SPEECH
SVERIGES RIKSBANK
DATE:
5 March 2018
SE-103 37 Stockholm
SPEAKER: (Brunkebergstorg 11)
Governor of the Riksbank Stefan Ingves
VENUE:
Expert Group on Public Economics, Stockholm
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Monetary policy in a new environment∗
This is a year of celebration for the Riksbank. The major event is our 350th
anniversary as Sweden's central bank, which will be celebrated in different ways
during the year. Furthermore, it is 25 years since the Riksbank announced its
inflation target, which was a milestone in Swedish monetary policy. It also
happens to be 20 years almost to the day since the Swedish Riksdag took the
decision to strengthen the Riksbank's position and, as part of this work, to create
a Riksbank Executive Board with the responsibility for conducting monetary policy
independently.1
As well as being a reason to celebrate, anniversaries can also give us cause to
pause and reflect on what has been, where we are and where we are heading. My
intention here today is to perform just such a positioning exercise. A general
reflection is that monetary policy internationally and in Sweden finds itself in an
environment that in many ways differs from the one we have been experiencing
for a long time. It is not merely a question of changes in economic activity.
Structural shifts in the economy and changes in underlying trends have also
created uncertainty about what the "new normal" will be in the future.
It is sometimes said in the debate that these changes have made it more or less
impossible for the Riksbank to keep inflation at such a high level as 2 per cent. We
should therefore either relate to our existing inflation target more freely or simply
lower it. I think this line of reasoning is misdirected. There is no doubt that it is
possible to get inflation to pick up, but it can be done in different ways. The
challenge is to create the right amount of inflation in an orderly manner and with
reasonable precision. This is the challenge facing monetary policy and it is in this
context that the new environment plays a role.
In a moment I will look more closely at the new environment and discuss a few
properties that characterise it and that monetary policy will need to relate to
going forward. Lastly, I also intend to provide an overall picture of what might
characterise the way forward. But before doing that, allow me to say something
about what has brought us here.
Where we are coming from
I spoke earlier about 2018 being a year of celebration. Another anniversary, but
one which does not give cause for any kind of celebration, is that it is also ten
years since the collapse of the investment bank Lehman Brothers. The problems
on international financial markets, which had been escalating for a long time,
came to a head. Confidence in the financial system evaporated and the financial
crisis was upon us.
Much has happened during the ten years since then. The actions of central banks
during this period have not just been about managing the direct crisis of 2008,
even though many of the problems stem from there. It is more accurate to
describe the actions as reactions to an interconnected series of crises, or, if you
like, a crisis that consists of several phases. These have, in turn, formed the
backdrop to the different phases of monetary policy that Sweden has gone
through.
Upturn cut short by sovereign debt problems in 2011-2012
An effect of the severe crisis of 2008 was a shutdown in global trade, which
brought the Swedish economy to a sudden halt. To support the economy, the
Riksbank quickly lowered the repo rate to a, at the time, historically low level of
0.25 per cent. Around the world, other central banks and governments made
herculean efforts to kick-start the financial system and reverse the trend. As the
situation on the credit markets improved and global trade picked up, the recovery
occurred more rapidly than expected in Sweden. From mid-2010, the Riksbank
began raising the repo rate towards a more normal level.
But during 2011, the recovery stuttered when unease linked to the problems of
heavily burdened public finances in several European countries started to affect
the credit markets to an ever-increasing degree. Measures by institutions such as
the EU and the ECB helped to stabilise the situation, but weak confidence and low
demand among households and companies subdued European developments.
This, in turn, led to a slowdown in Swedish economic activity, despite relatively
high domestic demand. GDP fell again in 2012 and the Riksbank lowered the repo
rate in a number of steps.
Focus on inflation and maintaining confidence in the inflation
target has produced results
Something which provoked head-scratching around the world during these years
was that inflation remained at a relatively high level to begin with, despite the
major economic slowdown after 2008. In hindsight we know that inflation
gradually fell and that it happened earlier in Sweden than in other countries -
discounting the effect of interest-rate changes, inflation fell from around 2 per
cent during 2010 to around 1 per cent in 2012. When inflation then fell further in
late 2013 and early 2014, despite brighter economic signals, it became necessary
for the Riksbank to focus more and more on bringing inflation back to the target.
