Kerstin af Jochnick: Unusual measures in unusual times - experiences
with the Riksbank's unconventional monetary policy
Speech by Ms Kerstin af Jochnick, First Deputy Governor of the Sveriges Riksbank, to SACO
(Swedish Confederation of Professional Associations), Stockholm, 29 January 2016.
* * *
Accompanying charts can be found at the end of the speech.
I would like to thank Carl-Johan Belfrage, Hanna Köhler and Cecilia Roos-Isaksson for helping me with this speech.
The start of a new year - particularly after such an eventful year as 2015 - can be a good time
to look back and try to learn a few lessons from the past year's experiences. I will therefore
focus today on the reasons for the new monetary policy ground broken by the Riksbank in
2015. This includes our introduction of a negative repo rate and our initiation of government
bond purchases as a complement to repo rate cuts to further boost demand in the economy
and increase inflation.
The inflation target is worth defending. This is why we have taken to unusual measures under
unusual circumstances and these measures seem to have contributed towards good growth
and a rising inflation trend. At the same time, there is reason to remember that the low level of
interest rates is leading housing prices and mortgages to develop in a dangerous direction. I
also intend to present a few preliminary reflections on the recently published assessment of
the Riksbank's monetary policy.
Why is the inflation target so important?
Understanding the Riksbank's actions first requires understanding why we think the inflation
target is so important. We introduced inflation targeting in Sweden in 1993 after we were forced
to abandon the fixed exchange rate regime. We used academic research to support this
decision, along with the good example provided by forerunners such as Canada and New
Zealand.1 A well-implemented inflationary targeting policy benefits economic development by
making inflation lower, more stable and more predictable. Sweden's experiences in the
decades before and after the introduction of the inflation target provide a rough idea of the
significance of inflation targeting for the development of prices and wages - severe fluctuations
in the 1970s and 1980s were followed by very stable development after the introduction of
inflation targeting (see Figure 1).
It has benefited economic development in Sweden. This is because more predictable price
developments make borrowers and savers feel more secure in how inflation will develop and
create good conditions for economic decisions. This lowers borrowing costs and thereby
benefits investments. Investments and new recruitments are facilitated by companies' ability
to make a reasonably good prediction of price and wage cost increases over the lifetime of an
investment. The less uncertainty there is over future price developments, the easier it also
becomes to agree on conditions for various contracts, not least the wage agreements
negotiated by the labour market parties. All in all, it is thus not unreasonable to consider that
inflation targeting has contributed towards the higher average growth we have experienced
over the two decades since targeting was introduced, as compared with the preceding period.
It is important that inflation expectations are not too low
There is consequently a lot to be gained from having low, stable and predictable inflation. But
it is also important that expectations of future inflation are not too low.
One reason for this is that inflation allows wages to develop more weakly in certain areas
without requiring nominal wages to be cut. This means that unemployment can be avoided
when changes occur that reduce the demand for certain types of knowledge, skill and
experience.
However, inflation expectations also affect the strength of the Riksbank's primary monetary
policy weapon - the repo rate - and thereby the Riksbank's ability to stabilise the Swedish
economy and lead it out of crises.
This is a product of the way inflation expectations affect real interest rates. In the same way as
the figures for GDP growth we usually discuss refer to real growth, which is to say growth
adjusted for inflation, there is namely reason to adjust interest rates in the economy for inflation
- in particular, to determine how much stimulus monetary policy is supplying. There are good
reasons to subtract the effects of inflation on debts and saving. For example, a loan for an
investment becomes less burdensome to repay the more the price of the goods the borrower
is selling has increased over the period in question. And the lender, correspondingly, has
reason to consider how much the money is worth when the loan is eventually repaid. Another
way of putting it is that those borrowing and lending must consider how much of the amount
lent they expect to be 'eaten up' by inflation. The economically-significant real interest rate is
therefore the usual nominal rate with a deduction for expected inflation:
Real interest rate = nominal interest rate - expected inflation
How expansionary the interest rate policy is, which is to say how low the real interest rate level
is, is thus determined both by the nominal interest rate level and by expected inflation. This
also means that how expansionary the level of interest rates can be made is not just
determined by how far the nominal interest rate can be cut but also by how high inflation is
expected to be. When inflation is expected to be high, the real interest rate can be made very
low, but this also means that, as inflation expectations fall, the scope for cutting the real interest
rate also decreases.
