SPEECH
SVERIGES RIKSBANK
DATE:
9 November 2016
SE-103 37 Stockholm
(Brunkebergstorg 11)
SPEAKER:
Martin Flodén
VENUE: West Sweden Chamber of Commerce, Göteborg
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riks bank.se
www.riksbank.s e
The Riksbank's bond purchases affect
government finances
Prior to the financial crisis of 2008, the Riksbank could make profits without taking
any actual risks. The assets on our balance sheet mainly consisted of foreign debt
securities while the main liability items were outstanding banknotes and coins and
our equity. The assets generated a reliable return, although their value fluctuated
with foreign exchange rates, while the liabilities were interest-free. The Riksbank
could therefore easily fund the bank's operations as well as distribute a surplus to the
government.
But the current picture of the Riksbank's financial position and risks is entirely
different, something that, in part, can be illustrated by how the balance sheet has
grown and changed in nature (see Chart 1). One important change is that the decline
in the use of cash and the low interest rates have impaired our earning capacity,
something which my colleague Kerstin af Jochnick has previously highlighted.1
Another important change is that the Riksbank has purchased large volumes of
Swedish government bonds since the beginning of 2015. These purchases have
increased the risks on our balance sheet and made our profits and dividends more
sensitive to interest rate changes. The bonds have so far increased in value but there
is every indication that they will lead to a loss in the future, and hence contribute to a
period of lower or zero dividends to the government.2 Today, I would like to outline
how the bond purchases have created these interest-rate risks and how future
interest-rate developments will affect the Riksbank's profits and dividends.
Chart 1. The Riksbank's balance sheet
SEK billion
900 900
Assets Liabilities
800 800
Equity
700 700
Other
Foreign
600 600
exchange
Foreign
reserve
500 500
exchange
loans
400 400
300 300
Certificates
Assets Liabilities
and fine
Government
200 200
tuning
Equity
bonds
Foreign
exchange
100 100
Banknotes
reserve
Gold
Banknotes
and coins
and coins
Gold
0 0
August 2008
September 2016
Source: The Riksbank
The Riksbank purchases government bonds to support the upturn in
inflation ...
To begin with, I would like to remind you that the aim of the Riksbank's operations is
not to make a profit and deliver dividends to the government. Our task is to maintain
price stability, and bond purchases are one component of the expansionary monetary
policy we are conducting in order to safeguard the credibility of the inflation target.
The Riksbank started purchasing government bonds in February 2015. At that time,
inflation had been low for a long time, long-term inflation expectations had fallen to a
record-low level and a period of falling oil prices risked pushing down inflation
expectations even further (see Chart 2). In this situation, the Riksbank needed to
safeguard continued confidence in its ability and willingness to stabilise inflation
around the inflation target. As we know, a credible inflation target lays the foundation
for efficient price-setting and wage formation and hence promotes good growth in
the economy.3
At the same time, the problems of falling inflation and inflation expectations also
became increasingly apparent in the euro area. This led to the European Central Bank
signalling the need for even more expansionary monetary policy in the period ahead,
with low interest rates for even longer, supplemented by extensive asset purchases.
The increasingly expansionary monetary policy in the euro area also led to monetary
policy reactions from several smaller countries on the outside.
Chart 2. Inflation and inflation expectations have picked up
3 3 2.3 2.3
2.2 2.2
2 2
2.1 2.1
2.0 2.0
1 1
1.9 1.9
Inflation expectations
1.8 1.8
0 0
CPIF excluding energy
1.7 1.7
CPIF
-1 -1 1.6 1.6
10 11 12 13 14 15 16 10 11 12 13 14 15 16
Note. Annual percentage change and per cent. The CPIF is the CPI with a fixed mortgage rate. Inflation
expectations 5 years ahead according to money market participants. The broken line indicates the time of the
monetary policy decision in February 2015.