This was particularly urgent bearing in mind that the long period of low inflation
had begun to leave its mark on inflation expectations.
To bring up inflation and help anchor inflation expectations to the target, the
Riksbank cut the repo rate to 0 per cent in 2014 and then gradually down to -0.5
per cent in the following years. As a way of making monetary policy more
expansionary, we also began purchasing government bonds at the start of 2015.
At that point, the ECB had begun buying assets on a large scale to stimulate
demand and bring up inflation. There was a concern that the Swedish krona might
strengthen significantly against the euro as a result of this and that this would
further prolong the period of below-target inflation. Monetary policy needed to
protect the economy against such a development.
Today, we can observe that the extremely low interest rate and the Riksbank's
asset purchases have contributed to economic activity growing ever stronger.
Employment has risen and growth has been on or above a normal level for four
years. Inflation, which has shown a rising trend since 2014, was around 2 per cent
last year and long-term expectations are anchored to the target.
The start of a new chapter?
Does this mean we can now sound the all-clear? As you know, there are no
guarantees in the forecasting business. Economically, things look good, not least
due to increasingly high demand from abroad. It has taken a decade, but it seems
as though the global economy has finally recovered enough from the after-shocks
of the financial crisis to start a new chapter. The US central bank has begun
normalising monetary policy. In Europe, recovery has occurred more slowly but
has now reached such a stage that the ECB has reduced the rate of its asset
purchases.
However, global inflationary pressures are still modest and the new outcomes for
Swedish inflation have been weaker than expected. For the Riksbank, it is a
question of remaining vigilant. A prerequisite for inflation to continue to develop
in line with the target is that economic activity remains strong and has an impact
on price developments. Monetary policy therefore still needs to remain
expansionary. But if everything goes as expected, the time to start normalising
monetary policy will come closer. The assessment we made in February was that
it is probably time to slowly start raising the repo rate during the second half of
this year. But such a turnaround requires considerable caution, in my opinion.
As regards the Riksbank's holdings of government bonds, we presented an overall
strategy for normalisation before Christmas.2 In brief, it states that the Riksbank
shall continue to reinvest redemptions and coupon payments until the repo rate
has reached a suitable level. Thereafter, reinvestments can also be scaled back.
When this happens, bond holdings will decrease.
What the environment looks like going forward
Economically, things look relatively good and if everything goes as expected,
monetary policy internationally and in Sweden will gradually and slowly move
closer to a normal situation. But in what kind of environment will monetary policy
be conducted going forward? And what does this normal situation actually look
like? These are questions that have come increasingly into focus in recent years.
It would probably be a mistake to take it for granted that the same map used
before the crisis can be used to get our bearings in the current situation. To begin
with, it is important to properly evaluate the experience gained over the last
decade and integrate the lessons learned into our economic thinking. Structural
changes may also have influenced underlying trends in the economy and I would
like to give three examples of such changes which, in some way or other, will
influence Swedish monetary policy in the future.
Lower interest rates on average than before
To start with, it can be noted that we find ourselves in an environment where
interest rates are much lower than before. "You've made your bed so you must lie
in it", someone may object - is it not central banks themselves that have created
this environment? It is true that policy rates have been cut significantly to support
economic activity and return to inflation targets. But the fact that this has caused
policy rates to fall to extremely low levels is because central banks needed to
adapt to a general downward trend in interest rates around the world, a trend
that began a long time before the financial crisis in 2008.
Declining trend in real interest rates on a global level
Returns and interest expenditure adjusted for inflation are important to
households and companies, as they make decisions on saving and investment. In
other words, it is real interest rates that matter. By changing the nominal policy
rate, the central bank can affect the real interest rate in the near term and thus
demand in the economy. This is possible, as it takes time for companies to adapt
their prices to the change in the policy rate and other interest rates in the
economy. But once prices have been adjusted, the real interest rate is also reset.
