Stefan Ingves: Introduction on monetary policy
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, to the Riksdag Committee
on Finance, Stockholm, 4 March 2010.
* * *
This figure (Figure 1) is one I showed the Committee around a year ago. At that time, acute
crisis management still required most of our resources. I compared our means of handling
the climax of the crisis to an ice-skater who notices that the ice has suddenly become very
thin, or unexpectedly begun to crack just in front of him. Then there is only one sensible
alternative - to make a sharp turn and try to return to safer ice as quickly and smoothly as
possible. To act quickly and forcefully. This is what we did, but the ice under our feet was still
uncertain.
Figure 1
On safer ice and with the acute crisis behind us
Photo: Fredrik Edin, Cykloteket Racing Team
Today the situation is different. And the picture of the lovely, thick ice stretching ahead of
the skaters in the sunshine is actually more appropriate now than it was one year ago, both
literally and figuratively. We have safer and firmer ground beneath our feet. We have
entered a new phase of the economic recovery and the acute crisis is behind us. But we
are now facing new challenges and considerations. The work on preventing future crises is
both important and urgent. Here we must show ability to take action, and I shall return to
this at the end of my speech here today. Some of the difficult considerations to be made
concern when and how quickly central banks, governments and other public authorities
around the world will withdraw the strong economic stimulus they have been providing
during the crisis. Now that the financial markets are more stable and the recovery in the
economies has begun, it is time to move towards a more normal situation, not least with
regard to monetary policy. We must make the transition from monetary policy during a
crisis to monetary policy in an economic downturn. For the Riksbank and many other
central banks, the question of when to begin raising the policy rate, and how quickly, is a
fairly difficult balancing act.
I intend to begin by talking about the considerations behind our most recent policy rate
decision and our forecast - the policy we consider necessary for inflation to be close to the
target of 2 per cent, at the same time as providing support for production and employment.
Transition from crisis interest rate to monetary policy in an economic downturn
At the most recent monetary policy meeting three weeks ago the Executive Board decided to
hold the repo rate unchanged at the historically-low figure of 0.25 per cent. We are on our
way up out of the steepest downturn in the economy for decades and the low interest rate is
necessary to provide sufficient support to the recovery. But at the same time, we are also
approaching a situation where it is time to leave the crisis interest rate behind us and take
steps towards an interest rate that is normal for a "regular" economic downturn. We are
expecting to begin raising the repo rate with effect from the summer or the beginning of the
autumn this year. This is slightly earlier than assumed in our earlier forecast.
There are two main reasons why we are revising our assessment somewhat. One is that the
situation in the financial markets has become increasingly stable over a long period of time.
The other is that the upturn in economic activity has gradually become more evident.
Roughly as the long, cold winter has steadily made the ice thicker than last year,
developments in the financial markets and the economy as a whole have contributed to the
recovery being able to continue on firmer ground. But the road ahead of us is certainly not
lacking in challenges. Before we reached agreement on our forecast we took into account a
number of different risks and deliberations in the two areas I just mentioned. And I would now
like to explain our reasoning to you.
Financial markets more stable
The situation in the financial markets is becoming increasingly stable. Previously the
uncertainty in the credit markets around the world in particular has appeared to be an
obstacle to economic recovery. But now there are many indications that we are
approaching a more normal situation and that the widespread uncertainty and mistrust
during the crisis has declined. Many measures taken by central banks and other authorities
to restore confidence in the financial markets and to stimulate the economy are still in
place. Naturally, this makes it difficult to say how the situation would look without this
support. But some measures have already disappeared. This is in itself a sign of greater
stability. In Sweden, for instance, measures such as the loans to the banks in US dollars
and the loans with a maturity of 12 months at a variable interest rate have more or less
phased themselves out. The demand for the measures, and in other words the need for
them, has quite simply faded.
