Stefan Ingves: Introduction on monetary policy
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, to the Riksdag Commitee
on Finance, Stockholm, 15 November 2007.
* * *
What is the objective of the Riksbank's monetary policy? To maintain price stability - an
inflation rate around two per cent a year? Yes, this is of course correct. But behind this
wording there lies a deeper meaning - the actual core of the task delegated by the Riksdag
(the Swedish parliament) and ultimately the Swedish people to the Riksbank. Because what
it is essentially all about is to create the best possible conditions for good and sustainable
economic development. And monetary policy contributes to this by keeping inflation low and
stable. The inflation target is not merely a target, but also a means.
The fact that I as Governor of the Riksbank have the opportunity to discuss monetary policy
with you who represent the Riksdag is also important for the prospects of reaching this goal
in the best possible way. The Riksbank must have support and legitimacy from the people to
be able to succeed in its policy. It must therefore be easy to examine how monetary policy is
conducted and how well we live up to our principles. The fact that the Riksbank Governor
regularly takes part in these hearings is an important part of this process. Our task also
means that we must constantly strive to become better at what we do and develop our
working methods. We must adapt to new demands from outside and implement changes
where we or others find scope for improvement. Evaluation and constructive debate
contribute to making us better at what we do.
My introduction on monetary policy here today will in a way deal with evaluation and
development. I shall talk about the contents of our Monetary Policy Report - our view of
inflation prospects, the decision at the end of October to raise the repo rate by 0.25
percentage points and what interest rate policy we believe will be required over the coming
years. The report is one of the best tools for examining how well we do our job. But I will also
talk about some changes we have made to better meet the requirements made of us, not
least in our role as independent authority.
Because if I summarise what has happened in monetary policy since I was here in February,
it is not merely a question of the forecasts and interest rate decisions we have published. We
have also made changes in the way we communicate, to become clearer and more open.
There have been fairly lively discussions of this over the past year.
It is good that the Riksbank's strategy is discussed. But I sometimes think that it has been
difficult to distinguish whether the criticism concerns our forecasts not being considered good
enough or whether it concerns our changes in communication. It is of course important to
distinguish between on the one hand our policy and our assessments, and on the other hand
the way we communicate them - our communication strategy. I therefore wish to discuss
these areas separately today. Moreover, there are other new elements that have been
discussed with the Committee on Finance and are linked to the ambition to become clearer
and more open. So let me begin there - by briefly discussing the changes we have made
recently and why we have made them. After that I will go on to talk about the economic
situation and interest rate policy.
Changes for better monetary policy
The driving forces behind greater openness and clarity
Both the Riksbank and most other central banks have become more open and clear in recent
years (slide 1). This is partly because we have seen it as a way to easier attain our target
and to make monetary policy more efficient. By being open about the way we think, it is
easier for others to predict our monetary policy. It will also be easier for the general public to
make sure that the interest rate decisions we make are really aimed at achieving low and
stable inflation. This increases the credibility of the inflation target and makes it easier to
anchor expectations around two per cent. Developments in Sweden from the mid-1990s
onwards are a good example of this (slide 2).
And by being clear about how we view future monetary policy we can also increase the
efficiency of monetary policy (slide 1). It is not merely the current interest rate decision and
the current level of the interest rate that are important to future inflation and demand in the
economy. Households and companies do not base their financial decisions only on the
current interest rates. Expectations of how the repo rate will develop over the coming years
are at least as important.
But there are also other reasons for the increased openness. As I mentioned earlier, public
support and legitimacy are a fundamental requirement for monetary policy to work. We have
freedom with responsibility and with this come demands for insight and accountability.
Openness is also something that has long imbued Swedish public administration. The
principle of free public access which means that public authorities' activities shall as far as
possible be carried out openly, was established as early as the late 18th century, a time
when few other countries had such ideas. So this is a long tradition we are maintaining.
The fact that we are examined closely is also something that affects the efficiency of our
work. The more open we are, the easier it is for a member of the Committee on Finance or
any other member of society to evaluate how well monetary policy works. Clarity and
increased openness outwards lead to a better discussion of monetary policy. In this way it
functions as an extra incentive for us to become even more efficient within the walls of the
Riksbank.
Changes in our way of communicating
So what are the changes that these driving forces have resulted in over the past year (slide
