rfr · H90WRFR5 · 2022-03-31 00:00:00 — A sharp fall in unemployment during late 2017 and early 2018 (to just below 6 per cent) was followed by a return to higher (and upward trending) unemployment later in 2018: by the end of 2019, unemployment, at 6.7 per cent, was only about ¾ percentage point lower than it had been at the end of 2014 and above the levels it had reached in 2007-2008 before the GFC (Figure 6). 10 The policy rate corridor, which had been at +/- 75 basis points around the repo rate, was narrowed at the end of October 2019 so that the deposit rate was just 10 basis points below repo, with the standing facility lending rate still 75 basis points above. The corridor was further narrowed in 2020. 11 At that point CPIF and CPIF excluding energy were forecast to reach 2 per cent in 2021 (Figure 10). 12 Household expectations continued to be much higher than that of businesses or financial professionals, and much higher than actual inflation. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 Comparator countries saw much greater improvement in unemployment in those years. Neighbouring saw the unemployment rate falling by 2.4 percentage points and the euro area as a whole by 4 percentage points (note that both of these had had much higher unemployment rates at end-2014). The decline in unemployment in the was 2.0 percentage points and in the 1.8 percentage points. Even in and , which began the period with unemployment at only 4.8 and 2.7 percent respectively, there were declines of 1.1 and 0.5 percentage points respectively. The consensus view among Swedish economists appears to be that resource utilization and the level of employment were high in 2019, and that the relatively high unemployment rate reflects primarily the structural challenge of absorbing immigrants lacking the appropriate skills into employment. However, this view seems inconsistent with the mild — but clear — upward trend of unemployment rate among Swedish-born since early 2018 (Figure 7). (An additional complication relates to the reliability of the various data sources on unemployment and labour force participation. There were significant data revisions and continuing question-marks over the reliability of some of this data.) Although the large immigration of persons unused to Swedish economic conditions was a factor in ’s underperformance in getting unemployment down, and although this clearly poses challenges to government policies aimed at upgrading and adjusting skills to facilitate the integration of immigrants into the labour market, this factor itself suggests perhaps that the economy needed to be run “hotter” for a while to enhance opportunities for labour market integration of less skilled or experienced would-be workers. focused micro-based research would be needed to assess the degree to which running the economy hot would help less skilled workers. Thus, neither price, output nor employment developments strongly pointed to a need for tighter monetary policy in 2018-2019. did overall output point in any different direction. Indeed, the Riksbank’s forecast at end-2018 of GDP growth in 2019-2020 was below 2 per cent per annum. Consistent with this perspective, both the rate increase decision in and the announcement in of the following year that a further increase was to be expected within six months came as surprises to financial market participants (De Rezende and Ristiniemi 2020). It thus seems that the decision to start increasing the policy rate was more prompt than would have been chosen by other leading central banks, to judge from their current policy statements. For instance, the ECB has declared its intention not to increase rates “until it has seen the inflation outlook robustly converge to” its target. Even more so, the US Federal Reserve now states that “following periods when inflation has been running below 2 per cent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 per cent for some time.” Although it is only in 2020 that the Fed has moved to this policy – which is in the direction of something like average inflation targeting, the Riksbank’s action in 2018-2019 to tighten at the first indication that CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 prices were rising at around 2 per cent seems tilted to the hawkish end of cur- rent policy stances elsewhere. All in all, the tightening of policy in 2019 might be considered somewhat (Still, there was a modest increase in QE purchases during 2019, which somewhat offset the repo rate tightening). It is hard to avoid the impression that being in a negative interest rate envir- onment was felt to be uncomfortable by the Riksbank. statistics indicate that deposit interest rates remained for the most part positive throughout, negative customer deposit rates were quoted for some corporate The Riksbank was especially concerned that persistence of the negative policy rates would eventually transmit to negative household deposit rates, which was seen as a development likely to undermine public support for the Riksbank’s measures; banks were understood to be making plans in that The external value of the krona may have been an additional consideration. Earlier concerns about potential overvaluation had likely receded. continued depreciation of the currency had led to a public perception (in some circles) of wider economic weakness which, despite the fact that this was not the case, was seen by some as weakening public support for the Riksbank’s Could the Riksbank have done better in the 2015-2019 period? view suggests that, although the response of inflation and unemployment to the relaxation of policy during 2014 and 2015 was a good result, and far super- ior to that achieved in the previous few years, the Riksbank could have achieved a somewhat better development by refraining from the tightening adopted from end 2018. Inflation would probably not have accelerated signifi- cantly and the added demand pressure would likely have resulted in a some- what better unemployment outturn. 