We can also note that the price of risk has fallen, for instance, on the interbank market where
the banks are lending to and borrowing from one another, and on other credit markets. This
can also be seen in a measure called the TED spread, which I have also shown earlier to the
Committee on Finance (Figure 2). The TED spread is the difference between an interest rate
in the interbank market and a government bond rate, both with three-month maturities. The
measure provides an indication of the confidence between the banks. The TED spreads
have gradually fallen and for some time have been at around the same levels as in summer
2007, before the financial crisis became acute. Although measures such as the central
banks' loans to the banks have probably played a role here, the low TED spreads indicate
increased confidence and a more stable situation in the interbank market.
Figure 2
More stable situation in the financial markets
The difference between interbank rates and government bond rates (TED spread), basis points
Sources: Reuters EcoWin and the Riksbank
Another healthy sign is that individual problems have not spread exaggerated unease in the
financial markets around the world. I refer here to Dubai World, for instance, which defaulted
on its payments earlier in the winter and has since suffered new problems, and to Greece,
which is struggling with very poor public finances. A further example is the economic
problems in the Baltic countries. While these events are reminders in themselves that we still
have some way to go before we can declare this crisis completely over, if the same things
had happened in autumn 2008 the waves of turbulence would probably have been much
higher and affected markets far from the eye of the storm. We are now on firmer ground - or
on safer ice, if you prefer. A further positive sign is that activity in the financial markets has
increased after being very low in some cases, particularly during the most intensive phase of
the crisis. For example, it appears easier for companies to fund themselves directly in the
markets.
When will the central banks and government phase out their support measures?
The extensive
measures taken by governments and central banks around the world to
counteract the effects of the crisis have contributed strong economic stimulation. But in many
countries some of the measures, however necessary they may have been, have led to much
poorer government finances. In countries such as the United Kingdom, Ireland, Spain,
Greece and the United States public finances are under great strain, for various reasons.
This means, for instance, that there is a risk that the long-term interest rates in these
countries will rise quickly, which to some extent has already happened. This in turn can
hamper the economic recovery. Sooner or later it is also necessary to do something about
the budget deficits. This is a cause for concern and we are expecting that such measures will
hold back GDP growth abroad somewhat at the end of the forecast period.
Most central banks which have managed the more acute phase of the crisis with the aid of
various support measures and very low interest rates, are now in a phase where it is time to
think about exit strategies and to return to more normal interest rate levels. At present the
Riksbank is lending almost SEK 370 billion to the banks, and around SEK 295 billion of this
is in fixed-rate loans. The fact that the loans are falling due is of course included in our
calculations when we assess how we will formulate our future monetary policy.
Phasing out the loans is fairly undramatic. The measures will disappear, as I mentioned
earlier; in principle this will occur automatically as the need for the measures disappears. The
fixed-rate loans that currently have the longest maturities mature in the autumn 2010. At
present we do not expect there will be a need to offer new fixed-rate loans at longer
maturities beyond this horizon. But of course we are closely following developments in the
financial markets, and are prepared to implement new such measures if necessary.
The interest rate increases entail slightly more difficult considerations. For many central
banks the question of timing is a difficult one. Withdrawing support measures and beginning
to raise interest rates too early or too quickly may slow down the economic recovery in a
sensitive phase. If the expansionary policy instead continues too long, there is a risk that
inflation will be too high or that imbalances will build up, for instance, on the housing market
or between different countries. Assets such as commercial property, but also residential
property, have often played an important role in economic crises. There are links between
house prices and the financial markets, not least through interest rates and lending. And low
interest expenditure usually stimulates both credit growth and house prices, all else being
equal.
Considerations regarding the housing market...
The monetary policy we have needed to conduct to attain the inflation target and to provide
sufficient support for the recovery has entailed historically-low interest rates and support to
lending through fixed-rate loans to the banks. In Sweden house prices have risen
substantially over several years. During the crisis, for instance, while house prices fell during
a period of time, data from Statistics Sweden indicate that they have been rising again since
the end of 2009 (Figure 3).