3)? There are primarily two changes involved. One is that we have followed the example of
the central banks in New Zealand and Norway and now publish our own forecast for the
future interest rate. The other is that representatives of the Riksbank no longer signal in
advance, through speeches and press releases, how they consider the interest rate should
be set at the next meeting.
There has perhaps been less focus on a couple of other changes, but these are also
important components in the whole that makes the strategy for our communication. Since the
summer we now publish in the minutes the names of Executive Board members as they
express their opinions in the discussion at the monetary policy meeting. We now hold press
conferences in connection with all of the now 6 monetary policy meetings a year. From this
December we will publish an interest rate forecast in connection with each of these meetings.
Previously the interest rate path has only been published in connection with the Monetary
Policy Reports issued three times a year.
We have already discussed the interest rate path here in the Committee on Finance, but not
the question of signalling. It is true that the signalling has been discussed in several
speeches by Executive Board members. But as the idea behind these hearings is that I shall
give an account of what has happened since the last time I was here, it seems appropriate to
take up this issue again.
Earlier the Riksbank applied something that I have on a couple of occasions described as
"signalling by degrees". Between the monetary policy meetings the individual Executive
Board members sometimes held speeches where we more or less explicitly indicated how
we thought the interest rate should be set at the next meeting. The idea was that sufficient
information on how the Executive Board reasoned should have come out by degrees to
prevent economic agents being taken by surprise when the interest rate decision was made.
But since we began publishing our own interest rate forecast the need for this type of
signalling between the monetary policy meetings has declined. Now that we will also be
publishing our interest rate forecasts every second month, the need has declined further. The
general public and the financial markets will now receive at fairly regular intervals a detailed
description of how a majority of the Executive Board members consider that the repo rate
should be set in the future. This is one of several reasons why we have stopped signalling in
speeches prior to coming interest rate decisions, unless there are special circumstances.
There were also some problems with the earlier signalling which we wanted to avoid. In
certain situations it was probably difficult to determine whether the signal in a speech should
be interpreted as an individual member's opinion or whether it reflected the views of a
majority on the Executive Board. If the individual Board members sent out different signals it
could probably also be difficult to distinguish a clear message. In addition, it was unclear
when and if the signals should be sent out.
Finally, and at least as important in my opinion, there was also a democratic aspect to this
question. This has to do with the fact that we are an independent authority and that the
general public should have good insight into the decision-making process. There must be no
doubt that the interest rate decisions are actually made at the monetary policy meetings and
not at some other, more diffuse, point in time - in some informal way that prevents insight. If
the signalling prior to the meetings leads people to believe that the interest rate decisions
have been made in advance of the meetings, then doubts may arise.
Why has this led to a debate?
The fact that the debate on our communication has been fairly lively probably has several
explanations. To begin with, the pace of our development towards openness and clarity has
been fairly high over the past two years. And if one makes a lot of changes in a short time it
is not so surprising that discussions arise. Because even if one has prepared the way,
changes often mean that all those involved must undergo a period of "learning by doing"
before everything falls into place. This applies not least to us, I would like to emphasise.
The changes also mean, in particular our own interest rate forecast, that we are now sticking
out our necks and opening up for criticism more than before. When we describe our policy it
is no longer in the form of a simple, but perhaps slightly misleading policy rule. This was the
way things were before when we used the more easily understood, but less realistic,
assumption of an unchanged repo rate. Instead we are painting a more complex picture, the
way it actually looks to us who make the decisions. Slightly more complicated on the one
hand, but on the other hand more realistic and with significantly better opportunities to
evaluate our work!
The fact that we are publishing our own forecast for the policy rate also means that it will be
very clear when we reconsider our view of what interest rate policy will be needed in the
future. It also becomes evident when our assessment differs from that of the market, and
these differences often cause a debate. But the fact that we are criticised for changing our
minds, or for our views being different from the market view, is hardly a reason to refrain from
reporting as honestly as possible what we believe. The fact that we changed our view or
made a different assessment than the market also happened before, when our forecasts
were based on the assumption of an unchanged repo rate. The difference was merely that it
did not show as much as there was no interest rate forecast to use as comparison.
