Kerstin af Jochnick: Monetary policy and the current economic situation
Speech by Ms Kerstin af Jochnick, First Deputy Governor of the Sveriges Riksbank, to the
County Administrative Board, Kalmar, 22 August 2013.
* * *
It has become something of a tradition for a member of the Executive Board of the Riksbank
to hold a speech on the current economic situation at the end of August. I think this is a good
idea; starting off the new term by summarising what has happened during the summer. I
appreciate being given the opportunity to come here to Kalmar to talk about the economic
situation. Kalmar is part of a region where economic developments are greatly affected by
cyclical fluctuations. Kalmar and Kronoberg, together with Blekinge, are the counties that
have experienced the largest fluctuations in growth since the early 1980s. One reason for
this, of course, is that a large share of the companies in the region comprises subcontractors
to the cyclically-sensitive manufacturing industry.
Today I intend to start off with the economic assessment we made in July and in particular to
describe my view of developments at that time and of the monetary policy we have decided
on. The main message in July was that the Swedish economy is heading for a recovery. But
we decided to hold the repo rate at a low, unchanged level to help the economy along.
Personally, I think the decision was a reasonable balance as it means that inflation will attain
the target in around two years' time, while we take into consideration the risks linked to the
high level of household debt.
One important issue that I would like to discuss in greater depth today is how monetary
policy takes into account household debt and what important role the emerging
macroprudential policy can play. Macroprudential policy is more suitable than monetary
policy for managing financial imbalances, such as a high build-up of debt in the household
sector, and it is therefore essential that it is implemented as soon as possible.
Well-balanced monetary policy in July
At the most recent monetary policy meeting in July we noted that growth would be weaker
than normal this year, both in Sweden and abroad. However, developments in the Swedish
economy were divided. At the same time as the household sector looked strong and
consumption was growing, companies were being affected by the weak demand abroad,
which was leading to lower export and investment. Moreover, the inflation rate was still low.
But our assessment at the meeting was that there were signs that the recovery in Sweden
and abroad was gradually strengthening.
Uneven but gradually strengthening recovery abroad
Economic prospects have for some time now looked different in different parts of the world,
but on the whole our assessment in July was that economic activity would gradually improve
in the coming period. However, I personally thought there were a number of factors in the
global economy that made the forecast unusually uncertain. Prior to the meeting in July,
there had been considerable fluctuations in the financial markets, which were largely due to
the uncertainty over when the Federal Reserve will begin phasing out its quantitative easing.
There was also uncertainty over what effects the problems in the Chinese banking sector
would have on the Chinese economy and also, as has been the case for a long time now,
over developments in the euro area.
Economic developments in the euro area are still marked by the need for the private and
public sectors to reduce their debt, which is a process that will of course take a long time.
However, compared with one year ago, developments had been in the right direction in most
of the problem countries and a number of measures had been taken that led to interest rates
falling to lower levels. Our assessment in July was based on the assumption that the reform
process would continue and the forecast was that GDP growth in the euro area would remain
weak but gradually increase. However, the slow recovery means that GDP will not reach the
same level as prior to the decline in 2009 until 2015. This shows what enormous costs the
global financial crisis has entailed, not only in the form of capital injections to international
banks and governments, but also in the form of loss of growth and welfare.
In the United States, conditions for a continued recovery were good, although growth was
expected to be slow this year. There were several signs that households would soon have
reduced their debts to more sustainable levels, at the same time as the housing market
continued to improve, with rising housing prices and increased turnover. We therefore
assessed that GDP in the United States will grow by just over 3 per cent on average in 2014
and 2015.
The economic prospects for other regions looked rather mixed. In China, the high growth had
slowed down at the beginning of 2013, while Japan had showed some positive signals after
the new stimulus package. The United Kingdom and Denmark showed weak growth, partly
due to problems in the housing market, while Norway was assessed to have somewhat
higher resource utilisation than normal. All in all, the economies in the countries important to
the Swedish economy were expected to be weaker than normal this year, and then to
gradually improve.