Figure 3
House prices
Annual percentage change
Source: Statistics Sweden
BIS Review 25/2010
There are many indications that the rise in house prices in Sweden as a whole is due to
fundamental factors, such as the fact that demand has increased more than the number of
new housing. But there may be risks. The Riksbank, like many other central banks, must
achieve the balance I just described - evaluate possible risks of an imbalance in the housing
market in relation to what we believe will happen in the economy as a whole. We have done
this when making decisions on interest rates right now and in our forecast of future monetary
policy.
In a way, this is nothing new. We always follow developments in the housing market very
closely. At the same time, we see a need to develop the analysis of house prices and credit
growth - not least with regard to the question of how the links between the housing market
and the Riksbank's tasks and objectives look. We have therefore appointed a special
commission of inquiry into the Swedish housing market - a broader and more coherent
approach which will supplement the analysis of individual issues that we and others conduct.
The inquiry will be based on two perspectives - financial stability and monetary policy.
...not just the Riksbank's field
Having said this, I would like to point out, or rather repeat something I have mentioned on
previous occasions. Monetary policy can probably only function as a complement to effective
regulation and supervision. Moreover, households have a responsibility to make realistic
assessments of what interest expenditure they can manage in the long run. The current
interest rate reflect the management of an acute crisis and not monetary policy under normal
circumstances. And as shown in our interest rate forecast we will probably begin raising the
repo rate within six months.
The banks must also make responsible assessments when lending money. Here
Finansinspektionen, the Swedish financial supervisory authority, plays an important role due
to its task of examining banks and credit institutions from a consumer perspective.
Finansinspektionen also has the possibility to implement more targeted measures than the
Riksbank has. The repo rate is a blunt instrument that affects the whole economy. In
February Finansinspektionen warned that even moderate falls in house prices could mean
that a number of households have mortgages that exceed the market value of their property.
Finansinspektionen believes there is reason to consider new regulations regarding
household loans in relation to collateral to create better margins. Without wishing to
anticipate this inquiry, let me just note that we should, as far as possible, manage problems
before they arise. Finansinspektionen's inquiry appears to be a step in this direction.
The Baltic countries - more stable but still cause for concern
One risk tied to the financial markets and which is particularly important to Sweden, is
economic developments in the Baltic countries. Just a few weeks ago, we met here in the
Riksdag Committee of Finance to discuss the Swedish banks' commitments in Estonia,
Latvia and Lithuania - what has happened in recent years, what we are expecting to see in
the future and what we can learn from recent events. I do not intend to repeat what we talked
about then, but can note that developments in the Baltic countries do appear somewhat
brighter now than they did a while ago, but that the future is still very uncertain. One question
that could affect the region as a whole is, for example, Estonia's application to join the EMU.
Loan losses in the Baltic countries are still increasing, which in turn has a negative effect on
the Swedish banks' profitability. We are counting on loan losses there peaking during 2010,
but also on the Swedish banks being able to cope with the strains this will entail. An
important element here is that the banks have increased their capital and thus their resilience
to increased loan losses.
The road ahead of us is not without problems. It is lined with a number of potential worries
and difficult considerations, not least for central banks. But the situation in the financial
markets is currently much more stable than it was during the crisis and the risk of setbacks
has declined. One can say that the ice is safer.
Clearer signs of a recovery in the economic statistics
As I have mentioned, there is a further overall reason that we are now on firmer ground. The
economic statistics that have been coming in have been mainly positive. Confidence in the
future development of the economy has also taken a sharp upturn in Sweden, the United
States and the euro area (Figure 4).
