Stefan Ingves: The current economic situation
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, at Avanza Bank,
Stockholm, 5 May 2009.
* * *
The minutes of the monetary policy meeting published yesterday show how we Executive
Board members reasoned when we decided to cut the repo rate to 0.5 per cent at our
monetary policy meeting on 20 April. Today I intend to give my views on economic activity
and monetary policy. he central points I wish to take up are:
•
The reasons for the global financial crisis and the ensuing recession in Sweden and
the world.
•
The economic policy measures taken globally and in Sweden to stimulate the supply
of credit and cushion the economic downswing.
•
The most recent developments in the Swedish and international economies.
•
My arguments for cutting the repo rate to 0.5 per cent, the repo rate path and
possible new unconventional monetary policy measures.
The financial crisis is a consequence of several factors
High saving in China and oil-producing countries has contributed to low interest rates
and credit expansion in a number of countries
From the beginning of the 1990s up to 2005 the US current account deficit increased
substantially. The main explanation for this was a reduction in saving among households.
The US current account deficit is counterbalanced by a surplus above all in China and a
number of oil-producing countries where saving is high. These countries have sought a
return on their financial capital abroad by investing, for instance, in US treasuries. The
increased demand for US treasury bonds has for a long time been pushing down long-term
interest rates in the United States. In addition, the US central bank conducted expansionary
monetary policy in connection with the recession at the beginning of the 2000s and in the
years immediately following. The low interest rates have stimulated consumption and
investment in the United States. They contributed in particular to house prices rising more
quickly than household incomes. The rising stock market and house prices contributed to a
reduction in household saving, which largely explains the rising current account deficit until
the housing market bubble burst. However, the problems of a previously overheated housing
market are not limited to the United States, they can also be found in a number of other
countries.
New forms of borrowing, including subprime loans, contributed to overheating in the
US housing market
During the years 2004 and 2005 new loan forms became increasingly common in the
housing market in the United States, not least subprime loans. Subprime loans are loans
aimed at households with low incomes. Often the lenders used very low interest rates during
the first two years of the loan as an enticement. However, after this period the interest rates
rose substantially. It is likely that the credit assessment of the households was not too
comprehensive. The lenders expected that house prices would continue to rise, increasing
the value of the collateral, an assumption which meant that the risk to the lenders was
assessed as slight. The strong increase in the new forms of mortgages contributed to the
overheating in the housing market.
Another factor that can also be assumed to have contributed to the housing market bubble in
the United States is the US housing policy, which since the mid-1990s had become
increasingly aimed at extending house ownership among households. For example, the
semi-nationalised mortgage institutions Freddie Mac and Fannie Mae were to offer a
particular share of their total lending to low-income families. This contributed to many
households receiving loans despite having an uncertain ability to repay. The credit expansion
that was seen in the United States can also be seen in a number of other countries.
In autumn 2005 the housing market bubble in the United States burst and house prices
began to fall. As the value of the households' most important collateral fell, an increasing
number of households could no longer renew their subprime loans at the same low interest
rate. The lenders had tightened the credit terms. The interest rate shock that followed meant
that an increasing number of households experienced problems in paying, which in turn
pushed down house prices even further. This occurred as an increasing number of
households and banks were forced to sell the houses at compulsory auctions at a lower price
than before.
The problems with subprime loans spread to other parts of the world economy
The subprime loans were repackaged into new investment instruments which were later sold
to investors in other countries. As it became increasingly evident that these securities were
probably substantially overvalued, it came to light that a number of banks had suffered large
losses. The uncertainty over which banks had suffered the largest losses made the banks
unwilling to lend to one another. The financial crisis escalated when the US government
decided in autumn 2008 to allow US investment bank Lehman Brothers to fail. The unease
on the global financial markets increased and the financial crisis that had started in the
United States developed into a global crisis.