Sources: TNS Sifo Prospera and Statistics Sweden
For the Riksbank, this development led us during the spring of 2015 to reduce the
Swedish policy rate, the repo rate, to negative levels and to start purchasing
government bonds. One purpose of the bond purchases was to push down interest
rates on longer maturities.4
My assessment is that this monetary policy has, on the whole, been successful. The
bond purchases seem to have pushed down interest rates more or less in the way we
expected.5 And the monetary policy also seems to have had the intended effect on
inflation and inflation expectations. The downward trend has been reversed and both
are now on significantly higher levels than at the end of 2014 (see Chart 2). At the
same time, the Swedish economy has developed positively, with high growth and
falling unemployment.
... but the effects on the Riksbank's finances must nevertheless be taken
into account
The purpose of the Riksbank's bond purchases is thus to support the inflation target's
role as nominal anchor for price-setting and wage formation, and thereby to
contribute to a positive development in the Swedish economy. How the Riksbank's
financial position is affected is therefore of subordinate, but not negligible,
importance. I see at least two reasons to monitor how the Riksbank's finances
develop. First, the Riksbank's finances are part of public finances. The size of the
Riksbank's profits and losses affect the dividends we can deliver to the government.
The Riksbank's annual dividends to the government have been SEK 5 billion on
average over the past five years. This is a considerable sum, albeit small in relation to
total tax revenues.
Second, the Riksbank, like other central banks, needs to have a balance sheet that
does not undermine its financial independence.6 Central banks differ from other
banks and companies, of course, in that they can always create new money to fund
their expenditure and because they are not subject to normal bankruptcy legislation.
But a central bank that is forced to create money in order to fund its expenditure
cannot simultaneously pursue a monetary policy that safeguards price stability.
Neither is it desirable for central banks to rely on funding from the government as
there is then a risk of the funding being linked to conditions being put on the bank's
management or actions. This is exactly why EU legislation requires a central bank to
7
have adequate financial resources to be able to carry out its tasks independently.
This reasoning does not necessarily mean that a central bank must have positive
equity. Negative equity can be compensated for by a large amount of outstanding
banknotes and coins, at least if there is confidence in the bank's continued earning
capacity.8 But in Sweden, the demand for cash is low and continues to fall. Therefore,
the Riksbank can hardly count on having sufficient earning capacity in the future
unless its equity remains positive.
But how does this reasoning about the Riksbank's financial position relate to the bond
purchases?
Bond purchases increase the risks on the Riksbank's balance sheet
When the Riksbank purchases a government bond, both the assets and the liabilities
on our balance sheet increase. The bonds purchased by the Riksbank are of course
reported as an asset. But we fund the purchases by simultaneously selling Riksbank
certificates with a maturity of one week. And these certificates become a liability on
the Riksbank's balance sheet, and the interest rate on the liability is the repo rate. As
the bonds we buy have a much longer maturity (about five years on average) than the
certificates, the Riksbank has to renew the borrowing every week by selling new
certificates.
It is this maturity transformation that poses an interest-rate risk for the Riksbank. If
we hold the bond until it has matured, we know exactly how many Swedish kronor
the Riksbank will receive in interest on it. And we also know how much it cost to buy.
But we don't know what the funding cost for the bonds will be. Because the cost
depends on how the repo rate develops up until the bond matures.
This maturity transformation is actually quite similar to operations pursued by
commercial banks to make a profit, i.e. holding long-term assets funded by short-term
borrowing. And even if such operations are associated with an interest-rate risk which
makes for an uncertain return, one can normally count on making a profit more often
than making a loss. This is because short-term rates (such as the repo rate that has a
one-week maturity) are usually on average slightly lower than long-term rates (e.g.
the rate for five-year government bonds). In economics jargon, this is referred to as
term premiums on the financial markets normally being positive.