Our assessment is that the situation in the world economy is continuing to improve. In most
countries the economy is growing again and world trade is beginning to pick up after the
abrupt slowdown in connection with the acute crisis (Figure 5). New figures have been
published by Statistics Sweden since our most recent forecast was published. These show
that GDP at the end of last year was lower than we had estimated. At the same time, for
instance, confidence indicators have continued to strengthen. However, the Executive Board
will weigh up and assess the new information at our next monetary policy meeting on
19 April.
Figure 4
Increasing confidence according to purchasing managers index
Note. An index over 50 indicates growth
Sources: Institute for Supply Management, Markit Economics and Swedbank
In the Swedish economy domestic demand has so far been supported primarily by
consumption and public investment. The expansionary fiscal and monetary policy has
stimulated household consumption. This includes tax cuts, low interest rates and other
measures.
Figure 5
Economies around the world are now growing
Outcome and forecast, Monetary Policy Report, February 2010
GDP level, index 2007 Q4 = 100
Sources: The Bureau of Economic Analysis, Eurostat, the OECD, Statistics Sweden
and the Riksbank.
However, the export sector has been hit hard by the fall in world trade and one can now say
there is a divide in the economy. This can be seen, for instance, if one looks at how retail
trade and exports have developed (Figure 6). But at the same time, export orders and world
trade have increased, which indicates that exports will recover, albeit from a low level.
Figure 6
Divided economy
Index 2005 = 100, seasonally adjusted data
Source: Statistics Sweden
BIS Review 25/2010
Rising domestic demand but low resource utilisation
The prospects for demand in the Swedish economy continuing to increase are good.
Household income has developed well and households have a high level of saving. As public
finances are sound, the need for fiscal policy constraint further ahead is lower in Sweden
than in many other countries. As growth abroad increases, exports will also rise again. All in
all, we are expecting GDP to increase fairly strongly in 2011 and 2012, by around 3.5 per
cent a year (Figure 7). This nevertheless means that it will take roughly three years before
GDP is back at the same level as prior to the crisis.
Figure 7
Employment has fallen less than expected
Employment and Swedish GDP, annual percentage change
Sources: Statistics Sweden and the Riksbank
Resource utilisation in Sweden is at present very low. The crisis may have lowered the
economy's long-term output level - it is not unusual that such radical changes will have a
more lasting negative effect on both capital and labour. But one can probably assume
nevertheless that there will be ample spare capacity which can be used relatively smoothly in
the upturn. This will entail, for instance, the need for investment, particularly in
manufacturing, remaining low for some time to come. It also means that there is hardly any
reason to expect a strong growth in employment over the coming period (Figure 7). We are
also assuming that the labour market will continue to weaken somewhat, but that the
downturn has begun to slow down.
It is worth noting that employment has nevertheless been maintained better than we had
previously assumed. Unemployment is still expected to be high, but the situation does look
much brighter now than in recent assessments and we have gradually revised down our
forecasts. During the 1990s crisis employment fell more than GDP, but during this crisis the
situation has been the reverse. Many companies appear to have chosen to retain existing
staff, perhaps because their assessment has been that demand will return fairly soon.
Many wage agreements will be renegotiated this year, but we are expecting the weak labour
market situation to contribute to holding back wage increases during the forecast period. This
contributes to lower cost pressures in the economy. As the companies have considerable
spare capacity, they can manage to meet increased demand abroad and here at home
without their production costs rising significantly. This has a strong impact on productivity,
which is now expected to increase after having fallen for three years in a row (Figure 8).
Figure 8
Lower cost pressures and increased productivity
Annual percentage change
Sources: The Riksbank and Statistics Sweden
The krona has been weak during the crisis. It is not unusual that small, open economies like
the Swedish one are affected by a depreciation of their currency in times of turbulence in the
international financial markets. The krona has strengthened considerably since its weakest
point and we are now assuming that it will gradually strengthen further, as we put the
financial crisis behind us. This will help to reduce inflationary pressures in the period ahead.