Gradually brighter growth prospects in Sweden
In July we pointed out that the weak developments in the euro area in particular affect the
Swedish economy, partly through low demand for Swedish exports and investment. We
therefore assessed that GDP growth in Sweden would also be lower than normal this year,
but would gradually strengthen in the coming period. However, developments in the Swedish
economy were divided. At the same time as companies in the manufacturing industry in
particular showed a low level of confidence and investment declined, households' finances
were relatively strong. Optimism in the household sector had begun to rise, which was
reflected in higher house prices, as well as increased lending and consumption. However, we
began to see some signs of a turnaround in activity in the manufacturing sector, too.
Our assessment in July was that the demand for Swedish exports would rise as international
demand increased, while the upturn in domestic demand was expected to broaden.
Household consumption and housing investment were expected to increase at a faster pace
as household confidence strengthened further and the labour market improved. At the same
time, companies are expected to increase their investment as demand rises. We therefore
made the assessment that GDP growth in Sweden will rise gradually in the coming years and
reach just over 3.5 per cent in 2015.
The labour market saw an increase in both the number of people in the labour force and the
number of persons employed. Our assessment was that unemployment will remain
unchanged in the coming year and then begin to fall when the higher GDP growth causes
employment to increase faster than the labour force.
Low but gradually rising inflation
Inflation in Sweden has been low for a long period of time and we devoted extra space to this
fact in the July report.1 It is not so strange that inflation has been low, given the Swedish
economy's dependence on global economic activity. One of the main reasons is that prices
of Swedish import goods have been low. This is largely due to global economic activity being
weak and having affected global export prices, but the stronger Swedish krona has also
contributed. Another reason is that companies have not raised their prices to the same extent
as their costs have increased. The low price mark-ups are partly due to demand being lower
than normal and to the considerable uncertainty over international developments.
In July we assessed that inflationary pressures would gradually increase over the coming
years, as Sweden and other countries recover. This means that CPIF inflation is expected to
reach 2 per cent in 2015. CPI inflation is expected to be higher than the target of 2 per cent
at the end of the forecast period, which is due to mortgage rates rising when the repo rate
starts to increase as the economy improves. Let me describe in more detail the factors
expected to contribute to the upturn in inflation.
When global economic activity improves, global export prices are expected to rise. Initially,
the krona is expected to strengthen somewhat in trade-weighted terms, which will dampen
the impact on Swedish import prices in the near term. However, from the beginning of next
year, we assess that the krona will no longer contribute to holding down import prices and
they will then rise faster. As economic activity in Sweden strengthens, the rate of wage
increase will also rise. At the same time, we have assessed that labour productivity is
increasing, which means that unit labour costs will continue to grow by around 2 per cent a
year in the coming years. The fact that import prices rise faster, at the same time as unit
labour costs continue to increase at a normal rate, will lead to companies' total marginal
costs gradually beginning to grow at a more normal pace.
We also predicted in July that the demand situation would improve during the forecast
period, partly thanks to higher demand from abroad and a continued expansionary monetary
policy in Sweden. We are expecting that it will become easier for companies to raise their
prices when demand increases. Companies' profit shares will also increase towards more
normal levels then. All in all, these factors - increasing unit labour costs, rising import prices
and higher price mark-ups - lead to the assumption that inflation will rise in the coming
period.
Continued low repo rate stimulates the Swedish economy
We Executive Board members assessed that the repo rate needs to remain low to support
economic activity and to ensure inflation rises towards the target. We therefore decided at
the meeting in July to hold the repo rate unchanged at 1 per cent, and the repo-rate path
shows a slow increase beginning during the second half of 2014.
Monetary policy is thus very expansionary. However, the decision to hold the repo rate
unchanged also gives consideration to the risks linked to Swedish households' high debts.
Personally, I consider the repo-rate decision to comprise a reasonable balance. The forecast
showed that CPIF inflation will attain the target in around two years' time. An even lower repo
rate could have led to inflation attaining the target slightly earlier, but the decision is about
stepping on the gas just enough. A lower repo rate would probably also lead to the risks
linked to household debt increasing further, particularly bearing in mind that the situation for
households was relatively favourable to start with. There could be a particularly difficult
situation if households expect the low interest rate to persist. This could lead to both house
prices and debts increasing further, which can have very negative consequences in the form
of sharply rising unemployment and difficulties in attaining the inflation target further ahead.
