Mr. Heikensten discusses independence and transparency in monetary policy  (Central Bank Articles and Speeches, 25 Sep 98)
Central bank: riksbank | Type: speech | Date: 1998-09-25

Mr. Heikensten discusses independence and transparency in monetary policy Speech by the Deputy Governor of the Bank of Sweden, Mr.

Lars Heikensten, at the Executive Club in Gothenburg on 25/9/98.This morning, rather than discuss current monetary policy, I shall be cons some questions that have to do with monetary policy's long-term conditions.Next year, a proposal that has received the preliminary approval of the R (Sweden's parliament) will make the Riksbank more independent.

Here, Sweden is particip in a development that has been in progress in the industrialised countries for a couple - monetary policy decisions are being delegated to the central banks.

This has been both because monetary policy is considered to focus too one-sidedly on a single objec because the increased independence is said to limit democratic influence unduly.

It may be appropriate to review the arguments behind the changes and comment on what they requ the Riksbank.A discussion of the process towards more independent central banks - and considerations that underlie this process - must take monetary policy's objective as point.

I shall therefore begin by discussing why low inflation is important.

Then I sh the arguments for central bank independence and outline the changes that are in train i Finally I shall put the case for the importance of monetary policy transparency.

## Why low inflation?From

time to time in the debate, the importance of having low inflati monetary policy's objective is called into question.

The critics consider that the f inflation is overdone and results in an unnecessary restriction on growth and employ allow me to motivate the wisdom of focusing monetary policy just on low inflation.The Riksbank's basic function is to provide Sweden with a stable and eff payment system.

In practice, this amounts to being accountable for maintaining a fixed money and ensuring that the banks provide money in satisfactory way.

If the payment sy to function properly, however, it must have a solid reputation.

If people believe, for e the value of money will be appreciably eroded, or will fluctuate markedly, they will uncertain and confidence in the payment system will be weakened.

That can result in decisions.In other words, low inflation renders the economy more efficient and mak easier for households and firms to arrive at long-term decisions.

A look at the s Sweden in the 1980s will illustrate this.

High inflation, recurrent cost crises and cycles made economic development erratic, with weak investment and productivity as a More and more misplaced investments were made as a 'bubble' grew and when the proper market subsequently collapsed, Swedish society was burdened by heavy adjustment costs.Inflation also leaves its mark on the distribution of income and wealth inflation tends to widen existing differences in wealth because it varies in its impact types of earnings and saving.

A person who has savings in a bank and earns a fixed wage is a loser from inflation, whereas someone who can save in real assets, for ins home-owner, stands to gain from rising inflation.

Once again, Sweden in the 1970s and 'good example: prices rose sharply for houses and tenant-owned dwellings, while bank were eroded.

Inflation widened the gaps.So far, so good, most people would say.

Few desire a return to the e inflationary and speculative economy.

A knottier question is just what rate of inflationIn Sweden we have chosen to focus policy on an annual CPI inflation rate of cent.

As monetary policy is not capable of directing inflation exactly, when the t established in 1993 it was surrounded by a tolerance interval of ±1 percentage point.This target is well in line with the rate of inflation that other ind countries, not least in Europe, are aiming for, though there are some minor difference well in line with a statement some years ago by Mr. Alan Greenspan, head of the US F Reserve, to the effect that inflation should be so low that economic agents need not w it when making economic decisions.

Perhaps that is as close to the truth as one can com

## Policy for low inflationLow inflation has been the normal state of affairs in the Swedish economy. the past one hundred years the rate has fluctuated around two per cent.

It is only in period, more exactly from the late 1960s onwards, that inflation has taken off.

The s happened in other countries.

Part of the reason seems to have been that economis politicians changed their view of what monetary policy could achieve.

At that time man considered that monetary policy could induce permanently higher employment; more jobs c be brought about simply by letting inflation rise.

What they overlooked was the centr primary function of safeguarding the payment system's stability.History has also clearly demonstrated that this strategy does not work; i countries, unemployment rose parallel with inflation.

In Sweden the rate of inflation r digit figures, accompanied by the erratic economic development which meant that we dr down the 'growth league'.

Then, when the inflation bubble burst, unemployment rose.What the economists and politicians had not allowed for was how rising inf would leave its mark on expectations of future inflation.

The original idea - that high via lower real wages, would result in higher demand and employment - did not hold in th run when firms and households realised that their elected representatives and central fuelling inflation.

In the original scenario, the higher inflation was supposed unexpectedly and therefore would not result in wage compensation.

In practice, the i inflation affected expectations of future inflation, for which employees demanded compe With the higher nominal wages, real wages rose again and labour demand fell back.

A si rose where prices and wages chased each other in an upward spiral.