The fact that inflation expectations were anchored around the target of two per cent meant that
the low nominal interest rates of 2009 and 2010 (see Figure 2) gave households and
companies very low real interest rates and supported the recovery of the Swedish economy.
With lower inflation expectations, the same interest rate policy would have had a less powerful
stimulatory effect and that would probably have meant lower employment and even lower
inflation in recent years.
Inflation expectations are thus of vital importance for how expansionary monetary policy is and
how expansionary it can be made when the Swedish economy is subjected to new severe
stresses. The stimulus provided by a really low real interest rate can make it possible to avoid
more prolonged low interest rate periods with the drawbacks in the form of rising indebtedness
and exaggerated risk-taking that we are now concerned about. But if inflation expectations are
too low, not even the lowest possible repo rate may be enough to push the real interest rate
down to the desired level.
To sum up, it is thus of great benefit to the Swedish economy if households and companies,
savers and investors, expect a future rate of inflation that is on a reasonably low level and that
their expectations more or less correspond. The key to such jointly-agreed inflation
expectations is that the inflation target of two per cent is seen as credible, which is to say that
all parties expect that the Riksbank will be able to hold inflation close to the target in the period
ahead.
Inflation expectations were losing their stable footing at two per cent
Unfortunately, one of the unusual circumstances prevailing at the start of 2015 was that
longterm inflation expectations were losing their stable footing around the target of two per cent.
Of course, there are no perfect measures of inflation expectations and it is not obvious whose
expectations are most important, but we carefully monitor the survey-based measures of
expectations provided by Prospera. The decrease in inflation expectations five years ahead
that took place in the period up to the end of 2014 was worrying (see Figure 3). Pricing on the
bond market gave the same view of falling long-term inflation expectations.
If this meant that doubts were now starting to arise about the two per cent target, this was
perhaps not so strange, considering that inflation at this point had been low for an extended
period of time. There was certainly reason to believe that this was at least partly the result of
temporary factors. The Riksbank's own analyses pointed to the strengthening of the krona
exchange rate between 2009 and 2013, the weak level of economic activity abroad and falling
energy prices. We also noted an unusually low interest among companies in raising their
prices, despite rising costs. Conceivable explanations for this included decreasing inflation
expectations and perceived uncertainty over the economic outlook, as reported by the
companies in our Business Surveys.2
The unusually low inflation in recent years is something we have shared with many other
countries. This may have strengthened the perception that there are forces in motion making
it impossible for the Riksbank to reach the inflation target. There has been, not least, an
emphasis on the effects of globalisation and digitisation on costs and competition. However,
as my colleague in the Executive Board, Martin Flodén, pointed out in a speech last autumn,
it is difficult to see why this should have persistent effects on the rate of inflation in particular
and why it has not prevented higher inflation in countries like Norway, Canada and Australia.3
In addition, these factors were relevant when Sweden had a higher rate of inflation, just a few
years ago.
Regardless of the underlying reasons, it would be very unfortunate if long-term inflation
expectations were to drift away from the inflation target. We would then start to lose everything
we gained by having an inflation target.
Inflation prospects are influenced by international developments
At the same time, at the start of 2015, the European Central Bank (the ECB) had announced
bond purchases in an amount of EUR 60 billion per month to make its monetary policy more
expansionary. Of course, these measures will eventually have positive effects on inflation in
Sweden as they provide welcome stimulus for an important Swedish export market. But, by
weakening the euro, the ECB's measures risked exerting price pressure on a significant portion
of Swedish imports over the short term.
In addition, the price of oil had fallen sharply in 2014 and continued to fall in 2015. The
international development of the price of oil directly influences inflation in Sweden via the price
of fuel oil and, not least, the price of petrol. Over time, it can also have effects on other prices,
as it affects companies' energy and transportation costs. It is true that, in normal cases, a fall
in the price of oil has a brief effect on the actual inflation figures. But as the price of petrol in
particular is so very visible for so many people, it may have a disproportionately high impact
on how inflation is perceived and thereby possibly also on inflation expectations.