There are numerous discussions in Sweden and abroad with regard to how much
consideration monetary policy should give to various types of financial imbalance, such as
high household debt. After the most recent financial crisis, which demonstrated how costly a
crisis can be as a result of a large build-up of debt, the pendulum has swung towards the
belief that monetary policy should to a greater extent lean against the wind, and take such
imbalances into consideration. Personally, I think that as long as there are no other tools in
place that can counteract the build-up of financial imbalances, monetary policy must take into
account the risks the imbalances entail. Let me explain my view of these questions before I
move on to summarise the information received during the summer.
Monetary policy and financial imbalances
International experience shows that a high level of indebtedness in all its forms can pose
major risks to the economy. It makes the economy more vulnerable to various types of
shock, such as a fall in house prices, and it can also increase the risk of shocks actually
occurring. The flexible inflation targeting conducted by the Riksbank is compatible with giving
consideration to this type of financial imbalance in our monetary policy decisions. Such
imbalances ultimately risk jeopardising both the stability of the real economy and the inflation
target. In a really bad scenario the imbalances could also entail risks for financial stability. As
the Riksbank's two main tasks are to attain price stability and financial stability, we must take
these risks into account.
Monetary policy needs a more long-term focus
As I see it, we need to make it clear in the monetary policy analysis how monetary policy
affects the risk of a financial crisis arising and how such a crisis scenario would look. As
financial imbalances usually build up over a long period of time, this means that, in practice,
we need to look beyond the three-year perspective that normally forms the base for our
forecasts. Monetary policy is already forward-looking, but with a more long-term focus we
could also include target attainment in the longer run.
So, to what extent can monetary policy affect the probability of a crisis occurring? Well, it is
mainly the effect of the repo rate on debt that is important in this context, as the probability of
a financial crisis increases when indebtedness is high or when debt increase at a faster rate
than normal.2 As the interest rate entails the cost of taking on debt, monetary policy has an
effect on indebtedness. In the short-term perspective it seems as though the relationship
between the repo rate and household debt is not very strong. However, if households expect
the prevailing low interest rates to persist, and therefore increase their debts to unsustainable
levels, the effects can be substantial.
In the July report we describe a potential scenario in Sweden if house prices were to fall at
the same time as indebtedness is high.3 Experiences from other countries show that this
would probably mean that households increase their savings and reduce their consumption,
which would subdue demand in the economy and push up unemployment. The effects on
GDP and unemployment may therefore be both substantial and long lasting. Relevant
examples here are Spain and Denmark. Experiences also show that the higher households'
debts are, the greater the negative consequences will be of a fall in housing prices.4 At the
same time, there would probably be long-lasting difficulties in attaining the inflation target, as
the uncertainty over future inflation increases significantly.
Conducting a flexible inflation-targeting policy in this context involves taking into account the
risk of a crisis occurring by balancing the effects within the normal forecast period against the
long-term risks I described. There is of course considerable scope here for different
assessments, for instance, to what extent monetary policy affects the probability of a crisis,
as well as how a crisis scenario would play out. These are difficult monetary policy
deliberations without easy answers. As Sweden is a small country with its own currency and
strongly dependent on other countries, it is particularly important that we do not create
imbalances that can affect confidence in the country, the currency and the banking system. I
consider the assessment we made in July to entail on the whole a good balance between
these difficult questions.
Macroprudential policy needs to be implemented without delay...
At the same time, I consider it important to emphasise that the repo rate is a blunt
instrument. Other policy areas have more effective tools for influencing household debt. One
such policy area is macroprudential policy, which entails limiting the risks in the financial
system as a whole. If there were more effective tools available for managing and preventing
financial imbalances, monetary policy would not need to take such risks into account to the
same extent.
At present, several countries and international organisations are working on producing and
implementing a new framework for financial stability, where macroprudential policy will be in
focus and the central bank will be given an important role. However, the design is slightly
different in different countries. For instance, in the United Kingdom the central bank has been
given the entire responsibility for macroprudential policy, while in Germany the responsibility
has been given to a council, on which the central bank has a central position.
It is important that a small country like Sweden does not deviate from the international
pattern, but also that it makes efficient use of the existing resources and competence. Both
the Riksbank and Finansinspektionen (the Swedish Financial Supervisory Authority) have
important competence with regard to conducting effective macroprudential policy. The
Riksbank has considerable knowledge and experience of analysing the risks that might
threaten the stability of the financial system, as well as of macroeconomic analysis and
forecasting. It is therefore easier for us to understand the linkages between the financial and
the real economies, which is essential for a successful macroprudential policy. Moreover,
there are clear points in common between macroprudential policy and monetary policy, as
they affect the conditions for one another. At the same time, Finansinspektionen currently
conducts supervision with a focus on individual institutions and thus has important
competence and experience for ensuring that macroprudential policy is effective.