In practice, however, it is very difficult to determine how large these term premiums
are at any one particular time. The premiums cannot be directly observed on the
financial markets but must either be estimated based on a forecast for future
shortterm rates or estimated using statistical methods based on historical connections
between interest rates at various maturities and different asset-types.
Both the Riksbank's own interest rate forecasts and the statistical methods suggest
that the term premiums are now very low, and maybe even negative. Chart 3 shows
the Riksbank's and the Swedish National Debt Office's estimations of the term
premium on ten-year government bonds based on similar statistical methods. These
statistical methods, as I have said, produce fairly uncertain results, but they clearly
indicate that premiums have fallen sharply in the last decade.9 Both the Debt Office's
and the Riksbank's estimates indicate that the term premium is negative. If the
premium really is negative, the Riksbank is expected to lose money on purchasing
bonds and funding them at the repo rate. The Riksbank's estimate points to the term
premium currently being around -0.7 per cent on bonds with long maturities.10 This
would mean that the loss is expected to be around 0.7 per cent of the purchase price
for each year of maturity. Since the average maturity on the bonds is about five years,
this would mean that the losses are expected to be 3.5 per cent of the purchase price.
Chart 3. Estimated term premium
Percentage points
3.0 3.0
Term premium, Swedish National Debt Office (10 year)
Term premium, The Riksbank (10 year)
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
-0.5 -0.5
-1.0 -1.0
99 01 03 05 07 09 11 13 15
Note. The Swedish National Debt Office's estimate is based on swap rates while the Riksbank's estimate is based
on government bond rates.
Sources: Swedish National Debt Office and the Riksbank
So far, interest rates and the Riksbank's costs have been lower than
expected
As the statistical estimates of the term premium are uncertain in many ways and have
several possible sources of error, I think we obtain a clearer picture of the effects of
bond purchases on the Riksbank's balance sheet by studying different interest rate
scenarios.
Let us begin with the situation in February 2015 when we started purchasing bonds.
The interest rate on five-year government bonds fell to just under zero after our
monetary policy announcement. But Chart 4 shows that those of us on the Executive
Board of the Riksbank as well as the money market participants in Prospera's survey
thought at the time that the repo rate would be brought back into positive territory
towards the end of 2016 and then continue to increase. One can say that the Riksbank
purchased government bonds that gave a return of approximately zero but that were
expected to be funded according to the repo rate forecast. The chart shows that the
Riksbank therefore expected to make a loss, as the funding costs were expected to be
higher than the yield.11
Chart 4. Actual and expected interest rate developments
Per cent
3 3
Repo rate
Survey
MPR February 2015
2 2
MPR October 2016
1 1
0 0
-1 -1
12 14 16 18 20
Note. Survey responses show the mean value for the repo-rate expectations of money market participants in
February 2015. "MPR" refers to the Riksbank's forecast for the repo rate in its monetary policy reports.
Sources: Statistics Sweden and TNS Sifo Prospera
But Chart 4 also shows that the repo rate has so far turned out to be much lower than
the interest rate forecasts. The bonds have therefore risen in value and the funding of
the bond purchases seems to become cheaper than expected, something which, at
least in the short term, has led to higher profits than expected for the Riksbank. This is
reflected in, for example, the forecast for the Riksbank's dividend-qualifying profit in
2015 and 2016.12 At the end of 2014, a total loss of just over SEK 10 billion was
expected for those two years.13 In March 2015, when bond purchases had begun on a
small scale, the expected loss had risen to almost SEK 14 billion. The latest forecast,
from October this year, has the benefit of hindsight and indicates that the outcome
will instead be a profit of almost SEK 13 billion.
Losses likely in the period ahead
The fact that the Riksbank's bond purchases have so far been profitable does not
mean that this will always be the case. For example, the ever-lower interest rates
have made bond purchases after the spring of 2015 increasingly costly. The Riksbank
has now purchased bonds for about SEK 275 billion and several bonds have a long
remaining maturity. How expensive it will be to fund this portfolio will therefore
depend on the development of the repo rate for a long time to come.
