the same as that in (where, however, the average rate of unemployment was just over 4 per cent) (Figure 6). Immigration of asylum seekers was a contributory factor in slowing the reduction of unemployment, because of the difficulty which many of the recent immigrants have had in the labour market (Figure 7). CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Figure 6 Unemployment rate, and selected countries 2013-2019 Note: The shaded area represents the range of outcomes among the set of comparator small open econo- mies: , , , , , and . SOE is the average of these countries. Sources: Czech , , , , , Statistics , Statistics , Statistics , Swiss State Secretariat for Economic Affairs and U.S. Figure 7 Unemployment rate, domestic and foreign-born 2005-2021 Domestic , 15-74 Years Foreign , 15-74 Years The emergence of the pandemic resulted in , as elsewhere, in a sharp decline in aggregate economic activity from 2020 and a jump in un- CHAPTER 1 PRICE STABILITY: CONVERGING TO THE employment, as well as in a sharp decline in inflation. However, experienced a more modest decline in GDP than most advanced economies, but its unemployment rate, which was higher than in most advanced economies at the eve of the pandemic, rose more sharply. Inflation dipped in early 2020, but recovered rapidly and was back at close to 2 per cent () by January 2021. It is also worth noting that household debt — already at record levels and growing rapidly at the start of 2016 – plateaued at around 190 per cent of annual disposable income from 2017 to 2020 (Figure 8). Housing prices followed a somewhat similar path (Figure 9). Figure 8 Household debt as percentage of disposable income CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Figure 9 Real house prices 2015-2021 Index, January 2015=100 Note: House prices deflated by CPIF. Sources: Valueguard and Statistics The current account of the balance of payments, which had been running at over 5 percent of GDP in 2013-2014 dipped to below 3 per cent 2017-2019. 1.3 Measurement of Inflation Different Measures of Underlying Inflation Concern in previous years about the measurement of inflation in abated during the past few years. Despite the fact that the Riksbank has listed at least seven different series measuring inflation to which it pays attention, the focus of this debate had been the treatment of owner-occupied housing costs in the CPI (cf. Figures 1 and 2). Several quite different approaches to measuring the housing costs of owner occupiers are used around the world. harmonized index HICP, which is used by the ECB as its target variable, excludes most of the housing costs of owner-occupiers. The approach uses for its CPI (applying a current mortgage rate to a long moving average of house prices) means that a reduction in the Riksbank policy rate (which is expected to boost inflation) mechanically reduces the CPI. This means that movements in the policy rate introduce a degree of volatility in the CPI that can mislead about the thrust of policy. To look through this problem, the Riksbank had long tracked CPIF as an important measure of underlying inflationary trends. Following discussion, CPI was replaced by CPIF as the formal target of monetary policy in October 2017. In practice, the modest interest rate movements in the period under review mean that this change has had actual effect to date. CHAPTER 1 PRICE STABILITY: CONVERGING TO THE Measuring Inflation in the Pandemic Years As in all countries, the pandemic years have seen a sizable shift in the composition of consumer purchases, reflecting the constraints on consumption of a wide variety of goods and services, especially those involving human contact. Using 2018 consumption weights to construct the 2020 CPI could mislead, and ad hoc revisions to the methodology have been necessary. From the point of view of monetary policy, it would seem reasonable to pay attention to the dip in measured inflation in 2020 in setting policy for 2021 and beyond. A forward-looking monetary policy strategy would look through transient pandemic effects. 1.4 Reviewing the Inflation Target In recent years there have been suggestions by distinguished scholars in several countries (see, for example, the cases cited in Gagnon and 2019) that 2 per cent is too low a target for inflation given the heightened frequency with which nominal policy rates hit or approach their lower bound. Whatever are the merits of such suggestions, it would be a mistake for a small open advanced economy like to adopt an inflation target that is markedly different from that of its major trading partners, especially because of the continuous pressure that would be placed on the exchange rate. Another recent suggestion in international discussions focuses on whether an overshoot of the target should be tolerated to compensate for undershooting attributable to having reached the lower bound of the policy rate (Bernanke 2017). Indeed, a degree of overshooting is now envisaged in the announced strategies of both and the ECB (, 2020; 2021; Reichlin et al. To date, the precise implications of these new formulations remain somewhat vague, though it is clear that there is no intention to aim for an average inflation rate of more than 2 per cent over the medium term. Cumulative inflation in did not fall as far below 2 per cent in