Irma Rosenberg: Monetary policy with our own interest rate path
Speech by Ms Irma Rosenberg, First Deputy Governor of the Sveriges Riksbank, at a lunch meeting
arranged by Öhmans, Stockholm, 8 June 2007.
* * *
Introduction
Let me begin by thanking you for the invitation to come here and speak about monetary policy. Today
I would like to take the opportunity to talk about some issues that are important to me. I would like to
explain why I considered that the repo rate should be kept unchanged at the most recent monetary
policy meeting. I shall also comment on some of the views we at the Riksbank have received with
regard to our forecast of the interest rate path. But I intend to begin with a few words on the changes
in our monetary policy communication which were decided by the Executive Board recently.
Changes in the monetary policy communication
Since the inflation target was introduced, the Riksbank has tried in different ways to become more
open and clear with regard to how monetary policy is conducted. We have gradually published more
and more of the background information used for our decisions, in particular the forecasts for inflation
and economic developments in general. The decision to publish our own forecast for the repo rate,
which we took at the beginning of the year, was a natural continuation of this process. In mid-May we
decided to implement some further changes to become even clearer in our monetary policy
communication.
From now on, we will hold press conferences after each monetary policy meeting, regardless of what
decision has been taken. Until now we have only held a press conference if the repo rate has been
adjusted or if we have published a Monetary Policy Report. But to understand the monetary policy
conducted, it is equally important to explain why the repo rate has been held unchanged as to explain
why the repo rate has been changed. By publishing our own interest rate forecasts and by holding
press conferences after each monetary policy meeting we will provide more detailed and more regular
information on the considerations taken by the Executive Board.
We have also decided to make changes in our way of signalling. By signalling I mean how we
communicate our monetary policy intentions. Previously, when we Executive Board members have
gone out and talked about the current economic situation between the monetary policy meetings we
have sometimes given indications of how we consider the repo rate should be set at the next meeting.
This has been on the condition that it is clear that the points of view expressed are the individual
member's. The idea was that when the interest rate decision was taken at the monetary policy
meeting, enough information on the different Executive Board members' views would already have
been given by degrees so that the decision would not surprise market agents. We have now
concluded that there is not normally reason to indicate prior to the monetary policy meetings in
speeches and press releases how our views of the repo rate path have changed. Our assessment is
that it is enough to signal our intentions clearly in connection with the seven monetary policy meetings
held every year. In connection with three of these meetings we will publish our own forecast for the
future repo rate, and our Monetary Policy Report will show clearly why we have chosen this particular
path. On the other four occasions we will make a qualitative assessment of how the most recently
published interest rate forecast relates to the new information received. Even if the interest rate path
forecast is only a forecast and not a promise, a central bank can hardly be clearer than this with regard
to its views on economic developments and the consequences for the interest rate.
There may also in exceptional cases be justification for some signalling between two monetary policy
meetings. If, for instance, something occurs to radically alter the economic situation, while there is a
long time until the next meeting, it may be necessary to make a comment in order to avoid the risk of
unnecessary uncertainty in the financial markets. It should then be clear whether the entire Executive
Board supports this view or whether it is the opinion of an individual member.
I and my colleagues on the Executive Board will thus continue to go out and talk about monetary
policy and financial stability, but there will be no signals regarding coming interest rate decisions. We
will each express our own assessments, but this will be a case of justifying and explaining our own
considerations after a meeting and not of signalling a stance to be taken at a coming meeting.
The third change we decided on was to state our names in the minutes of the monetary policy
meetings, with effect from the meeting to be held in June, so that it is possible to see who said what.
Previously, we have only named members who have entered a reservation against the decision. This
change will make differences of opinion between Executive Board members even clearer. It means
that it will become easier both to predict how monetary policy will be conducted in future and to assess
it. This change is also a step towards increased openness and clarity.