As I see it, there are two main principles that should be used when drawing up
macroprudential policy. Firstly, there should be a clear mandate covering accountability and
the requirement for insight. Secondly, it is important that the authority that is given
responsibility for macroprudential policy is also equipped with the right tools, that is, given the
possibility to intervene at an early stage when risks that could lead to negative effects on the
Swedish economy have been identified. Sweden's place in the global financial system and
our domestic conditions mean that we cannot delay any longer in designing a framework for
financial stability and macroprudential policy; we need to get this in place as soon as
possible.
...and we need an even better analytical base
However, to be able to make the best possible analyses and thus design effective tools to
counteract the risks of high indebtedness, we also need to have better statistics on
household borrowing. This has also been pointed out by both the IMF and the European
Commission in their assessments of the Swedish economy.5
As a preliminary step towards improving the analytical base we at the Riksbank have asked
the Swedish banks to provide us with data on households' loans. The data collected by the
Riksbank will be used to analyse how vulnerable the Swedish households are and how
potential risks are distributed among the population. Finansinspektionen already makes good
analyses and have on several occasions gathered random samples among newly-granted
loans. The Riksbank and Finansinspektionen cooperate in the analysis of the mortgage
survey, but these random samples entail a small selection and only capture the new loans
granted by the banks. There is thus a need to go one step further to see how the debts are
distributed and thus how large the risks in the entire banking system are, not merely those in
the newly-granted loans.
Another factor that affects household debt is residential construction. Not enough housing is
being built in metropolitan regions to keep up with the growth in population. This naturally
affects both housing prices and household debt and is a long-term problem that should be
managed but that neither monetary policy nor macroprudential policy can affect.
Developments during the summer
While waiting for macroprudential policy to be established, we are continuing to work on our
monetary policy analysis in the way I have described and at the beginning of September it
will be time for a new repo-rate decision. Since we made our assessment in July new
information has been published that we will analyse and make an overall assessment of at
our meeting in September, but I shall now summarise what has happened so far.
Clearer guidance about future monetary policy
During the summer the financial markets have largely focused on expectations of future
monetary policy, in particular how the Federal Reserve is expected to act in the coming
period. At the same time, both the European Central Bank and the Bank of England have
stated clearer forward guidance in order to increase transparency and reduce uncertainty.
One reason for the need to increase transparency is that these central banks have come
down to very low policy rates. This means there is a greater need for central banks to clearly
communicate their views on future monetary policy. The Riksbank has long emphasised the
importance of a central bank being transparent and giving clear guidance, which is why we
started publishing a repo-rate path and forecasts for inflation and unemployment, for
instance, in connection with our monetary policy decisions back in 2007.
The uncertainty on the global financial markets has declined during the summer and the
increased volatility which we noticed prior to the meeting in July in the stock markets as well
as the bond and foreign exchange markets has also decreased somewhat. Government
bond yields in the United States and Europe have continued to increase while stock markets
around the world have risen, even if the latter fell somewhat during the last week. The
Swedish financial markets have followed the international developments and market rates
and the stock market have risen in Sweden during the summer. The Swedish krona has
fluctuated considerably but all in all the change is small compared to the level at the
beginning of July. The Swedish krona has strengthened somewhat in trade-weighted terms,
which is mainly due to a strengthening against the US dollar.
Some improvement in the euro area
Developments in the euro area have been relatively calm over the summer, despite some
political uncertainty in Portugal, Spain and Italy. Moreover, there have been assessments of
Ireland and Greece, for instance, that indicate the on-going reform work is progressing well.
The reform work in both countries has been approved, which has paved the way for
continuing aid payments. But the problems remain, and during the summer both Italy and
France had their credit ratings downgraded because of poor growth prospects.