We have also had a year characterised by a large degree of uncertainty over international
developments in general. Greece's membership of the single currency and possibly, therefore,
the entire European monetary union was, at moments, on the ropes. The conflict in Ukraine
and the sanctions levied on Russia had consequences for the Russian economy but also
created unease over the political and economic development of eastern and central Europe in
general. We saw drastically reduced demand from the global growth engine of recent years,
China. This gave new fuel to concerns over an imminent hard landing of the economy there.
The severe conflicts in the Middle East started to make themselves increasingly felt via a heavy
increase in the numbers of people seeking safety in Europe. The possible effects of the central
banks acting out of step - after a number of years of crisis policies - also led to a degree of
concern.
There is always uncertainty but, nevertheless, my impression is that it has been unusually high
over the past year. Uncertainty in itself can cause problems as it can lead households and
companies to hold off consumption and investment, and can reduce companies' willingness to
raise their prices. Everything else being equal, a higher degree of uncertainty therefore argues
for a more expansionary monetary policy. In addition, greater uncertainty over international
developments also entails a greater risk that the Swedish economy will be exposed to such
strong negative pressure that we will end up in a really serious situation with persistently falling
prices and employment. A desire to lower the chances of such a situation may, in itself, argue
for a more expansionary monetary policy.
A more expansionary monetary policy
At the start of 2015, we thus found ourselves in an unusual situation with a series of
circumstances that suggested that monetary policy needed to be more expansionary: declining
confidence in the inflation target, the measures adopted by the ECB to weaken the euro, the
risk that the falling oil price would put further pressure on inflation expectations and increased
uncertainty over international developments.
Consequently, there was a need to strengthen confidence in the inflation target through clear
signals of the Riksbank's ability and willingness to bring inflation back to the two per cent target
in a controlled form. We needed to clarify and practically demonstrate that monetary policy had
more to give.
The repo rate was already at a historically-low zero per cent and even the interest rates we
sometimes call the final interest rates - that is, those actually paid by households and
companies - were at historically low levels. But interest rates needed to be even lower and we
needed to counteract the increasingly rapid appreciation of the krona.
Negative interest rate?
The most obvious measure was to cut the repo rate further, that is to make it negative - to
introduce what, in everyday parlance, was starting to be called a negative interest rate. When
we cut the repo rate to zero per cent, we did not observe any major problems. But would
making the repo rate negative and quite simply forcing the banks - and, ultimately, perhaps
their customers - to pay to keep money in an account really have the same impact on final
interest rates for households and companies and, if so, could it be implemented without
causing problems elsewhere in the system? One objection towards negative interest rates is
that people will choose the alternative of keeping cash in their mattresses. As this would be
troublesome and not entirely risk-free, it can be imagined that most people would want to hold
off stuffing their mattresses with cash as long as interest rates stay only slightly negative, but
it is, of course, difficult to gain clarity as to exactly where such a boundary would lie. If the
banks were unwilling to introduce negative deposit rates, would they then attempt to maintain
their earnings by not cutting their lending rates either, in the eventuality that the repo rate was
cut to below zero per cent? There are some international experiences, albeit short-lived, of
negative interest rates that can be looked at - from the euro area, Denmark and Switzerland
- but how would the Swedish system react?
Purchasing government bonds?
Another measure with the potential to push interest rates down and counteract the excessively
rapid appreciation of the krona was the purchasing of government bonds. There were
significantly more comprehensive historical and international experiences of this than there
were of negative interest rates.
The bond purchases made by a number of central banks in the wake of the global financial
crisis were aimed at pushing down yields on longer maturities. Put simply, the idea is that, if
the central bank purchases part of the available debt securities, anybody wishing to have these
in their portfolios will be forced to compete for a smaller supply. This will push up the prices for
debt securities so that yields will decrease.
Of course, assessments of the effects of central banks' bond purchases vary between different
analyses, but there is a lot to suggest that three major central banks (the Federal Reserve,
ECB and Bank of England) have succeeded, to some degree, in pushing down long-term yields
and weakening their exchange rates.4 But there has, of course, been some uncertainty over
what the effects would be in Sweden's case. There have also been risks to consider, for
example that the functionality of the Swedish bond market may start to become impaired if the
Riksbank were to purchase a large portion of the supply.
There are also other measures on the menu. One of these is lending to companies via the
banks to reduce the differences between the final interest rates for companies and the yields
on government securities with corresponding maturities. Another possible measure, justified
by the great significance of the krona exchange rate for the development of inflation, is
conducting currency interventions.