The supervision in the financial markets has been insufficient
With hindsight, we can observe that many investors took excessive risks. The risk price they
had calculated on was too low. It can also be noted that the credit rating agencies gave the
new financial products too high ratings because they had not taken sufficient account of the
risk that it would not be possible to sell these products in the market. At the same time, the
supervision of the financial markets did not give sufficient consideration to the problems that
can arise when a house price bubble bursts. The remuneration structure in the private sector
has moreover encouraged short-term thinking and substantial risk-taking. However, all of
these problems are partly related to the good access to venture capital that has been created
by high saving in some parts of the world.
Credit granting has slowed down in a number of countries and the financial crisis has
contributed to the recession in the world economy
The problems in the housing market and the financial crisis that arose have led to credit
terms being tightened in some of the world's larger economies. The difficulties in obtaining
loans have contributed to a number of companies experiencing difficulty in financing their
investment, and have subdued household consumption.
Falling stock market prices and house prices have contributed to household wealth declining
rapidly in many countries. This also slows down consumption and investment. The financial
crisis has contributed to GDP in the world as a whole declining this year and to
unemployment rising in most countries. The Riksbank's assessment is that the recession in
the global economy in 2008-2009 will be the worst since the post-war period.
Extensive economic policy measures have been taken
In contrast to the way that economic policy was conducted at the end of the 1920s and the
beginning of the 1930s, the authorities have on this occasion acted quickly and forcefully.
Central banks have acted quickly
In the United States the policy rate has been cut from 5.25 per cent in autumn 2007 to 0.25
per cent. The European Central Bank has cut its policy rate from 4.25 per cent in autumn
2008 to 1.25 per cent and the Riksbank has cut the repo rate from 4.75 per cent to 0.5 per
cent. A number of other central banks have implemented similar monetary policy easing with
the aim of stimulating demand and alleviating the repercussions of the financial crisis on
production and employment.
In addition to the interest rate cuts, some central banks have implemented what is known as
unconventional measures. The purpose has been to secure the supply of credit and to
counteract the threats to financial and macroeconomic stability. The central banks have
contributed large liquidity injections, that is, lent money to the banks against collateral.
Several central banks have also provided emergency liquidity assistance to individual
institutions. The Federal Reserve, the European Central Bank and a number of other central
banks have also lent money to other central banks through what are known as swap
agreements to increase the access to foreign currencies in some other countries.
Governments have offered guarantees and capital injections to reduce the risk of further
bankruptcies in the domestic banking sector.
Another important measure to reinforce confidence in the world economy is the decision at
the G20 meeting in London at the beginning of April to increase the IMF's resources to
provide assistance to emerging economies experiencing problems.
The measures taken by central banks and governments around the world so far have
contributed to reducing the pressure on the interbank markets. Without these measures we
would probably have faced a financial meltdown. One sign that the crisis is no longer as
acute is that what are known as TED spreads have fallen in Sweden, as well as the United
States and the euro area. The TED spread is the difference between a three-month interbank
rate and a three-month treasury bill rate. The spreads are now back at around the levels
prevailing immediately prior to the worsening of the crisis in autumn 2008. But the financial
markets are still functioning much less efficiently than normal. It is also still difficult for
companies to finance themselves in the capital market. Moreover, the liquidity injection from
the central banks does not solve the banks' capital problems. For this reason it is not
surprising that the international discussion is currently aimed more at solvency than liquidity.
It would be very much appreciated if many countries could begin to distinguish bad banks
from good ones in an effective and transparent manner.
In Sweden, too, we have implemented a large number of unconventional measures to
safeguard financial stability and mitigate the negative effects of the financial crisis. During the
second half of 2008 the Riksbank increased its lending to the banks by more than SEK 450
billion. Almost SEK 200 billion of this was comprised of loans in US dollars. This has largely
been financed by means of swap agreements with the Federal Reserve in the United States.
Our own foreign exchange reserve was not sufficiently large to manage such extensive
lending in dollars. The increased lending has meant that the Riksbank's balance sheet has
grown since summer 2008 from around SEK 200 billion to around SEK 600 billion.