the past five years as happened in the euro area. Accordingly, this problem may not be as acute for . Nevertheless, the implication that euro area policy may become more expansionary needs to be borne in mind, and the Riksbank will need to ensure that its announced policy framework does not systematically neglect the new policy environment risking an unwanted appreciation of the SEK as a result. Overshooting of inflation beyond the 2 per cent target for some time is consistent with the current framework that includes the variation band of +/-around the 2 per cent target. Chapter 2 The Operation of Monetary Policy 2015-2019 This chapter reviews the monetary policy measures adopted by the Riksbank in the period 2015-2019. The five pre-pandemic years can be divided into two quite distinct phases, as far as the use of policy instruments is concerned. 2.1 Phase A 2015-2018 During this phase, the end of the Riksbank’s previous tendency to “lean against the wind” of asset price excesses was confirmed; and the accommodating stance of monetary policy was reinforced by the response to ECB’s QE and the further lowering of the ECB deposit rate, which had already moved into negative territory. Negative interest rates came to in early 2015.9 In February of that year, the ECB moved towards its long-awaited asset purchase programme, representing the most far-reaching easing of its monetary policy to that point. In response, the Riksbank, which had been gradually lowering its repo rate from 2 per cent in late 2011, decided on a further 10 basis point reduction making repo negative for the first time ever. Two further reductions were announced in the first half of 2015 (one of them following an unscheduled meeting in ), bringing the rate to -0.35 per cent, and it was further reduced to an all-time low of -0.50 per cent in early 2016. This easing can be best understood against a background in which not only was actual CPI inflation (which had been running at or below zero for more than two years 2012-2014 – partly depressed by falling energy prices) undershooting the target, nor only that the financial market’s inflation expectations (as measured by the 5y5y inflation compensation) was still around only 1.6 per cent, but also the very relevant consideration that the ECB was continuing to lower its deposit rate, which fell to –.40 per cent in 2016 (Figures 10, 11). 9The Riksbank’s deposit rate had been negative earlier in the crisis, but this rate has not been significant in transmitting monetary policy since the Riksbank is in mopping up excess liquidity in the interbank market at rates close to repo. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 Figure 10 Inflation expectations Sources: Kantar Prospera and the Riksbank Figure 11 monetary policy rates in and selected central banks 2013-2021 Note: The shaded area represents the range of outcomes among the set of comparator small open econ- omies: , , , , , and . SOE is the average of these countries. Sources: , , , , , Federal Reserve, , of the , of and the Riksbank. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 The generally expansionary stance was supported by QE purchases of govern- ment bonds, albeit in gradually diminishing amounts until 2020. Although CPI inflation remained close to zero during 2015 despite the ag- gressively expansionary interest rate policy, it picked up during 2016. inflation, which had not fallen as low as that in CPI, also increased in 2016). 2.2 Phase B 2019 With inflation returning to target – briefly exceeding it for parts of 2018 and 2019, thanks to a resurgence of energy prices – the need for extraordinary easing was no longer felt to be so pressing. The two further repo rate changes that occurred in our six-year review window happened at the beginning and end of 2019. The rate was increased to -0.25 per cent in January 2019 (announced in ), with the accompanying Riksbank forecast indicating that further regular increases were to be expected, the next one in the second half of 2019 with the repo rate likely to pass +0.50 per cent by end-2020. However, the other increase (to zero) did not happen until January 2020 (announced in ) and had then been accompanied by a Riksbank expectation that further increases would not occur for another six quarters or so.10 The fact that the ECB had further lowered its deposit rate to -0.50 per cent in October 2019 was a likely contributing factor to the slowdown in rate normalization. Thus, the negative interest rate policy was abandoned. The Riksbank was the last of the five central banks around the world to go negative and the first to exit. Can this pattern be explained by the time-path of ’s inflation and macroeconomic evolution, or did it reflect structural differences or a different approach to monetary policy choices? Take inflation first. Average CPIF inflation was 1.7 per cent in 2019 (and fell in the first two months of 2020). Furthermore, neither market compensation nor professional (“money market players”) forecasts around the end of 2018 indicated an expectation that medium-term inflation would be above 2 per cent.11 And by the end of 2019, the Riksbank’s own end-2019 forecast was for CPIF to remain below 2 per cent for the following three years.12 How about the evolution of unemployment: did it point strongly to a need for tightening?