In the longer term, therefore, monetary policy has no major effect on real interest
rates. In this time perspective, it is structural factors, such as demographics and
long-term growth rates, that affect developments.
One striking feature over recent decades is the downward trend in real interest
rates around the world. Various explanations have been put forward for this,
including demographic trends.3 One theory that has attracted major attention is
that the decline is a sign of secular stagnation, where different factors have driven
up saving but dampened the propensity to invest. This has led to a chronic
condition of "excessively low" demand in the economy, which has contributed to
a lasting decline in real interest rates. Others think that it is not necessarily a
question of secular stagnation, but that the situation can, for example, be better
described as a deep recession following excessively high debt accumulation in
many countries.
An environment with a lower average repo rate
The major question is what we can expect going forward. For a small, open
economy like Sweden's, the interest rate on a global level is important as it affects
domestic rates. With free movement of capital, it is difficult to have real interest
rates that deviate a great deal from the global level in the long run, even if
differences in demographic trends or long-term productivity growth can naturally
play a part. It is true enough that real interest rates in Sweden have exhibited a
similar downward trend to real interest rates internationally. This is of significance
for monetary policy as it implies that the Riksbank's repo rate is lower on average.
And a lower repo rate on average means that the margin down to zero and minus
rates decreases - I will come back to the implications of this in a moment.
How long will low real interest rates last? The answer naturally depends on what
are believed to be the most important driving-forces behind developments. But
regardless of whether you believe that it is a permanent phenomenon or that
there is a more cyclical explanation, the low interest-rate environment will
probably last for some time to come. Even if interest rates will rise in the near
term, it is towards a lower average level than previously. Many central banks,
including the Riksbank, have adjusted down their assessments of long-term policy
rate levels. Our current assessment is that the repo rate will, in the long run, be
between 2.5 and 4.0 per cent.4 But it will probably take a long time before we
reach that level.
Higher interest-rate sensitivity among households
One effect of the decline in interest rates in Sweden is, as we all know, the
increase in household indebtedness. Seen over the last twenty years, debt in
relation to disposal household income has almost doubled. Currently, aggregate
household debt is almost twice the level of income. For around a quarter of a
million households, debt is 6 times greater than income or higher.
High indebtedness linked to rising housing prices
As most of the debt consists of mortgages, the growing indebtedness reflects the
development in housing prices. Prices of detached or semi-detached houses have
tripled in the last 20 years, while prices of tenant-owned apartments have
increased at an even faster rate. The rapid price increase depends on several
factors, in addition to the low interest rate level. The population and income have
increased, driving up housing demand while new housing construction has lagged
behind, apart from in the most recent years. The abolition of property tax is also a
factor that might explain the growing indebtedness, as is the fact that an
increasing number of households own their own home.5
The rate of increase in lending to households is still on a high level. The Riksbank's
assessment of future developments is that overall household debt will not rise at
quite such a high rate as in recent years, due to more subdued housing price
growth. But debt is still expected to increase more rapidly than disposable
income. So the debt-to-income ratio will continue to rise.
High indebtedness is making household finances more sensitive to
interest rate adjustments
When monetary policy gradually starts to normalise and interest rates rise, it will
happen against this backdrop of high indebtedness among households and high
housing market valuation. In addition, many have taken out variable-rate
mortgages with short interest-rate fixation periods. Taken together, this means
that household finances are now more sensitive to adjustments in interest rates
than before. Disposable income, that is income minus borrowing costs, is affected
to a greater extent by interest rate adjustments when debt is high, all other
factors being equal.
Calculations show that an interest-rate rise of about 1 percentage point now has a
significantly greater direct effect on household disposable income than in the
mid1990s. In this sense, households' interest-rate sensitivity is now greater.6 The
interesting question is whether households adapt their consumption to a
corresponding degree so that consumption also changes to a greater extent. It
need not necessarily be so. For example, interest income can offset the effect of
higher interest expenditure. If households also plan in advance for a scenario
where interest expenditure takes a greater share of their income, consumption
may not necessarily be affected to any great extent.