According to the current assessments made both by ourselves and others, it is more
likely that the bonds that we have purchased in recent months will lead to losses
rather than profits for the Riksbank. For example, the yield on ten-year government
bonds is now 0.2 per cent. The Riksbank does not make forecasts for the repo rate for
more than three years in the future. Even within this limited time horizon, interest
rate developments are very uncertain, but let us in any case assume that the repo
rate develops in line with the forecast. And let us assume that the repo rate then
continues to rise slowly towards 4 per cent (see Chart 5).14 The average interest rate
level up until the bond matures in 2026 will then be 1.2 per cent. Paying on average
1.2 per cent in interest and receiving on average 0.2 per cent in interest represents a
loss of 1 per cent a year. Overall, this would be about 10 per cent up until the bond
matures. This loss can be seen in Chart 5 as the difference between the repo rate, i.e.
the funding cost, and the forward curve that follows from the pricing of the bonds.
This difference increases from about 0.3 percentage points on short-term maturities
to about 2 percentage points on the ten-year horizon, and is hence on average 1 per
cent.
The example shows that the interest rate risk and the possible loss are particularly
large when we purchase bonds with long maturities. But ten-year bonds are not, as I
have said, representative of the bonds purchased by the Riksbank. A more
representative bond has a maturity of five years. For a five-year bond purchased
today, the loss will be between 3 and 4 per cent of the purchase sum if the interest
rate develops as in this example. This is of a similar magnitude to the calculations
based on the estimated term premium.
Chart 5. Yield in accordance with the forward curve but funding at the repo rate
Per cent
4 4
Repo rate
Forward curve
3 3
2 2
1 1
0 0
-1 -1
12 14 16 18 20 22 24 26
Note. Projection of the repo rate extended from the forecast in the Monetary Policy Report in October 2016. The
forward curve is estimated on 26 October 2016.
Source: The Riksbank
Changed interest rate environment directly impacts the Riksbank's profit
and dividend
Up to now, the bond purchases have thus been profitable for the Riksbank. There are,
however, good reasons to anticipate counteracting losses in the period ahead, but it is
still unclear what the total effects on the Riksbank's financial position will be. The
effects depend, of course, on how the interest rate develops in the long term. What is
clear, however, is that the interest rate risk on our balance sheet has increased
substantially.
The interest rate risk will also be reflected in major fluctuations in the Riksbank's
profit and its dividends to the government. This is due to the practice of market
valuation of the assets on the Riksbank's balance sheet.15 I mentioned earlier that the
forecast for the dividend-qualifying income for 2015 and 2016 has been transformed
from a loss of SEK 14 billion into a profit of SEK 13 billion over the last year or so. A
major part of this improvement can be explained by the increase in the market value
of the bond portfolio due to interest rates being lower than expected.
A back-of-the-envelope calculation shows how interest rate changes now have a
considerable impact on the Riksbank's profits. The bond portfolio has a market value
of just under SEK 300 billion and an average maturity of five years. The value of the
bonds then increases by about SEK 15 billion if interest rates suddenly fall by one
percentage point on all maturities.16 And correspondingly, the value of the bonds falls
by SEK 15 billion if interest rates instead rise. Such changes in value immediately
affect the Riksbank's dividend-qualifying profit, but the impact on the dividends
delivered by the Riksbank to the government is dampened by the fact that the
dividend is calculated as 80 per cent of the average dividend-qualifying profit over the
last five years.
Lower borrowing costs for the government
The bond purchases affect government finances in ways other than via dividends from
the Riksbank. They are supposed to push down interest rates in order to push up
inflation. If this works, it reduces the government's costs for both its outstanding debt
and new borrowing. This is because lower interest rates reduce the nominal cost of
the government's new borrowing, while inflation reduces the real cost of both the
outstanding debt and new borrowing when the policy rate is restricted by its effective
lower bound.