Unemployment remain the best case at its initial level.When it was realised that monetary policy could not generate permanen increased employment, politicians and people in general had to think again.

The at stimulate increased economic activity and employment by means of fiscal and mone measures had failed.

This line therefore had to give way to a policy that focused on p stable fundamentals for economic development.

One of these fundamentals is low inflati central banks were in the best position to shoulder the task of safeguarding the valueSweden switched to the same track as other countries in the early 1990s. was directed at price stability with the explicit ambition of thereby laying a good fo future growth and employment.

The next few years were onerous for Sweden's economy.

T bill for the excesses of the 1980s had to be paid at a time when global activity was and Europe was hit by currency crises.

Since the summer of 1993, however, events have different turn.

Growth above the rate in the boom years in the late 1980s has been comb lastingly low inflation.

Employment is now picking up but in order to push unemployment towards the earlier, very low levels, changes are presumably needed in the workings of t market and wage formation.

## Increased independence for the RiksbankToday,

therefore, most, though not all, economists and politicians are b agreed that monetary policy has a very limited potential for permanently altering th employment.

But monetary policy is capable of influencing growth temporarily.

So for tho decide economic policy, there is always the temptation to try to strengthen economic a the short run and push unemployment down.

In order to restrict the scope for such a governments and parliaments in most industrialised countries have taken the initia decided to make their central banks more independent.

This is often combined with a price stability objective.

Some countries have also established procedures for asse exacting accountability.Experience shows that the countries with a far-reaching delegation of mon policy have had a favourable development of inflation.

It is probably not just t framework that has resulted in low inflation.

Central banks have been most succes countries where the aversion to inflation is strongest and most widespread.Central bank independence is thus, you might say, a straightjacket that parl and governments have put on themselves.

Paradoxically, it is just by tying their hands that the legislators have actually given monetary policy more scope to pay some heed to considerations.

This is so as a result of greater independence and because everyone assured that inflation will continue to be low in the future.

In actual fact, a cre target strategy normally caters to cyclical factors.

An economic slowdown tends accompanied by a weakening of inflationary pressure, making it possible to ease the m stance.

The stance is then tightened again when inflationary pressure rises.

In this w policy can contribute to economic growth, without unnecessary upsets, at a rate that is with the development of productivity, employment and so on.A government bill proposing increased formal independence for the Riksbank of 1999 was presented to the Riksdag in November 1997.

Five political parties in the Ri behind the proposals and they have also given the constitutional amendments their pre approval.The new legislation accordingly gives the Riksbank the constitutional funct conducting monetary policy.

The constitutional provisions also state that the Riksbank take instructions from authorities concerning the construction of monetary poli Riksbank's current obligation to hold consultations with the government prior to i decisions of monetary and exchange rate policy is converted into an obligation to in government.

The price stability objective is incorporated in the Riksbank Act, whichthat the objective of monetary policy is to safeguard the value of money and promote a efficient payment system.The greater independence also involves changes in the Riksbank's managemen Instead of being directed, as at present, by a Governing Board appointed by the Riksd will be an Executive Board with six full-time members, chaired by the Riksbank Governo the Executive Board that will manage the Riksbank and be accountable for all monetary decisions.

Unlike the system in the United Kingdom, besides acting as a committee for m policy decisions, the Executive Board will be responsible for managing the whole Riksbank.Even under the new law, however, the Riksbank will still have a Govern Board.

It will consist of eleven members, instead of eight at present, and will ha supervisory role.

Its principal functions will be to monitor and control the activ Riksbank, appoint the Executive Board and, if necessary, dismiss any member of the Exe Board who no longer fulfils the conditions required for the performance of duties or i serious misconduct.In this context I also want to say something about the timetable this autu the new legislation requires.

As usual, our newly elected Riksdag will appoint a new G Board in accordance with the existing procedure.

As previously, these eight Delegates w the Riksbank and decide monetary policy, up to the turn of the year.

When the const amendments have been approved a second time, the Riksdag will appoint a Governing Bo under the new order; this will probably be done in late November or early December.

Bef end of 1998 the new Governing Board - which for a month or so will accordingly exist side with the current arrangement - must then appoint the members of the new Executive The new Governing Board and the new Executive Board will then take over from 1 Janu 1999.As there will be little time for the two new Boards to prepare their ne initial decisions, preliminary work will have to be done this autumn.

Matters that Governing Board will have to decide at its first meeting include the Riksbank's procedure, while at more or less the same time the Executive Board will have to fin details of work at the Bank: which matters can be delegated further down the organisat matters should be drafted in the Bank and similar questions.