But research findings point to this potentially playing a major role at least for
certain groups of households.7 More specifically, it is shown that highly indebted
households with variable-rate mortgages adapt their consumption to a greater
extent than other households when interest rates change. This may be due to an
interest rate adjustment affecting their disposable income to a greater extent, as I
just described. But it may also be due to highly indebted households reacting
more to a given change in income than other households. You would expect this
to be the case if households with high debt do not have the same opportunity as
others to maintain their consumption by borrowing more.
Greater interest-rate sensitivity creates uncertainty about the impact of
monetary policy
How total consumption will be affected when interest rates are gradually raised
towards more normal levels is difficult to know. Interest expenditure will increase,
and for some households by a relatively large extent. But the total effect will also
depend on what happens in the economy otherwise as regards income from
employment, housing prices, expectations, etc. It is difficult to include all such
factors, but calculations show that we should expect a given interest-rate increase
to subdue consumption for mortgage holders more now than in the mid-1990s.8
At least for certain groups, monetary policy therefore has a greater impact on the
real economy now than previously. This could justify slower rate hikes than has
been the case in similar economic situations in previous years. For other groups of
households, on the other hand, the impact of rate hikes is not as great. There is
hence an intrinsic tension here. The Riksbank has only one policy rate and it is
adapted to aggregate demand and the economic outlook in general, and above all
to how inflation will develop. Higher interest-rate sensitivity and the extent to
which it affects the impact of monetary policy will, in other words, be a source of
uncertainty. It will, after all, be a challenge to have a situation for a number of
years in which interest rates rise - albeit slowly - while debt is higher than ever
before.
The supply of labour is greater
From household consumption and the demand side of the economy, I would like
to go on to the labour market and the supply side and my third and final example
of the transformation of the economic landscape.
Migration and reforms behind labour force participation
Various structural changes have meant that the Swedish labour market differs
considerably from the structure in the mid-1990s, and in the ten years since the
financial crisis alone, a great deal has happened. One such change is that the
number of persons at the disposal of the labour market has grown significantly.
Since 2006, the number of persons in the labour force aged 15-74 has increased
by over half a million.9 This means that the share of the working-age population
participating in the labour force is now the highest for almost thirty years.
Several factors lie behind this. The working-age population has increased, much as
a result of Sweden's substantial intake of refugees. Various reforms in recent
decades have also increased the incentives to participate in the labour force by
making it more profitable to work and to continue working to a more advanced
age. Relatively better health and level of education also seem to have contributed
to a rather large increase in the labour force participation rate among older
people.10 We should also remember that the increasingly strong economic
situation in recent years has probably made it more attractive to participate in the
labour force.
Monetary policy cannot solve structural challenges with greater labour
supply
Higher labour supply is basically positive as it should lead to higher employment in
the long term - which is beneficial not least in light of the challenges we face as
regards a greying population. Higher labour force participation in the long term
raises the economy's output potential, which means that the wheels can turn
more quickly without the risk of overheating and rising prices, which monetary
policy ultimately needs to subdue.
But a prerequisite for this positive effect is that the increased labour supply also
leads to higher employment. As it takes time for the labour market to adapt to
rapidly increasing supply, it is likely that the increase will, in part, result in higher
unemployment in the near term. High demand in the economy can facilitate the
adjustment. But the extent to which greater labour supply leads to higher
employment in the longer term is determined by how the labour market works
and by the matching of job-seekers to vacancies. This is particularly true of groups
with a vulnerable position on the labour market, for example persons born
outside Europe.
We have had a strong labour market in recent years and not only the labour force
but also employment are now on a historically high level. The expansionary
monetary policy has contributed to this development. But there are signs that the
matching of job-seekers to vacancies is not working well. The decrease in
unemployment in recent years has, above all, been among those born in Sweden.
For this group, unemployment is now on a very low level. Unemployment among
those born abroad, on the other hand, has not decreased to the same extent and
is significantly higher to begin with. A greater supply of foreign-born labour
creates the conditions for long-term higher employment, but it is important that
the labour market functions efficiently so that the supply of labour can be fully
utilised. With a greying population, this will also become increasingly urgent as
the demand for labour in areas such as health and social care rises.