It is difficult to determine what effect the Riksbank's monetary policy has had on
interest rates and the development of inflation, and it is of course even more difficult
to say how much the bond purchases have contributed to this development.
Nevertheless, I would like to try to calculate how monetary policy may have affected
the costs of government borrowing. Due to the high level of uncertainty, these
calculations should mostly be seen as providing a ball-park figure.
The underlying inflation rate, the CPIF excluding energy, was 0.7 per cent in 2014 but
rose to 1.4 per cent in 2015 and is expected to remain on the same level this year and
next year. Of course, we do not know how inflation would have developed with a
different monetary policy, but let us assume that all this inflation upturn of 0.7
percentage points can be explained by the unconventional monetary policy with bond
purchases and a negative repo rate. Since the repo rate has been and is expected to
remain close to its effective lower bound during 2015-2017, we further assume that
the upturn in inflation has not affected the repo rate in this three-year period. If this is
true, the unconventional monetary policy has led to lower real interest on both the
outstanding debt and new borrowing. With a bond stock of SEK 700 billion, the result
is that the monetary policy, by avoiding excessively low inflation in 2015-2017, has
reduced the real borrowing costs for the outstanding debt by 0.007*700*3 = SEK 15
billion.
According to some studies, central bank bond purchases in Sweden and other
countries have also had a significant impact on nominal interest rates when policy
rates have been restricted by their effective lower bounds. De Rezende, Kjellberg and
Tysklind's (2015) study indicates that Swedish interest rates may have been pushed
down by 0.4 to 0.7 percentage points of the purchases.17 I find it a little hard to
believe that the effects are in the upper region of this interval, but the lower figure
does not seem at all unreasonable. As the Riksbank has purchased an increasingly
large share of the outstanding government bonds, the interest rate for treasury bills
(government securities with short maturities) has fallen to almost 0.4 percentage
points below the repo rate. As a result, the interest rate for these is now close to the
Swedish National Debt Office's "repo facility" which allows the Debt Office's dealers
to borrow bonds from the Debt Office at a cost of the repo rate minus 0.4 percentage
points. It gives market participants the opportunity to make secure profits at even
lower interest rates and hence sets a lower bound for how low the interest rate on
short-term government securities can fall.18 It seems reasonable that this price
development has been caused by our bond purchases and that the interest rate on
government securities with short maturities has been pushed down by at least 0.3
percentage points, and that a similar price effect has also been exerted on
government bonds with longer maturities.
As the public sector budget is more or less balanced, the government's total
borrowing requirement does not increase over time, but the government must
nevertheless take out new loans when older ones mature. In other words, new
government bonds and treasury bills need to be issued on a continuous basis.
According to the Debt Office's latest forecast, bond borrowing will amount to about
SEK 90 billion a year in 2015-2017 while borrowing via treasury bills is expected to
amount to just over SEK 110 billion a year. Government bonds have an effective
maturity of just over 7 years while all treasury bills by definition mature within a year.
If the Riksbank's bond purchases push the nominal interest rate down by 0.3
percentage points on average, this produces a total profit in terms of lower interest
expenditure of approximately 0.003*(7*90+110)*3 = SEK 7 billion for these three
years.
These calculations indicate that the bond purchases and other unconventional
monetary policy in recent years have reduced the government's borrowing costs quite
considerably, compared to a monetary policy that had not kept interest rates down
and avoided excessively low inflation in the same way. But the calculations should be
taken with a large pinch of salt as they take a very narrow perspective on government
finances. They ignore, for example, the fact that the government has other assets and
liabilities, as well as other commitments, that are also affected by the development of
nominal and real interest rates. The calculations also ignore the fact that bond
purchases also stimulate GDP growth and employment in the short term and that by
strengthening confidence in the inflation target, also contribute to healthy, long-term
growth. This benefits Swedish households and strengthens public finances by
boosting tax revenues and reducing expenditure.