Perhaps the most important thing is that new statistics show that the euro area GDP has
begun to grow again. After being negative for six quarters in a row, GDP growth was 1.1 per
cent in the second quarter of this year, according to preliminary figures and calculated as an
annual rate. In Germany, which is very important to Swedish exports, GDP growth was
clearly above the average for the euro area as a whole. At the same time, indicators for the
start of the third quarter point to a continued improvement. The aggregate purchasing
managers' index rose in July to just over 50, for the first time since the start of 2012, and
consumer confidence also began to rise. New labour market statistics also show that
unemployment in the region has stabilised, albeit at a very high level. All in all, the new
information confirms the picture that the recovery in the euro area has begun.
Mixed signals from the rest of the world...
New US statistics indicate continued strength in the US economy. Preliminary figures show
that GDP increased in the second quarter by 1.7 per cent, calculated as an annual rate,
compared with the first quarter of this year, which is in line with the assessment we made in
July. At the same time as the new outcomes were published, the statistics authority released
revised GDP figures for previous periods. These show that GDP growth has been slightly
higher since 2007, and that the fall in GDP during the financial crisis was thus not as large as
indicated by earlier statistics. In the United Kingdom, GDP was slightly better than expected
during the second quarter. The indicators for July also point to a gradual recovery in the
British economy.
However, in Japan, which showed positive signals at the start of the year, newly-received
statistics over the summer have not been as clear. GDP growth slowed down during the
second quarter and the recovery in both the household and corporate sectors appears to
have been dampened slightly further at the start of the third quarter. At the same time, data
shows that emerging markets are slowing down somewhat. In China, preliminary figures for
the second quarter show that GDP increased by 7.5 per cent as an annual percentage
change, which was a slowdown compared with the previous quarter. Indicators for the other
BRIC countries, that is, Brazil, Russia and India, show some slowdown. All in all, the new
information shows some signs of strength in the recovery in advanced economies, but a
rather more subdued development in emerging markets.
...but also in Sweden
It was clear that international developments play an important role for the Swedish economy
when the preliminary GDP figures for the second quarter were published. GDP fell by 0.2 per
cent when calculated as an annual rate compared with the first quarter of this year. The
negative growth was largely due to a fall in exports, but household consumption also fell
somewhat. The outcome was slightly weaker than we and several other analysts had
expected. But as the figures are preliminary, we probably should not draw any major
conclusions from them. At the same time, new monthly statistics for the retail trade showed
that sales were strong at the end of the second quarter.
Indicators for the start of third quarter have given mixed signals. So far, the information is
limited to the business tendency survey for July and the purchasing managers' index for the
same month. The economic tendency survey, which includes both households and
companies, rose slightly in July and the upturn was on a broad front. Confidence in the
household sector is now at its historical average. The purchasing managers' index for the
manufacturing industry was over 50 in July, for the third month in a row, which indicates
growth in the manufacturing industry, but the most recent outcome showed a fall compared
with the previous month. At the same time, however, the purchasing managers' index for the
service industries rose.
According to new labour market data for June, the earlier positive trend continued for both
the number of people in the labour force and the number of employed. Unemployment rose
marginally in June, but monthly data is usually volatile and if one looks at the second quarter
as a whole, unemployment fell somewhat more when compared with the first quarter than we
had assessed in July. During the summer, inflation outcomes were published for June and
July. CPI rose by 0.1 per cent in July, compared with the same month last year, at the same
time as the underlying CPIF inflation rate was 1.2 per cent. This was somewhat higher than
expected, mainly owing to an unexpectedly sharp rise in energy prices.
During the summer, new financial market statistics were also published for the month of
June. The annual growth rate for lending to households was 4.7 per cent in June, that is, the
same as in May. This means that the rate of increase in lending has remained more or less
unchanged since last summer.
Next monetary policy decision on 4 September
A number of mixed signals have been received during the summer. While the volatility on the
financial markets has declined, there is still some uncertainty over the strength of the
recovery in the real economy. There have been signs of a gradual improvement, for instance,
in the euro area and the United States, but on the other hand the GDP outcome in Sweden,
for instance, signalled that the recovery is fragile. At our monetary policy meeting on 4
September we will have to balance these factors against one another, and also take in the
information received in the meantime.
Until macroprudential policy has been established, we will continue to conduct a flexible
monetary policy that enables us to take into account a number of different factors, such as
household debt. At the Riksbank we are busy working on new analyses and forecasts on
which to base the next repo-rate decision. We will return with a new overall assessment in
connection with the monetary policy meeting in September.