We have also changed our collateral requirements for lending to the banks so that the banks
can offer more types of security as collateral and thus more easily sustain their functions in
the market. We have provided special liquidity assistance to Kaupthing and Carnegie to
safeguard financial stability and the functioning of the financial markets. We have decided to
lend at longer maturities, with variable interest rates and with smaller supplements. We have
also extended the number of counterparties in our lending. In addition, we have signed swap
agreements with Iceland, Estonia and Latvia to support crisis management in these
countries.
Developments in the Baltic are important to the Swedish financial sector. Here the economic
downturn has been particularly severe and the necessary adjustments have not been made.
In other words, there are substantial risks in our neighbouring area and if things go very
badly the Swedish financial sector will suffer negative effects. However, the measures taken
by the Riksbank and by government authorities have had a positive effect on the supply of
credit in Sweden. So far there are few signs that companies have been affected by a credit
crunch over and above the credit tightening caused by a deep recession. As the banking
sector is a very important part of the way monetary policy affects the economy, it is essential
to closely follow developments in the credit market. Indirectly it also means that it is important
that the Swedish banks attend to their problems in the Baltic both forcefully and quickly. This
is to avoid the domestic transmission mechanism being disturbed by the international
uncertainty. Here monetary policy and financial stability merge.
The Swedish National Debt Office and Finansinspektionen (the Swedish financial
supervisory authority) have also taken measures to alleviate the financial crisis. The
Government has raised the state deposit guarantee and extended it to cover all types of
deposits in accounts, it has introduced a guarantee programme, established a stability fund
and decided on means of capital injections to the banks.
Large fiscal policy stimulus packages
Governments in many countries have presented substantial fiscal policy stimulus packages,
which have been supported by the countries' parliaments. Large packages have been
presented in China, Japan and the United States, but there is substantial fiscal policy
expansion even in a number of European countries. These include Sweden, where there is
greater scope, in the form of strong public finances to begin with, than in most other
countries. However, it is difficult to determine exactly what effects the fiscal policy measures
will have on individual countries and on the global economy. In addition to the positive effects
from the recently decided measures, growth is being stimulated by what is known as the
automatic stabilisers. This concerns public expenditure linked to the economic situation, for
instance, expenditure for support to the unemployed, which automatically rises when
economic activity deteriorates. In general, these stabilisers are much more important in
Europe than in, for instance, the United States, as the public sector's share of the economy
is greater there than in the United States.
Economic activity in the world economy and in Sweden has deteriorated rapidly since
the February monetary policy meeting
Rapid deterioration in global economic activity at the end of last year
Global economic activity deteriorated rapidly at the end of last year. GDP fell by around 1.5
per cent between the third and fourth quarters of last year in both the United States and the
euro area. GDP fell by around 3 per cent in Japan and by just over 5 per cent in Korea. In
Sweden, GDP fell by just over 2 per cent. At the same time, world trade has more or less
collapsed. In addition to a decline in demand, world trade is also affected by supply shocks
related to funding problems in the form of fewer trade credits. A rapid decline in world trade
naturally affects a small, trade-dependent economy like Sweden's.
However, there have recently been some positive signals abroad
Around a month or so ago it was difficult to see any positive tendencies at all in the world
economy. However, since the end of March the situation has brightened marginally as the
bad news has been followed by some positive news. In the United States a number of
confidence indicators are pointing upwards, there are some signs of stabilisation in the
housing market and in household consumption. It is as yet too early to talk of a stabilisation
in the US economy, particularly given that the labour market is continuing to weaken rapidly.
However, there are signs that the rate of the downturn may be slackening.
The Riksbank cut the repo rate further in April to attain the inflation target and to
counteract the fall in production and employment
Weaker growth is predicted
The economic downturn in the world and in Sweden at the end of last year was greater than
expected in the February Monetary Policy Report. Indicators point to developments still being
weak at the beginning of the current year. There are still risks that the development of the
global economy will be weaker than the Riksbank is predicting as a result of self-reinforcing
contagion effects between the weak real economy and undercapitalised financial systems. It
is also important to remember that different countries have different capacities and
willingness to resolve the problems in the financial sector. They have also been affected to
different degrees by the decline in world trade. The countries that have quickly taken
concrete measures will probably come out of the recession first. This indicates that the
recovery will not be synchronised.