The Riksbank's finances are strong but sensitive to interest rate changes,
and dividends will be lower
Concern has sometimes been expressed over the fact that bond purchases are
expensive and lead to losses for the Riksbank.19 This concern is hardly unwarranted,
even though it is not certain that the purchases actually do lead to losses. The
Riksbank's balance sheet, profit and equity are now being affected more by interest
rate adjustments than before purchases began. Dividends will therefore fluctuate
considerably more year on year in the future than they have done in recent decades.
So far, the bond purchases have generated a profit but our interest rate forecasts
indicate future losses and thereby lower or zero dividend payments to the
government. Despite the increased risks, my assessment is that the Riksbank's
financial position remains healthy. The Riksbank's equity has increased from just over
SEK 70 billion before the financial crisis to its current level of just over SEK 120 billion.
Even though it is likely that equity will shrink substantially in the coming years, it is my
opinion that profit fluctuations are unlikely to be large enough to cause equity to fall
to worryingly low levels.
Finally, I would like once again to remind you that the aim of the Riksbank's
operations is not to make a profit and deliver dividends to the government. Our task
is to maintain price stability, and we do that by safeguarding the credibility of the
inflation target. In this way, we promote efficient price-setting and wage formation in
the economy, which forms the basis of sustainable economic development with high
employment.
References
af Jochnick, Kerstin (2015), "Does the Riksbank have to make a profit? Challenges for
the funding of the Riksbank", speech, 23 January 2015, Sveriges Riksbank.
Alsterlind Jan, Henrik Erikson, Maria Sandström and David Vestin (2015), "How can
government bond purchases make monetary policy more expansionary?", Economic
Commentaries, No. 12, Sveriges Riksbank.
Archer, David and Paul Moser-Boehm (2013), "Central bank finances", BIS Papers No
71, Bank for International Settlement.
Armelius, Hanna, Paolo Bonomolo, Magnus Lindskog, Julia Rådahl, Ingvar Strid and
Karl Walentin, (2014), "Lower neutral interest in Sweden?", Economic Commentaries,
No. 8, Sveriges Riksbank.
De Rezende, Rafael (2016), "The interest rate effects of government bond purchases
away from the lower bound", Sveriges Riksbank Working Paper No. 324.
De Rezende, Rafael B., David Kjellberg and Oskar Tysklind (2015), "Effects of the
Riksbank's government bond purchases on financial prices", Economic Commentaries,
No. 13, Sveriges Riksbank.
Del Negro, Marco and Christopher Sims (2015), "When does a central bank's balance
sheet require fiscal support?", Journal of Monetary Economics, 73.
ECB (2012), Convergence Report, May 2012.
Ernhagen, Tomas, Magnus Vesterlund and Staffan Viotti (2002), "Central banks' equity
needs", Economic Review 2/2002, Sveriges Riksbank.
Flodén, Martin (2015), "Sweden needs its inflation target," speech, 13 October 2015,
Sveriges Riksbank.
Holston, Kathryn, Thomas Laubach and John Williams (2016), "Measuring the natural
rate of interest: international trends and determinants", Working Paper 2016-11,
Federal Reserve Bank of San Francisco.
Sims, Christopher (2016), "Fiscal policy, monetary policy and central bank
independence", Jackson Hole Symposium, Federal Reserve Bank of Kansas City.
Stella, Peter and Åke Lönnberg (2008), "Issues in central bank finance and
independence", IMF Working Paper WP/08/37.
Svenska Dagbladet (2016), "Professor: Riksbanken agerar dumt och verktygslådan är
tom" [Professor: The Riksbank is acting stupidly and the tool-box is empty], 1 February
2016.
Sveriges Riksbank (2010), "What is a normal repo rate?" Article in Monetary Policy
Report, February 2010.
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target?", Article in Monetary Policy Report, July 2015.
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February 2015".