CPIF close to 2 per cent at the end of the forecast period
With regard to inflation measured in terms of the consumer price index, CPI, future
developments will be affected by the rise in interest rates, or rather by the increase in
households' mortgage interest expenditure. This is clearly visible if one looks at the same
time at CPIF inflation, which quite simply is CPI inflation with a fixed mortgage rate. The
CPIF is thus not directly affected by changes in mortgage rates, which means that these
measures differ quite considerably over the coming years, although they approach one
another further ahead.
Both CPI and CPIF inflation rose in the months prior to the publication of the Monetary Policy
Report (Figure 9). This was mainly due to rising energy prices, but also to weak productivity
growth and to the previous year's weaker exchange rate having a delayed impact. However,
data published two weeks ago show that both the CPI and the CPIF fell in January. During
2010 CPIF inflation is expected to fall, primarily as a result of companies' costs falling and
the krona strengthening, which is expected to make imports cheaper. The rate of increase in
the CPIF will rise from 2012 and onwards as economic activity improves and companies'
costs begin to rise again. At the end of the forecast period, we expect inflation measured in
terms of the CPIF to be close to 2 per cent. However, CPI inflation is expected to continue to
rise. This is mainly because households' interest expenditure will stop falling and then rise as
the repo rate is raised.
Figure 9
Inflation measured as the CPI and the CPIF
Annual percentage change
Source: Statistics Sweden
From crisis interest rate to monetary policy in an economic downturn
The Executive Board of the Riksbank decided at the latest monetary policy meeting to hold
the repo rate unchanged at 0.25 per cent to attain the inflation target of 2 per cent and to give
sufficient support to the economic recovery. We are expecting to begin raising the repo rate
again in the summer or in early autumn 2010 (Figure 10). This is slightly earlier than in our
last forecast, which is because of the two components I mentioned. The financial markets
have become increasingly stable and statistics on economic activity - such as slightly higher
growth abroad, stronger employment and higher inflation - have gradually confirmed the
picture of the recovery being on firmer ground.
Figure 10
From crisis interest rate to monetary policy in a recession
Per cent
Source: The Riksbank
BIS Review 25/2010
At the same time, we are now assuming that the increases in the repo rate can be made
more gradually. This means that the forecast for the repo rate in the longer term is marginally
lower than before, just under 4 per cent at the beginning of 2013. But, of course, forecasts so
far ahead are very uncertain.
Even in the slightly shorter term, there are difficult considerations that must be made and
risks connected to our interest rate decisions. As we often point out, the repo rate path is a
forecast and hence by definition uncertain; it is not a promise. How we will conduct our
monetary policy in practice in the future will depend on how economic developments in
Sweden and abroad affect the prospects for inflation and economic activity. There is a risk
that the upturn in inflation during the winter will not be temporary, but will persist a little
longer. One indication of this is the fact that the rate of price increase has risen with regard to
many goods and services. Risks that could put greater upward pressure on inflation in the
future are if the krona were to weaken or wage increases were to be higher than the
Riksbank has forecast. We may then need to raise the repo rate more quickly than expected.
If, on the other hand, wages increase more slowly or the supply of labour is higher, then
monetary policy may instead need to be more expansionary than in the forecast.
We must now begin to lay a safer foundation for the future
With the monetary policy we presented a couple of weeks ago we expect to meet the
inflation target and for the recovery to continue from a more stable foundation. We will
probably have to live with some of the repercussions of the crisis for some time to come, but
we expect the financial markets to normalise. But it is necessary to achieve a balanced
economic growth even beyond the monetary policy forecasting horizon. If we are to do so we
must attend to any deficiencies regarding, for instance, regulation, supervision and the
allocation of responsibility, deficiencies which have come to light rather clearly in recent
years. It is important to establish a system that covers all aspects; a system that prevents
unnecessary risks and imbalances from building up.
Experiences of the financial crisis in the 1990s have in many ways contributed to changes
that have given our economy better resilience during periods such as the past few years.