The monetary policy decision on 3 May
This naturally leads me on to the stance I myself took at the most recent monetary policy meeting in
early May. My assessment was then that the new information received indicated that the repo rate
should be raised more during the forecast period than was implied by the forecast in the February
Monetary Policy Report. This is to ensure an inflation rate in line with the target and a balanced
development in the real economy. But at the same time I considered that the changes in the economic
picture were not so great that the interest rate needed to be raised immediately. Let me explain why.
In February we believed that growth would continue to be good, although it was expected to be slightly
lower than last year. We estimated that cost pressures would rise during the forecast period as
employment was expected to increase and wages were expected to rise faster. Higher cost pressures
could also lead to inflation rising, but we estimated that the favourable supply conditions would
contribute to a relatively modest rate of increase. At the same time, we pointed out that the
assessment of wage developments was uncertain. For instance, the rapid upturn in employment and
the increased labour shortage implied more rapid wage increases, while the increase in labour supply
and continued price pressures from abroad indicated slower wage growth. The assessment in the
main scenario was that the repo rate should be raised at a fairly slow pace. We also presented a
number of alternative scenarios and the consequences they would have for monetary policy. In one
such scenario we investigated the consequences of more rapid wage increases than calculated.
At our monetary policy meeting in May we were able to observe that the new information received
since the publication of the Monetary Policy Report in February indicated higher inflationary pressures
than we had predicted. One reason was that the result of the spring wage bargaining rounds indicated
that wages could increase more quickly during the forecast period than we had estimated in the main
alternative in the report published in February. The motive for high wage increases not being part of
our main scenario was that we considered that the spare capacity in the labour market still appeared
substantial, which would slow down the rate of wage increase.
How high wage increases will be in total will depend not only on the collective wage agreements, but
also on how much wages rise outside of the agreements. As I mentioned in May, it is reasonable in
the currently strong labour market situation to count on wage increases outside of the agreements
being higher than they have been in recent years. How high will depend on how well the labour market
functions. I pointed to a number of important questions then. Will the labour supply increase to the
extent expected? Will the matching of demand for and supply of labour function? How will the stronger
labour market situation affect wage negotiations?
At the May meeting we were also able to observe that the statistics received for the first quarter
showed a slightly more strained labour market situation than we expected to see in February.
Employment had developed roughly in line with our forecast, while the labour supply appeared to have
increased slightly less than expected. Unemployment was therefore a little lower than we had
predicted in the February report. Shortages in the business sector continued to increase. But my
assessment was nevertheless that there was still plenty of spare capacity, if not yet to the same extent
as we expected in February. A further reason why we foresaw higher inflationary pressures was that
the Government's Spring Budget Bill appeared likely to stimulate demand slightly more, at least next
year, than we had previously estimated.
As I said earlier, I drew the conclusion from this that the repo rate needed to be raised more during the
forecast period than we believed in the February report. But my assessment was that the economic
picture on the whole had not changed so much that the repo rate needed to be raised immediately.
Inflation was low, and it appeared, as I saw it, reasonable to assume that it would rise fairly slowly.
The reason for this was that there were still several factors holding back prices. I pointed out that the
important thing was to balance the pace of the interest rate increases so that inflation does not
accelerate more rapidly than expected, but so that growth in production and employment is not slowed
down too soon. How these considerations will be transformed into a new interest rate forecast is
something we will return to in our next Monetary Policy Report in June.
Views on our interest rate path
In conclusion, I would like to say a few words on the experiences thus far of publishing our own
interest rate path. It is still too early to draw any definite conclusions about how this has functioned, but
some reflections may be worthwhile.
The debate after our monetary policy meeting in February, when we presented our own interest rate
forecast for the first time, was very lively. This was not because we chose to raise the repo rate by
0.25 percentage points - this decision was hardly discussed at all. What attracted attention was the
fact that the forecast for the repo rate that we published differed from the average expectations
prevailing at the time. This applied both to the expectations that could be interpreted from market
pricing and to the average of the interest rate forecasts made by other forecasters. But there were also
fairly substantial differences between market analysts. There were those whose views were relatively
close to ours and there were those whose views differed substantially from ours. I do not consider it
strange that such differences of opinion should arise. They reflect in part differences in the view of
economic developments and how inflationary pressures may develop. For instance, in February we
considered that the new information received since our previous monetary policy meetings in October
and December did not justify the relatively large upward adjustments in the interest rate forecasts
made by some other market analysts.