2.3 Conduct of Deliberations While there were clear differences in , the frequency and persistence of dissent was lower in the period under review than in the previous five years (12 dissents in the six years 2015-2020 as against 42 in the five years 2010-2014 – an average reduction of four-fifths). The animosity of debate also seems to have been lower than reported for the previous review. The pattern of dissent has been fairly consistent with at most one or two persons dissenting in favour of higher rates at any of the meetings in 2015- 2018 and one or two in favour of lower rates 2018 and 2019. The identity of the dissenters was stable.13 13 On rates, dissented against the lowering decision at the 2015 meeting; at the February 2016 decision to lower repo to -0.5 was again not unanimous, with Flodén and dissenting. The next dissent was in 2018: throughout that year advocated raising the repo rate and he was joined by Flodén in October. When the rate increase was decided at the meeting, dissented in favour of no change. again dissented from the final rate increase (to zero) in , and was joined in this by CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 A typical monetary policy meeting cycle occurs over about five weeks or so: during the first two of which discuss briefings on recent developments in the Swedish economy (including the staff “nowcast”) and financial markets and in the international economy, before proceeding to the likely evolution of economic activity in and the for wages and prices. Staff prepare draft forecasts and policy options before these are taken to where they are debated and revised. While staff proposals are key inputs, is clear that the majority view of is ultimately decisive and does not always coincide with the proposals made by staff. About four weeks into the process the is finalized several days before the formal and minuted Monetary Policy Meeting is held. The latter meeting begins with presentations by the Heads of the Markets and Monetary Policy Departments before the members of express their opinions. Like the , but unlike the , each meeting is attended by a sizable group of staff experts — typically around 20 in number — as well as one or two members of the Riksbank’s and occasionally one or two from other central banks. While this large audience for the main meeting, and the detailed quasi-verbatim nature of the minutes, might suggest a degree of formality in the decision-making process, it is clear that the preparatory meetings involve a lively interaction among the members of and between them and staff. The forecasts contained in the are adopted by rather than being staff forecasts as is the case for the ECB. are clearly in control of the deliberations, rather than being strongly steered by staff. Central banks need to communicate in a wide range of ways, channels, levels of depth and specificity. Like most central banks in recent years, the Riksbank views its communication as an important strategic tool towards its policy objectives. This is reflected in the documents it has been issuing periodically, explaining the aim and objectives of its policy and the strategy it follows. Riksbank communication has several target audiences. –the Riksdag, the main body to which it is accountable; –the traditional and social media commentators, which help to transmit and interpret the messages; –the financial markets, whose expectations regarding future policy actions strongly influence asset prices beyond those directly controlled by the Riksbank; new member Breman. There were some differences also on asset purchase decisions with the same dramatis personae augmented by Skingsley. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 –businesses and trade unions who base their strategic and negotiation objectives on expectations of future price and demand conditions; –and the general public, in whose interest Riksbank policy is directed. Internal staff communication and a strong link with professional researchers are other important dimensions. Regarding monetary policy, clear and credible communication has been long recognized by central banks as a policy tool, as it helps shape expectations and thus makes monetary policy more effective; the Riksbank is no exception. The documents and public appearances communicating monetary policy by the Riksbank are clear, including in terms of language, open, transparent, and well suited to the wide range of target groups. The quality of its communication, and in particular its transparency, stands out among its peers. This is reflected in the Riksbank receiving the highest ranking in the Central Banks Transparency Index.14 Its outstanding transparency was also recognized by the magazine which awarded the Riksbank the in 2014.15 Inasmuch as influencing expectations is a key goal of central bank communications, the accuracy of its macroeconomic forecasts is clearly vital. 2.5 Accuracy of Forecasts In preparing for each monetary policy meeting, Riksbank staff apply a suite of econometric models as well as informal judgment. Short-term dynamics of different economic variables are modelled using about a dozen time series models and these help in guiding the Riksbank’s short-term forecasts. However, these seem to be based as much, if not more, on an eclectic synthesis of expert opinion at the Riksbank. For medium-term projections and policy simulations, the two main modelling tools are: i.A dynamic structural general equilibrium (DSGE) model called (Corbo and Strid 2020), which is the latest generation of structurally similar models that have been used at the Riksbank since about . It draws on long-standing behavioural assumptions about relationships among 15 Swedish and 10 foreign data series. These series cover: GDP, aggregate consumption and investment spending; CPI and wage inflation; employment and unemployment; and two interest rates. Constantly being refined, Oikonomou, and Spyromitros (2017), who updated the central bank transparency index of Eijffinger and Geraats (2006) covering political, economic, procedural, policy and operational transparency. Using data from 2011-2016, the Riksbank was the only central bank scoring a perfect score of 15, up from 14.5 in 2014. 