Despite the economic situation continuing to be strong and both the labour force
and employment being expected to increase further in the future, it is the
Riksbank's assessment that unemployment is not expected to fall much more in
the years ahead. So, to keep unemployment down - and above all to bring it
down significantly below its current level - measures are needed within policy
areas other than monetary policy. I do not mean by this that monetary policy has
been exhausted. There is scope to make it even more expansionary if need be. But
monetary policy cannot be expected to be able to solve structural problems on
the labour market.
What we need to carry with us
Before saying a few words about the way forward for monetary policy in the new
environment, I would like to dwell for a moment on the question of what
expectations there should be about monetary policy. The fact is that we are
emerging from a period in which this question has, in a sense, been brought to a
head. Monetary policy in recent years has been focused on bringing inflation up to
the target, while consideration of other circumstances in the economy has
basically had to take a back seat. I am thinking here primarily of the risks of
various negative side-effects from the low level of interest rates. This is an
experience we carry with us as we go forward. And it is not only of significance for
monetary policy.
Confidence in the inflation target cannot be taken for granted
For a long time, the Riksbank has been expressing concern for the risks posed to
the economy by household indebtedness and rising housing prices. And during
the period up until 2014, these risks periodically had some influence on
ratesetting. As always, however, it was the economic outlook and inflation prospects
that directed the focus of monetary policy. But the Riksbank made use of the
flexibility in inflation targeting to help subdue debt accumulation and housing
price increases to some extent. This was done by keeping the repo rate marginally
higher than was justified by the outlook for inflation alone.
Flexible inflation targeting means in practice that the aim is not to bring inflation
back to the target as quickly as possible if it deviates from 2 per cent. But a
precondition for being able to be flexible is that there are expectations of inflation
still returning to target in the longer run. The inflation target has been the
nominal anchor in the Swedish economy for so long that it is easy to assume that
inflation expectations automatically stay around 2 per cent. But, as developments
after 2011 have shown, long-term inflation expectations are not immune to
influence. A long period of sub-target inflation caused expectations to creep
further and further below 2 per cent. It therefore became increasingly urgent for
the Riksbank to focus on reversing the trend and bringing inflation up to the
target. This turned out to require major monetary policy efforts over a long period
of time.
An insight gained in recent years that therefore needs to be highlighted is that
confidence in the inflation target cannot be taken for granted. The main task of
monetary policy is to maintain the nominal anchor in the economy and the
expectations and demands placed on monetary policy should take this as a
starting-point. But on condition that confidence in the anchor is not jeopardised,
monetary policy has a certain amount of scope to allow deviation from the
inflation target to take a back seat in favour of other considerations.11 This might,
for example, be a question of helping to mitigate risks associated with high
indebtedness and rising housing prices. But, and this is important, monetary
policy cannot be expected to be the solution when managing risks that stem from
fundamental problems relating to the functioning of markets and the incentives
for indebtedness, housing construction and employment. Other policy areas need
to rectify such problems.
Reforms needed in the housing and macroprudential policy
areas
As a result of Sweden's own crisis in the early-1990s, comprehensive changes
were made to economic policy in order to come to terms with deficiencies that
became clear during the crisis. We adopted a floating exchange rate and a
framework for fiscal policy that would ensure public finances were sustainable.
The changes created a stability in the Swedish economy that has been of
considerable benefit, not least during the financial crisis. Sweden had the
advantage of being able to tackle the economic slowdown with a fiscal policy that
was not hampered by major deficits and a monetary policy.
The latest crisis was also the starting point for changes in economic policy areas,
primarily to mitigate the risks of financial imbalances once again creating
problems for the economy as a whole. But the difference is that Sweden still, ten
years after the crisis, has not really managed to fully implement these changes.
The most concrete example of reform based on the lessons learned from the crisis
is that macroprudential policy has been established as a separate economic policy
area. Over the last ten years, intensive efforts have been made around the world
to define and implement macroprudential policy. Sweden has made some
progress but more needs to be done. At the end of last year, Finansinspektionen,
which has the main responsibility for macroprudential policy, was given the
goahead by the Government to introduce a tougher amortisation requirement. This
is, in itself, a positive development. But a regulatory framework that makes
macroprudential policy more flexible needs to be put in place so that measures
can be implemented quickly when necessary.