But it is important to distinguish between what is criticism of the Riksbank's economic
assessments and what is criticism of the actual communication strategy. At the time as we
published the first interest rate paths and stopped "signalling by degrees", our view of
economic developments differed from many market agents' analyses. I believe that this
contributed to criticism that actually dealt with differences in economic assessments partly
spreading to the changes in our communication. It is too early to assess as yet, but I am
convinced that the advantages of our new method of communicating will in the long term
outweigh any disadvantages.
I would like to emphasise that an open and constructive debate is something we welcome.
We will not refrain from changes that we believe lead to a better monetary policy, just
because we risk being criticised in the process. This would be a very bad strategy and does
not fit in with our task. We believe that the best way to conduct monetary policy is to explain
as openly and honestly as possible both what we are doing and how we are thinking. And
this is definitely something the general public can require of us in our role as independent
authority.
All of these changes are steps in that direction. Steps we have taken to become clearer and
more open - to become more efficient in our way of communicating. I would also like to point
out that much of what we have done is in line with questions discussed here in the
Committee on Finance. This emphasises the importance of using debate and dialogue to
reach new solutions. We essentially all want the same thing - to create in the best way
possible the right conditions for good and sustainable economic growth.
Other changes
The Committee on Finance itself has also initiated several changes that contribute to good
discussions on monetary policy (slide 4). One change I am thinking of is the fact that the
hearing with the Governor of the Riksbank now takes place a couple of weeks after the
Monetary Policy Report has been published and that experts can be called in to assist the
Committee, if necessary. Of course, it means I have to answer more difficult questions the
more time you have had to prepare yourselves. But this is how it should be and something
positive for all parties.
I would also like to mention another new element - a change of name which was largely
initiated by the Committee on Finance. I am referring to the measure of underlying inflation
calculated as CPI adjusted for households' mortgage interest expenditure. It also excludes
the direct effects of changes in indirect taxes and subsidies. This measure was previously
called UND1X. This name referred to the fact that it was a measure of underlying inflation,
but probably appeared a little too cryptic. I remember that I may have let slip that I thought it
sounded like the name of a rocket fuel during my first hearing. The new and hopefully slightly
less difficult name since a week ago is CPIX, where the X indicates that something has been
excluded from the CPI.
This takes me onto today's second theme, namely inflation prospects, our most recent
interest rate decision and our view of what monetary policy will be appropriate in the future.
The economic situation and future prospects
It can hardly have escaped the attention of anyone here today that we now base our
forecasts on our own assessment of what future movements in the repo rate we believe will
provide a well-balanced monetary policy. So before I take up the rest of the economic
analysis, I shall first describe the interest rate assumption. Our analysis is based partly on
the increase in the repo rate of 0.25 percentage points to 4 per cent which we decided on
just over two weeks ago, and partly on the fact that the interest rate will need to be raised
slightly further in the future - to around 4.25 per cent during the first half of 2008. So how did
we reach this assessment?
A strong Swedish economy with increased cost and inflationary pressures...
If we begin with the situation at home, it is clear that the Swedish economy is continuing to
show strong growth (slide 5). We see increased cost and inflationary pressures ahead of us
and there are a couple of main factors in this development that I wish to highlight.
Strong growth
Both the statistics in the National Accounts and the survey of Swedish companies carried out
by the Riksbank confirm the picture of strong growth in Sweden. Although the rate of
increase in GDP has slowed down slightly, it remains fairly high and is expected to be around
3 per cent this year. Our assessment is that we are in a situation where we are currently
making more use of economic resources than normal.
If we look ahead, we are expecting GDP to grow slightly more slowly up to 2010 than it has
in recent years. This is due to several interacting factors; we believe that productivity and the
labour supply will increase more slowly, and that international growth will be lower. In
addition, we are expecting the interest rate to rise gradually, the exchange rate to be stronger
and investment to increase at a slower rate. These factors subdue growth.
... and tighter labour market
Despite the fact that GDP growth has been strong for several years, it was not until 2005 that
employment began to increase (slide 6). And in 2006 both the number of hours worked and
the number of persons employed rose quite substantially. This was partly because the
number of people in employment measures increased considerably during the fourth quarter
of last year. But despite the fact that fewer people are in labour market programmes this
year, the number of employed has continued to increase. This indicates considerable
strength in the labour market. We also assess that employment will continue to increase