A cautious combination of a negative repo rate and bond purchases
So how have we chosen to act, and what have the results been, so far? Up to this point, we
have kept to changes to the repo rate and repo rate path, and purchases of government bonds.
As it has not been completely certain how these would function in practice, there has been
reason to proceed cautiously. We have combined several measures over the past year to make
the combined effect sufficiently great. Over a number of stages, we have cut the repo rate
and/or the repo rate path, at the same time as we have announced and initiated bond
purchases in amounts that have been increased in several stages (see Figure 4 and Figure
5). In addition, in our communication, we have emphasised our preparedness, if necessary, to
also rapidly increase monetary policy stimulus between the ordinary monetary policy meetings
held every second month. In March 2015, we did exactly this - we took a decision on new
monetary policy stimulus between two ordinary meetings.
The repo rate cuts have largely worked
As regards the repo rate cuts, so far we have been able to observe that lending rates followed
to a normal extent, while deposit rates have stopped at zero for everybody except some larger
companies.
The bond purchases have had the intended effect on interest rates
To get an idea of the effects of the bond purchases, staff at the Riksbank have studied the
financial markets' immediate reactions to the announcement of the decisions.5 On those
occasions on which the decisions were deemed unexpected, yields fell over the days on which
the decisions were announced. In addition, they fell in comparison to corresponding yields
abroad, for example in Germany. It therefore seems reasonable to conclude that the bond
purchases have pushed interest rates in the economy down - Swedish government bond
yields are now probably lower than they would have been without the purchases. These effects
are in line with those observed in studies of the Federal Reserve's bond purchases in the
United States.
Our analyses of the financial market's reactions to the monetary policy decisions have also
concluded that the decisions have entailed a weakening of the krona exchange rate.
It thus seems to be the case that the additional monetary policy measures that we introduced
over the past year have given us lower interest rates and a weaker krona than we would
otherwise have. This means that the measures have probably achieved and are continuing to
achieve greater demand for domestically-produced goods and services, higher employment
and thus, ultimately, greater cost and price increases than we otherwise would have
experienced.
The monetary policy conducted last year can therefore be said to have contributed towards
turning the development of inflation and inflation expectations around (see Figures 3 and 7).
The positive effect of last year's measures on inflation expectations is also suggested by the
slight increase in what is known as inflation compensation - that is, the difference between the
yields for nominal and real government bonds - in conjunction with the announcements of repo
rate cuts and bond purchases that came as surprises.
Standing prepared to make monetary policy more expansionary
Inflation and inflation expectations are now higher than they were one year ago. But, over the
autumn, the development of inflation was weaker than we predicted and the rise in inflation is
still largely due to the krona being weak. If the rise in inflation is broken, confidence in the
inflation target may be weakened. We are therefore prepared to do even more if it proves
necessary to safeguard the inflation target.
We still have many possible measures in our toolbox. Experiences from the past year suggest
that cuts to the repo rate and repo rate path also work below zero and that purchases of
securities form a good complement. We can do more in this style if we deem that inflation
prospects are changing. Loans to companies via the banks are another possibility that I have
already mentioned. In addition, the Riksbank is prepared to carry out currency interventions if
the exchange rate develops in a way that is not compatible with a rise in inflation to two per
cent. The aim of this would not be to influence the long-run krona rate, but to counteract an
overly rapid strengthening before inflation has stabilised around 2 per cent.
I hope that my comments so far have made clear that confidence in the inflation target has
been given the highest priority by the Riksbank and that monetary policy has contributed
towards the favourable development of the real economy. At the same time, since 2012, we
have been careful to point out that a situation with low interest rates over a long period of time
may create imbalances on the financial markets and on the housing market. We have therefore
clearly communicated to the Government and other authorities that it is important to use
various measures to limit risk-taking in the economy. My assessment so far is that significantly
more commitment will be required to obtain a functioning housing market in Sweden and to
reduce the risks of household indebtedness. The risk otherwise is that we will create new
problems that may lead to low growth further on and new difficulties for monetary policy to
reach the inflation target. I am concerned about Sweden's position as one of a handful of
countries in Europe that has not succeeded in getting a functioning macroprudential policy into
place. With such a large financial system and the obvious major vulnerabilities present in the
Swedish economy, our focus should be on urgently adopting measures.