Macroprudential policy can be specifically focused on reducing the risks
associated with household debt. But the Riksbank's assessment is that a
combination of different measures is required in several policy areas to reduce
these risks.12 Above all, the fundamental causes of rising indebtedness need to be
dealt with, something that is difficult to do without first tackling the Swedish
housing market and its inherent imbalances. This is of course no easy task. But
nevertheless an urgent one. As I mentioned earlier, the interest rate will be lower
on average in the period ahead, sometimes much lower if monetary policy is to be
able to meet the inflation target. The financial side of the economy needs to be
robust enough to cope with such periods without macroeconomic developments
being exposed to too large risks.
The way forward
Structural changes and our experience over the last ten years will thus be of
significance for monetary policy going forward. But what does this mean in more
concrete terms?
The main direction is determined by international developments
To begin with, it is important to bear in mind that the Swedish economy is very
dependent on developments abroad. Just as before, the main direction of the
Swedish economy will follow international developments. I have already
discussed how significant the global level of interest rates is for interest rates in
Sweden and hence for monetary policy. In addition, the economic outlook and
inflation prospects will, to a large extent, be influenced by what happens abroad,
especially in the rest of Europe.
One special circumstance is that economic activity and normalisation of economic
policy will be in a different phase in the euro area than in the United States in the
coming period. This is not so strange given developments over the last ten years.
But as Swedish economic activity has been stronger than in the euro area,
normalisation here at home looks as though it might start earlier than in the euro
area, according to our forecast. In other words, we will probably be after the US
central bank but slightly before the ECB. This is a special situation that can affect
the impulses from abroad as regards economic activity and inflationary pressures.
Inflation can rise in different ways. Lately, price pressures from abroad have been
subdued and the upturn in inflation has largely been domestically driven,
primarily via price increases in the service sector. The combination of wage and
price developments in domestic sectors and inflationary impulses from abroad
will determine how monetary policy should be designed to influence domestic
demand and the exchange rate in the desired direction, so that inflation
ultimately stays around the target. To some extent, it will of course be less
complicated for monetary policy if inflationary pressures both rise abroad and in
domestic sectors and in ways we are used to - and the risks of imbalances may
then also be mitigated.
Complementary monetary policy measures may be the norm
As I mentioned earlier, the environment of low real interest rates will probably
last for quite some time to come, which means that the policy rates of central
banks will on average be on a lower level. This may, in turn, limit the scope of
central banks to tackle economic downturns by cutting policy rates. Say, for
example, that the repo rate will on average be around 2.5 per cent, that is, at the
lower bound in the Riksbank's assessment of the long-term level. That does not
provide much leeway down to zero. As we have shown, it is possible to lower the
rate some way below zero but it is clear that there may be less scope for rate cuts
than previously.
Discussions are ongoing among central banks as to what the significance of low
interest rates will be for monetary policy and how the scope for monetary policy
to act in economic slowdowns can be increased. One conclusion is that
complementary monetary policy measures of the type used by many central
banks in recent years, such as the purchasing of various assets, may become more
common in the future. Other feasible measures in the monetary policy toolbox
are loans directly to companies via banks, and foreign exchange interventions.
The new environment also affects other policy areas
Another possibility is other policy areas being used more actively to stimulate the
economy in times of recession. In the international debate, it has, for example,
been said that the limitations imposed on monetary policy by the low
interestrate environment mean that fiscal policy may need to contribute to stabilisation
policy to a greater extent than before.13
I think, to start with, that it is important to point out that monetary policy has not
be exhausted as a result of the policy rate being lowered as far as is practically
possible. As I just mentioned, there are several tools in the monetary policy
toolbox that can be used if need be, in order to stimulate the economy. That said,
there are obviously feasible tools in other policy areas as well. And it is reasonable
to evaluate the costs and benefits of using all these different tools so that
economic policy is as efficient and effective as possible for the economy as a
whole. But how the various tools are used is a matter for those responsible for the
different policy areas and as r