during the forecast period, but at a slower rate. The fact that the pace slows down is due to
the economic upturn slackening. It is also due to higher wage increases contributing to a
lower demand for labour.
The supply of labour has also increased, but not as much as employment. Open
unemployment has thus fallen (slide 7). According to our forecast, the labour supply will
continue to increase, albeit at a slower rate, during the forecast period. This development is
mainly due to the economic cycle, but also to some of the Government's measures. The fact
that the rate of increase is slowing down is due to the economic upturn slackening, and also
to factors such as the number of persons in the age groups with high participation in the
labour force declining. All in all, this will lead to the number of open unemployed persons
continuing to fall, but at an ever slower rate. Compared with what we were expecting in June,
the conditions in the labour market have become tighter.
This means in turn that it is reasonable to assume that wages will rise more quickly (slide 8).
And the agreements signed so far support this picture. The new agreements will make an
impact in 2008, and the labour shortages will also become more marked then. We are
therefore counting on wages increasing more during next year than in 2007, by around 4.5
per cent. Labour costs per hour are also expected to increase. How this affects companies'
costs for the goods they produce will in turn depend on how productivity develops.
Productivity growing more slowly and labour costs increasing
If one looks back at the past decade, productivity in the Swedish economy has improved
significantly (slide 9). This meant that production could increase more quickly than costs. It
also contributed to employment showing fairly weak development over a long period, despite
good growth.
But more recently employment has increased, while productivity growth has been lower. We
believe that the slower productivity growth is to some extent temporary. There can be several
reasons for this. One reason is probably that new persons are being employed in the
companies and that it quite simply takes time before they are fully productive. Another could
be that new groups are entering the labour market. For instance, the service sector normally
increases fairly late in an economic cycle and then the productivity measured is slightly
weaker. Something that further fuelled the slowdown in productivity during the second
quarter this year was the low holiday absence in June, which we assess to be a temporary
effect. Our forecast is that productivity will once again accelerate, but increase at a slower
rate than it has in recent years.
If one looks at the forecasts for the labour market and productivity together, one can also see
that companies' costs in production are expected to increase more rapidly than in recent
years. Unit labour costs are rising according to our assessment, by 4.8 per cent a year, but
the rate of increase will then fall back as productivity begins to increase more rapidly once
again.
Expectations confirm the picture of increased cost and inflationary pressures
If I very briefly summarise the domestic situation, the wheels of the Swedish economy are
turning at a good pace. We have a high level of utilisation of economic resources and cost
pressures are increasing. Something that supports this picture is that both households and
companies have adjusted their inflation expectations upwards, according to various surveys.
And if one instead measures inflation expectations by looking at the difference between
nominal and real bonds, the results point in the same direction.
... is counteracted by slightly weaker international developments
International developments appear to provide some counterbalance to the slightly stronger
Swedish economy. Although we are counting on international growth being good, it will
probably be lower than we predicted in June. There has been unrest in the financial markets,
particularly in recent months, and there have been signs of weaker economic growth in the
United States and the euro area, among others (slide 10). But at the same time we are now
expecting slightly higher growth in other parts of the world, including Asia and eastern
Europe. Our view of growth in the world economy is therefore only marginally changed.
Nevertheless, our assessment is that the slowdown in among others the United States,
together with the unrest in the financial markets will slow down economic developments in
Sweden somewhat. I would therefore like to take the opportunity to say a few words about
this, as it has received so much attention in recent months.
The financial unrest and how it affects the Swedish economy
The weaker growth in the United States and the anxiety that has arisen in the financial
markets is largely linked to the problems in the US housing and mortgage markets. This
concerns above all the market for sub-prime loans. These are, somewhat simplified, loans to
households that do not have sufficient credit rating to be granted a normal mortgage.
During the summer there were signs that all was not well. The number of households
experiencing difficulties in paying their mortgages had gradually increased. The unrest
intensified when it was revealed that several financial institutions had made substantial
losses related to the sub-prime market. The fact that an apparently national problem has
global effects to the extent that we have seen is due in this case very much to the fact that
the loans have been "repackaged" into fairly technically complicated securities and sold on to
investors around the world. And the unrest that has arisen has largely been concerned with
the fact that it is difficult to see who is bearing the credit risks, and to what extent.