The fact that other agents make their own assessments of how the interest rate will develop is
essentially very positive. One of the arguments put forward against a central bank presenting its own
forecast for the interest rate path was that the agents in the financial market would then stop making
their own analyses of interest rate developments. However, these misgivings have proved unjustified.
Opinions on the interest rate and future economic developments still differ, which is a natural
consequence of the uncertainty regarding the future development of the economy. In particular those
who operate in the financial markets know that we live in an uncertain world and for this reason the
assessments of interest rate developments will continue to differ.
Another argument against a central bank presenting its own forecast for the interest rate is that the
central bank would lose credibility if the forecast proved to be wrong. It has also been speculated in
various market comments that it would entail a loss of prestige for the central bank to revise its
forecasts and that the central bank should therefore by wary of doing so. But it is no stranger that we
should revise our view of the future development of the repo rate than that we should revise our view
of growth, employment or inflation when new information is received that changes the outlook. Nor is it
stranger for the central bank to revise its forecasts than for other analysts to do so. What is important
is that we can motivate why we are revising our views and that we can do so in an understandable
manner.
This is linked to the fact that it is difficult to make forecasts, not merely for interest rates, but also for
other macro economic variables. The fact that it is difficult to make forecasts for the interest rate is
illustrated clearly in the development of, for instance, forward rates over time. The figure (figure 1)
shows implied forward rate curves calculated on the basis of bank papers from the middle of each
quarter. Expectations of the development of the repo rate have varied substantially over time when
measured in this way. During the years the interest rate has gradually been cut, expectations
according to implied forward rates have substantially overestimated the level of the repo rate. After we
began to raise the interest rate one and a half years ago, there has rather been a tendency for the
repo rate path to be slightly underestimated.
It can thus be noted that market agents have had difficulty in forecasting interest rate developments.
The fact that forecasters revise their assessments is not at all strange, as new information is received
all the time. This indicates that as the conditions for the real economy change and new information is
received the forecasts for the repo rate path need to be adjusted. There is nothing particularly
dramatic about this. It applies to all market agents, to the major banks, to the Ministry of Finance and
also to us at the Riksbank. The great uncertainty factor means that all forecasters should be humble,
but this should not prevent them from making forecasts.
I would therefore like to emphasise once again that the repo rate path we present in the Monetary
Policy Report is a forecast and not a promise. The Riksbank cannot undertake, regardless of what
happens in the economy, to follow the path published. The interest rate path is quite simply the best
assessment we can make at a given point in time, given the information that is then available. New
information may change the picture of the economy and then the Executive Board will have to rethink
how we set the repo rate.
The reason why we have chosen to publish our interest rate forecast despite the uncertainty over the
future is largely because we believe this is the best way of explaining our thoughts on monetary policy.
It also makes it easier for us to justify forecasts and interest rate decisions and to outline alternative
scenarios for the repo rate. It will also be easier to evaluate monetary policy. The debate has not been
slow in coming. Analyses and discussions on monetary policy are now being conducted outside of the
Riksbank in a way that would not have been possible if we had not presented our own interest rate
path. It is not, as before, primarily the current interest rate decision that is discussed, but more a
question of the monetary policy fluctuations throughout the entire forecast period. The fact that the
interest rate forecast may later be changed is a different, and quite natural, matter. Withholding
information on how we view the future development of the interest rate merely because this view may
need to be revised would make us a less open bank.
Figure 1. Is the market always right?
Repo rate expectations according to implied forward
rates
Per cent
7.5 7.5
7.0 7.0
6.5 6.5
6.0 6.0
5.5 5.5
5.0 5.0
4.5 4.5
4.0 4.0
3.5 3.5
3.0 3.0
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
99 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: The Riksbank