Merely the fact that we entered this crisis with sound public finances, a surplus on our current
account and a lower, more stable inflation rate has given us room to manoeuvre that we
previously lacked and which many other countries lack now. Some changes have also been
made with regard to financial supervision and analysis of the bank sector. The banks
themselves have also learnt from the previous crisis and have acted, at least in Sweden, in a
much more responsible manner with regard to credit granting, for instance.
But to some extent I think our memories were too short in the 1990s, when the acute crisis
was behind us and crisis management was no longer such a pressing issue. One central
area where I believe we should have achieved more is legislation and regulation with regard
to how and by whom banks in distress should be managed. Following the previous crisis I
saw important reforms in legislation being investigated over a long period of time only to be
more or less forgotten with nothing implemented. I fervently hope this will not happen again.
Quite simply, it must not happen again.
Towards a cohesive and efficient financial regulatory framework
The Executive Board of the Riksbank and the General Council of the Riksbank have
presented a joint report to the Riksdag where we propose that one or several commissions of
enquiry should be appointed to review the regulatory framework in the financial sector. We
need to create a cohesive and efficient regulatory framework. It should contribute to
maintaining financial stability and if a crisis nevertheless arises, it should minimise the costs
to consumers and to society as a whole. These are questions that should neither be
discussed endlessly nor allowed to come to nothing when the situation stabilises. If we are to
prevent costly crises in the future, we must together investigate and implement changes.
Urgently!
Around the world there is already extensive work being carried out in this field, particularly
with regard to the international supervision perspective. But implementing changes at
international level can take time. Even if some progress has been made, it is likely that no
comprehensive measures will be implemented until we have in principle left the crisis entirely
behind us. We should not wait for this work to be completed in all areas. In several cases we
should instead remedy deficiencies as quickly as possible and improve our own financial
regulatory framework.
More tangibly, we propose, for instance that the Sveriges Riksbank Act should be reviewed.
This is with the aim of clarifying the Riksbank's responsibility for financial stability and what
tools the Riksbank needs to manage this task. There are several important issues in this
field. For example, should it be explicitly stated in the Instrument of Government or the
Sveriges Riksbank Act that the Riksbank has a responsibility for financial stability? I hope
that we will fairly soon have the answer to this and other related questions.
Another area concerns investigating how the allocation of responsibility and coordination
between the Riksbank and Finansinspektionen can be improved. Moreover, the distribution
of responsibility between the Riksbank and the Swedish National Debt Office with regard to
loans to the foreign currency reserve should also be made clearer. A further question is the
one I raised just now, namely that an efficient regulatory framework is needed for managing
banks in distress.
Concluding remarks
Let me finish where I began. We are on safer and firmer ground now than we were a few
months ago. The acute crisis is behind us. We have passed the worst economic trough in
several decades and have now entered a new phase of economic recovery. Monetary policy
will probably begin to be adjusted to a more normal economic downturn situation in the
summer or early autumn this year. And this is a healthy sign. The road ahead of us is
certainly not an easy one. New challenges and considerations await us, but we are at the
same time more than ready to meet them.
The resources that we were forced to use some time ago for more or less acute crisis
management can now be partly used for analysis, development of our methods and the work
on preventing imbalances in the economy and future crises. No one can say that the latter is
a simple task. There are many problems that need to be solved. But we are not alone in this
work, which must be conducted on both a national and an international level. As long as we
have the motivation and the will to succeed our chances are good.
In the most acute phase of the crisis many of the countries of the world joined together and
took action to prevent a total collapse. When it has been necessary, the authorities here in
Sweden have showed an excellent ability to cooperate. We must make use of the drive and
spirit of cooperation that were demonstrated in the crisis. If we do this, I believe that we will
acquire a financial regulatory framework that can efficiently prevent unnecessary risks and
imbalances from building up, both nationally and globally. But we must act now while we
have the chance. The lessons from this crisis must not be forgotten.