At its first meeting, mo Executive Board will have to decide the frequency of its meetings, which tasks its members are to be responsible for and how the Board is to communicate with the general

## Importance of transparencyThis brings me to the degree of transparency in monetary policy.

In recent the Riksbank has worked to make monetary policy more transparent, with good communicat with market players and the general public.A basic reason behind our drive for transparency is the need for clarity.

Th that clarity in monetary policy will make the policy more effective.

If market agents understand how we are reasoning, there will be less risk of unnecessary fluctuations rates and the exchange rate.

That in turn should help to make general economic devel more stable.

In drastic terms one could say that we aim to make the markets so familiaranalytical framework and our deliberations that the available information would enable set the interest rate on their own.Another reason for transparency has to do with the Riksbank's social fun This responsibility is augmented in that the increased independence has the force of then all the more important to develop and communicate the arguments behind the Riksb actions.

This is a prerequisite for a sound discussion and evaluation of our policy and the Riksbank accountable if the policy is not conducted in a reasonable way.More generally, moreover, the Riksbank should continue to work for increa transparency in order to promote a widespread understanding of what we are doing.

In the discussion, for instance, there is some criticism of the low-inflation target.

The Rik to be unduly focused on combating inflation at the expense of growth and employment therefore need to persist with an open dialogue to explain that we, too, desire and st economic growth but that the best thing monetary policy can do to this end is just e stable framework for other components of economic policy.The internal work at the Riksbank also calls for external transparency. away with a hush-hush attitude to outsiders makes a frank internal discussion easier.

C goals are also a help in focusing internal work and analysis on the relevant issues.The open presentation of a clear line of thought simplifies the education The Riksbank's line consists of an explicit inflation target and an account of the fac consider affect inflation; it also includes how monetary policy measures are construc light of the inflation assessment.

Current forecasts and assessments are presented in t Inflation Reports.

In between we try to comment, in speeches and other ways, on any cha our appraisal of inflation.Unfortunately, a soundly constructed line of thought does not always su From time to time we are highly uncertain about how the available information sho interpreted.

That is something which we and all economic agents must learn to live w exact statement may not be possible in such situations.One matter connected with the independence and transparency of the Riksbank whether or not the Riksbank should publish minutes of its discussions and/or sho decision-makers have voted.

One reason why this issue has attracted so much attention is no doubt that the new Bank of England legislation stresses the monitoring of how i members have voted.The Riksbank's new Executive Board will clearly have to adopt a position on matter.

So permit me to raise a couple of relevant aspects.

It seems to me that a disti made between requiring accountability on the one hand and clarity or distinctness of the other.- As regards accountability, it is clearly important how individual members vote.

The Governing Board's long-term influence over Riksbank policy wi after all, be exerted primarily through the composition of the Executive It follows that the Governing Board - presumably the general public as needs to be in a position to assess how different members of the Exec Board have acted.

The knowledge that voting is made public no doubt a- makes every member of the Executive Board all the more keen to arrive a personal conclusion about the difficult issues that have to be resolved.- As regards transparency , on the other hand, what matters most in my opinion is to have a clear line of thought, as I outlined earlier, and on this ways of communicating how assessments change over time.

The latter can done in Inflation Reports and speeches, as at present, as well communiqués after board meetings, etc.

In this context, information a how the individual board members have voted is not so self-eviden important.There will doubtless be reason to return to this issue.

The conclusion from discussion is not automatic.

A good combination of the two perspectives above is p feasible.

A further consideration is the need to create an Executive Board that functio not only when it comes to making wise monetary policy decisions but also in the Riks effective management.

## Concluding remarksSince the early 1990s the Riksbank has clearly had the task of establishin stability in Sweden.

Strong confidence in the Riksbank means that monetary policy is achieve the desired results without resorting to emphatic interest-rate signals.

In an with low inflation and high credibility, monetary policy may be in a better position fluctuations in growth and employment.Confidence in the low-inflation policy does seem to have been establi Inflation has been low and inflation expectations are in line with the inflation tar fiscal policy is contributing to this but so, of course, is a monetary policy consistently on low inflation.

The credibility of policy is, however, a continuous qu process will be facilitated by the Riksbank's statutory independence but the Riksbank m for example, work continuously to communicate its policy deliberations clearly and distThe conditions for policy are affected by many factors.

A labour market and formation that function better make it possible to combine low inflation with higher em Fiscal policy is another central matter; it needs to be sustainable in the long run a also help to counter any signs of incipient overheating.If some component of economic policy fails to promote the inflation targe burden on monetary policy will be heavier.

Stronger measures by the Riksbank will be ne a clear demonstration of the determination to achieve low inflation.

Insufficient supp inflation target and policies that are not permanently sustainable would then be a burd for the Riksbank but for the economy in general.