Valuable evaluation of monetary policy
We thus have an unusual time behind us that has required unusual measures over the past
year. Under such circumstances, it is natural to wonder, for example, how well the inflation
target is functioning and which areas monetary policy should be responsible for. It therefore
seems appropriate that the Riksdag Committee on Finance has just published its latest
assessment of monetary policy.6 First and foremost, I would like to say that it has been a
privilege to have my work reviewed and assessed by people with such impressive academic
and practical credentials in the area of monetary policy as those possessed by Messrs.
Goodfriend and King. Assessments are a key ingredient in every kind of work to improve
operations and this assessment contains many reasonable opinions and suggestions for
discussion and further work. We will do this over the spring, before submitting our consultation
response in April. Today, I will just express my own initial reactions to a few of the elements in
the assessment that come closest to the theme of today's address.
First and foremost, I cannot, of course, avoid noting that Goodfriend and King also consider
that Swedish monetary policy since the introduction of inflation targeting has been an overall
success. Neither is there any doubt that they support an inflation target as the starting point
for monetary policy.
However, they would like to switch target variable to the CPIF, that is the CPI with a fixed
mortgage rate. It would not be difficult for us to make such a change, as we already focus most
of our analysis and communication on the CPIF. At the same time, I think that there may be
reason to evaluate several possible measures, for example the internationally-comparable
measure HICP, as my colleague on the Executive Board Per Jansson has previously
discussed in a speech.7
I appreciate how much Goodfriend and King have endeavoured to base their assessment on
the information and experience available at the time of each individual decision, rather than
proceeding on the basis of everything we know today about how developments turned out. As
they note, we have been through a difficult period with major challenges and difficult decisions.
One consequence of this is that it has been particularly difficult to make a good forecast of the
repo rate and to take into consideration the repo rate expectations reflected at that moment by
pricing on the financial markets. However, speaking for myself, I have always seen the repo
rate path as a component of our ambition to be transparent as it shows which repo rate we
include in our forecasts. And we always emphasise that the repo rate path itself is a forecast
and not a promise.
One important source of the difficulties that Goodfriend and King point out is the unclear
allocation of roles, responsibilities and instruments for managing the work of financial stability
and macroprudential policy in Sweden. As I have already mentioned, I consider sorting this
matter out to be a matter of great urgency, considering that Sweden has one of Europe's
largest banking systems in relation to GDP.
This spring, Goodfriend and King's assessment will provide an excellent basis for the
discussion of monetary policy and the issues that a modern central bank must manage. These
unusual times are placing great demands on both monetary policy and macroprudential policy.
It is important that we are able to meet these challenges in the right way.
Figure 1. Inflation targeting has made inflation lower, more stable and more predictable.
Note. Annual percentage change.
Sources: Statistics Sweden and the Riksbank
Figure 2. Average mortgage rate and corporate rate, and repo rate
Note. MFIs' lending to households for housing purposes and to non-financial companies, new loans and agreements, refers to
monthly data. Repo rate refers to daily data and date of implementation.
Sources: Statistics Sweden and the Riksbank
Figure 3. Inflation expectations
Note. Per cent. Money market agents.
Source: TNS Sifo Prospera
Figure 4. The development of the repo rate
Note. Per cent. Outcomes are daily rates and the forecasts refer to quarterly averages.
Source: The Riksbank
Figure 5. Bond purchases
240 240
200
200 200
65
160 160
135
120 120
45 45
80-90
80 80
50 50
40-50
40
40 40
30 30 30 30
10
10 10 10 10 10
0 0
February March April July October
Policy meeting
Note. SEK billion. Government bond purchases will continue until the end of June 2016.
Source: The Riksbank
Figure 6. Development of interest rates under a negative repo rate
Note. Per cent. Interest rate to households, lending rate refers to loans for housing purposes.
Sources: Statistics Sweden and the Riksbank
Figure 7. Inflation has turned up
4 4
CPIF
CPIF excluding energy
3 3
2 2
1 1
0 0
-1 -1
07 09 11 13 15
Note. Annual percentage change. The CPIF is the CPI with a fixed mortgage rate.
Source: Statistics Sweden