15The award committee stated that: "Of the pioneers, though, Riksbank is the one that continues most determinedly to break new ground in ensuring its processes and decision making are transparent and clearly communicated through whichever channel is most effective." CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 the magnitudes of the model’s parameters have been estimated using Bayesian estimation on quarterly data since 1995. ii.A Bayesian vector auto-regressive model (BVAR) using somewhat fewer variables. This type of model relies less heavily on economic theory and more on the statistical relationships between the different variables. Both of these models sit squarely in a tradition which represents internationally accepted good modelling practice for central banks. Of course, they do not claim to capture all relationships. For example, DSGE models have been criticized for having been unable to foresee or track the kinds of influence between financial and real sectors that were so important in the Global Financial Crisis. do they cope well with tracking economic developments in the years of pandemic. But these limitations are fully recognized by Riksbank staff and members. The latter do not lean too heavily on the models in coming to their decisions on policy and on the published medium-term forecasts, often substituting informal judgment not only when the models disagree, but especially when conditions prevail that are not thought to be wellcaptured by the models. Indeed, this has long been the case, as is documented in and Reslow (2017). In its Monetary Policy Reports, the Riksbank publishes a forecast path for macroeconomic variables such as GDP, inflation, the SEK exchange rate and for its own policy rate. During the period under review, the accuracy of these forecasts was not particularly high, but nor did it fall below that of the median external forecaster (cf. Riksbank 2021). Commentators continued to complain that the Riksbank’s inflation forecasts tended to converge to the target over a period of several years, but in fact the inflation forecasts did improve relative the previous five years, and this kind of deviation was not unusual among other central banks in the same period.16 A distinction is usually made between forecasts of a central bank’s own policy rate (and other tools) and its forecast of the rest of the economy. The former is often termed “forward guidance.” As the Riksbank has often emphasized, its announced policy path is a forecast of the policy rates it believes to be consistent with its wider expectations for the economy as a whole and with its objective for inflation. Thus, this is what is sometimes called “Delphic” forward policy guidance; indicating what is likely to happen rather than setting out a promise or a commitment (which would be “Odyssean” forward guidance). The policy path forecast has not been at all realized in recent years. This is illustrated in Figure 12 which shows that the deviation between forecast and subsequent realization continued to be very wide until 2020, albeit somewhat narrower than in the previous five years. As in other countries, market forecasts of interest rates were not accurate either; the question, though, is whether or not announcing a forward path helps the Riksbank in its task. 16For example: “the ECB tends to overpredict (underpredict) inflation at intermediate forecast horizons when inflation is below (above) target” (Granziera et al. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 Figure 12 The Riksbank’s repo rate forecasts 2007-2021 Note: The blue line is the repo rate, the black dotted lines are forecasts by the Riksbank and the grey dotted lines are market forecasts as quarterly averages at announcement dates. The market forecasts, as well as Stibor, are more volatile around the turn of the year since 2016, when the resolution fee was introduced. Source: Following (2017). We are very grateful to for agreeing to bring his calculations up to date for presentation here. The financial market generally continues to behave as if it attached relatively low precision to the Riksbank’s path. Thus, in econometric research based on earlier years, it appeared that “the response of market expectations to a surprise in the announced repo-rate path is not one-to-one, but is estimated to be less than half of the surprise and decreasing in the forecast horizon” (, 2017).17 It may be noted that both the credibility and the accuracy of the Riksbank’s forward guidance was much higher in the first couple of years of its operation (2015). Furthermore, the uncertainty fan-chart bands published by the Riksbank to accompany the point forecasts were so wide as to be virtually useless. For example, in early 2015 the fan chart implied that the betting odds against a repo rate lower than -200 basis points (bp) by mid-2016 was only 10-1; a similar odds was implied for repo rate higher than +400 bp (Figure 13). With this experience, the guidance path has limited value in anchoring expectations, and should be seen mainly as just one element in the Riksbank’s macroeconomic projections. The wide of error bands presented by the Riksbank around the path help to ensure that it will not be misunderstood as a firm promise. Forward guidance issues arose again in 2020, as is examined in Chapter 2. The overall effectiveness of forward guidance is further discussed in Chapter 4. 