These events have had several effects. There has been a more general reassessment of risk
in the financial markets. The general uncertainty has led to an increase in demand for liquid
and safe assets such as government securities. The interest rate on government securities
has fallen, while the unwillingness to take on risk has contributed to rising interest rates on
loans and investments between banks; interbank rates (slide 11). But all in all, it nevertheless
appears as though the financial turbulence has so far not had as large repercussions on the
financial markets as, for instance, the Asia crisis in 1997 and the IT crash in 2000.
What effects can we expect on the Swedish economy? Perhaps the most important effect will
arise in that growth in the United States will slow down when housing investments there fall
and households consume less. The lower demand in the United States to some extent slows
down international economic activity and there will be a slightly slower increase in Swedish
exports. The financial unrest will probably also contribute to Swedish households maintain a
certain level of precautionary saving. The fact that it costs more for banks to finance
themselves may also contribute to households and companies sooner or later facing dearer
loans.
But there is considerable uncertainty over how extensive the effects of the financial unrest
and the US housing market will finally be. We therefore analyse an alternative scenario with
weaker international growth in our Monetary Policy Report.
Prospects for inflation and interest rates
We are expecting inflation to rise fairly sharply next year (slide 12). This is partly connected
to energy prices rising more rapidly. But inflation is rising even adjusted for energy prices.
And the reasons are primarily that utilisation of the economy's resources and cost pressures
have increased. Moreover, there are signs that food prices will increase rapidly over the
coming year. Inflation measured in terms of CPI will amount to around 3 per cent in 2008,
according to our forecast. The measures of underlying inflation, CPIX, which I recently
mentioned, will in our opinion rise from the current level to around the target next year. The
differences between the measures are largely due to households' mortgage expenditure
increasing and to higher indirect costs. When the economic cycle enters a calmer phase, the
CPIX will fall back to levels around 2 per cent, while the CPI will remain slightly higher. This
is our assessment, given that we raise the repo rate in the way I described earlier.
The interest rate decision and our forecast for the interest rate
To summarise, one can say that two forces are pulling in opposite directions (slide 13). One
is the stronger development here at home, and the other is a slightly weaker demand abroad.
But even if we expect that slightly poorer international growth will have a dampening effect
on the Swedish economy, this is not sufficient to hold back the increased cost pressures. The
interest rate therefore needs to be raised, and this was what we did around two weeks ago
(slide 14).
With regard to the future repo rate, our forecast remains largely the same as in June, despite
the fact that a lot has happened in the world economy since then. So to keep the underlying
inflation rate around our target of 2 per cent a couple of years ahead, our assessment is that
it is necessary to raise the repo rate slightly further in the future - to around 4.25 per cent
during the first half of 2008. This interest rate policy should at the same time contribute to
balanced growth in production and employment.
A couple of words about uncertainty - a forecast and not a promise
There is always considerable uncertainty regarding future economic events. This means
there is also considerable uncertainty regarding future repo rate movements. The interest
rate path we have published is a forecast. It is not a promise!
There are primarily two risk scenarios involved this time. If cost pressures become higher
than in the main scenario, the Riksbank may need to raise the repo rate more. This could
occur if wages rise more quickly or if productivity increases more slowly than expected. If the
financial unrest persists and international economic activity will be weaker than expected, the
interest rate may instead need to be lower. The direction for monetary policy in practice will
depend on how new information on economic developments abroad and in Sweden will
affect the prospects for economic activity and inflation. (Slide 15)
Conclusion
The Swedish economy is doing well. And the essential purpose of our work is to ensure good
economic growth that is sustainable in the long term. As things look today, we are assuming
that the interest rate path in our forecast will contribute to inflation being in line with our target
around two years ahead. We believe that this will at the same time contribute to a balanced
development in production and employment. (Slide 16)
And we also believe that the changes we have made in our communication will help enable
us to fulfil the requirements made of us in a better way. We have made the changes in our
communication to become even clearer and more open. We always have this ambition, and
have had it since the inflation target was introduced.
But it is not merely with regard to communication that we are constantly reviewing and trying
to develop our methods of working. No, it applies of course to all parts of our activities -
everything from our way of making forecasts to how the organisation looks and how we can
improve the opportunities to assess how well we are doing. And an important part of this is
discussions like the one we are having today.
Thank you!
1. Driving forces behind increased
openness and clarity

Monetary policy works better

Efficiency reasons

Independence requires openness

Democratic reasons
2. Increased credibility
5 5
Inflation expectations
CPI
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Sources: Prospera Research AB and Statistics
3. Changes in our communication
2007
•Forecast for the repo rate
February
•Monetary Policy Report
•Press conference after each monetary policy meeting
•No signalling in normal cases
May
•Names in the minutes of the monetary policy meetings
•Repo rate forecast at each monetary policy meeting
September
•6 times a year
4. Other changes...

Time lag between the Monetary
Policy Report and the hearing

UND1X has become CPIX
5. Swedish economy is strong
GDP growth. Annual percentage change. Striped bars/broken lines
refer to the Riksbank's forecast.
7 7
Sweden
6 The world 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Sources: the IMF, the OECD and the Riksbank
6. Tighter labour market
Thousands of persons. Broken lines refer to the Riksbank's
forecasts.
4800 4800
Labour force
4700 4700
Employed
4600 4600
4500 4500
4400 4400
4300 4300
4200 4200
4100 4100
4000 4000
3900 3900
3800 3800
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
Sources: Statistics Sweden and the
Riksbank
7. Percentage open unemployed
Per cent of labour force. Broken line refers to Riksbank's forecast.
12 12
10 10
8 8
6 6
4 4
2 2
0 0
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
Sources: Statistics Sweden and the Riksbank
8. Wages expected to rise faster
Different agents' expectations of the rate of wage increase two years ahead,
Per cent
5 5
4 4
3 3
2 2
Employer organisations
Employee organisations
Purchasing managers
1 1
Wages in the business sector, outcome
0 0
98 99 00 01 02 03 04 05 06 07 08 09
Sources: The National Mediation Office and Prospera Research AB
9. Cost pressures increasing
Annual percentage change. Broken lines and striped bars refer to
the Riksbank's forecasts.
8 8
Unit labour cost
7 7
Hourly labour cost
Productivity
6 6
5
5
4 4
3 3
2 2
1 1
0
0
-1 -1
94 96 98 00 02 04 06 08 10
Sources: Statistics Sweden and the Riksbank
4,5 4,5
USA
4,0 4,0
Euro area
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
01 02 03 04 05 06 07 08 09 10
Sources: Eurostat, US Department of Commerce and the
Riksbank
11. Disruptions to the interbank
market
Percentage points. Difference between interbank rate and government bond
rate with three months duration for each respective country.
2,5 2,5
United States
Sweden
Euro area
2,0 2,0
United Kingdom
1,5 1,5
1,0 1,0
0,5 0,5
0,0 0,0
jan feb mar apr maj jun jul aug sep okt
Source: The Riksbank
12. Inflation rises first then falls back
towards the target
Per cent. Broken lines refer to the Riksbank's
forecasts.
4 4
CPI
CPIX
3 3
2 2
1 1
0 0
-1 -1
00 01 02 03 04 05 06 07 08 09 10
Sources: Statistics Sweden and the Riksbank
13. Two counteracting forces give
largely the same interest rate path as
in June...
Higher cost pressures Financial unrest
Tighter labour market Weaker growth in USA
and euro area
4 4
3 3
2 2
1 1
0 0
dec-02 dec-03 dec-04 dec-05 dec-06 dec-07 dec-08 dec-09 dec-10
Source: the Riksbank
15. Risks

Higher cost pressures

Financial unrest and weaker
international growth

The Swedish economy is doing well

Balanced development

Changes for a better monetary policy
BIS Review 132/2007