17Indeed, as with many other countries, firms and households typically attach much weight to current inflation in forming their expectations about future inflation (et al. CHAPTER 2 THE OPERATION OF MONETARY POLICY 2015-2019 Figure 13 Forward guidance on the repo rate Note: The uncertainty bands for the repo rate are based on the Riksbank’s historical forecasting errors and the ability of risk-premium adjusted forward rates to forecast the future repo rate for the period 1999 up to the point when the Riksbank started to publish forecasts for the repo rate during 2007. The uncertainty bands do not take into account the fact that there may be a lower bound for the repo rate. Outcomes are daily rates and forecasts refer to quarterly averages. Source: February 2015 Chapter 3 The Response to the Pandemic a matter of days in early 2020 it became clear that the Covid-19 pandemic would have a severe economic effect across the world and that would not be exempt. Financial market turmoil spread from leading international centres, reflecting soaring uncertainty about future developments. , large parts of economic activity were paralyzed by government-imposed restrictions and/or by consumers’ avoidance of services involving person-to- person contact. Services such as tourism, hotels and restaurant were especially vulnerable, but before long a much wider range of sectors was affected. This resulted in a sharp decline in household incomes and business revenue. These in turn exacerbated liquidity shortages. The global economy was rapidly sliding into recession. These developments called for a sharp and rapid response by governments and central banks to support incomes and maintain demand for services that could still be operated, to minimize and shorten the contraction of activity and employment, avoid a sharp decline in inflation and to avoid disruptions in financial markets. In , as in almost all advanced economies, the Government and the central bank responded accordingly. The prompt and decisive policy actions taken in helped to prevent an even more severe and prolonged recession, and to avoid a financial crisis. 3.1 Measures in Phase C The Riksbank’s initial response to these developments was a decision taken at an extraordinary meeting on 12 approving actions aimed at alleviating the consequences of the pandemic on economic activity as well as avoiding a lasting effect on inflation, and maintaining financial stability: “Thus, the measures had the twofold purpose of maintaining financial stability and economic stability, including the inflation target” (Monetary Policy Account 2020). This necessitated ensuring that financial institutions had sufficient liquidity and that the flow of credit at low interest rates to households and business could continue in order to avoid an even greater contraction in consumption and activity, and to reduce financial stress. Given the widespread scramble for liquidity, massive bond sales by investors would have had disruptive effects had the Riksbank not stepped in with its purchases. Specifically, while the repo rate was held at zero, the interest rate on the Riksbank’s standing loan facility was reduced in two steps, and a wide range of unconventional policy instruments introduced (see Table 1).18 These measures included: 18The standing facility rate was reduced from 0.75 per cent to 0.20 per cent on 18 , and further 0.10 per cent on 8 , from which date the interest rate corridor became +/- 10 basis points. CHAPTER 3 THE RESPONSE TO THE PANDEMIC –greatly expanded asset purchases, not only government bonds and Treasury bills, but also covered bonds, municipal and corporate bonds and commercial paper; –provision of liquidity in krona, while easing collateral requirements, and in US$, to banks; –funding for on-lending to non-financial institutions. Table 1 Measures taken by the Riksbank during the Covid-19 crisis Source: February 2021 CHAPTER 3 THE RESPONSE TO THE PANDEMIC This set of unconventional measures used by the Riksbank during 2020 was similar to the set used by other central banks in the major advanced economies and in the comparator SOEs (Table 2). The decision not to lower the policy rate back into negative territory was common to the other advanced SOEs as well as the UK and the US, while the ECB, , and maintained their negative policy rates. The asset types purchased by the Riksbank spanned a wider range than that in most other comparable central banks, notably in its inclusion of commercial paper and other private assets. Table 2 Measures taken by the Riksbank and other central banks during the Source: BIS –A global database on central banks’ monetary responses to Covid-19 (2021). CHAPTER 3 THE RESPONSE TO THE PANDEMIC The decision not to lower the repo rate back to the negative territory that it had occupied until just a few months before is discussed in greater detail below. Nevertheless, as mentioned, the rate on the Riksbank’s standing loan facility was reduced (resulting in a narrowing of the policy interest rate corridor to +/- 0.1%). In order to strengthen the banks’ access to liquidity in local currency as a way of facilitating their funding and their role as credit providers for Swedish companies, the Riksbank offered unlimited 3- and 6-month collateralized lending at the repo rate on a weekly basis (and with relaxed collateral rules). Given that the Swedish banking system usually operated with a liquidity surplus (apart from a two-year period 2008-2010), it is notable that immediate takeup of this facility was over SEK 20bn, later rising to SEK 32bn. In addition, in order to support credit flow to non-financial corporations, a special liquidity program for a wider range of credit institutions (including savings banks and a finance company) to fund their lending to corporate borrowers was also introduced. (This was dubbed the “funding for lending scheme” by reference to somewhat similar schemes that had in the past been introduced elsewhere19). This provided collateralized lending at the repo rate. It quickly attracted a sizable SEK 143bn of usage out of a programme envelope of SEK 500bn.20