In Sweden we are now assuming that GDP will fall almost as much as during the crisis in the
1990s. At that time the crisis was domestically-generated with financial imbalances, high
nominal interest rates and an overvalued currency. On this occasion much of the disruption
comes from outside. Public finances are in a good condition to begin with, interest rates are
low and we will probably continue to have a current account surplus. At the same time,
exports are declining rapidly, which has negative repercussions on investment. Household
consumption is subdued by the deterioration in the labour market and an increase in
precautionary saving. The outcomes and confidence indicators in recent months emphasise
the weak developments.
The recession is assessed to be unusually deep, which affects the supply of credit. Although
corporate borrowing is still increasing, loan terms for companies have been tightened. There
are also signs that there has been some substitution from market borrowing to bank
borrowing. It is the larger companies that are experiencing the biggest problems with funding
in the market and taking up a rising share of bank loans, which contributes to smaller
companies seeing themselves at a disadvantage. There are now clear risks that increased
credit losses will subdue the banks' lending to companies. There is also a risk that small and
medium-sized companies will be pushed aside.
Funding difficulties and weak international demand have led to companies revising down
their investment plans.
All in all, this points to the Swedish economy being weaker than was expected in February. It
means that resource utilisation will be lower than normal during 2009-2011. This entails a
risk that inflation could be lower than the monetary policy target. In addition, inflation
expectations have fallen and are slightly below 2 per cent two years ahead.
The repo rate and the repo rate path need to be lower to counteract the weak resource
utilisation and inflationary pressures. This is why the repo rate was cut to 0.5 per cent and
the Riksbank considers there is some probability of a further cut in the future. The future repo
rate path has also been lowered and the interest rate forecast now points to a very low repo
rate during a relatively long period of time. The repo rate is expected to remain at a low level
until the beginning of 2011.
The economic policy measures that have already been taken and are expected to be taken
in the future will contribute to a recovery abroad and in Sweden as the global financial
system begins to function better. At the same time, a weak krona stimulates the economy.
GDP growth is expected to be positive but relatively low in 2010. However, the labour market
will lag behind and employment will not begin to rise until 2011.
Inflation measured in terms of the consumer price index will fall very rapidly in 2009. This is
primarily because the Riksbank's substantial interest rate cuts at the end of 2008 and the
beginning of 2009 reduced households' housing costs. If the effects of unchanged mortgage
rates are excluded, inflation will develop in a more stable manner and be close to the target
of 2 per cent for most of the forecast period. It is weak productivity developments and the
weak krona that will contribute to holding up inflation despite the economic recession.
If the Swedish economy risks deteriorating more than expected, it may be necessary
to implement further unconventional measures
The future direction for monetary policy will depend, as usual, on how new information on
economic developments abroad and in Sweden will affect the prospects for economic activity
and inflation in Sweden.
If the economic situation deteriorates further it is possible to use monetary policy easing to
further stimulate the economy. But there are also reasons for further consideration of what is
an appropriate level for the repo rate. If the repo rate were to become too low the
transmission mechanism might become less effective. This is because some market rates
are lower than the repo rate. When the repo rate approaches zero, these interest rates would
no longer be able to follow. A too low repo rate could also create costs in the financial sector
as the result of, for instance, a reduction in the banks' margins. There is thus a risk that the
functioning of the financial markets will deteriorate if the repo rate is cut further. In this case
monetary policy will not have the intended effect.
However, the Riksbank can stimulate the economy further in other ways without needing to
cut the repo rate to zero. The most important measure concerns ensuring that the real
interest rate, that is, the repo rate adjusted for inflation expectations, is sufficiently low. This
can be done by influencing inflation expectations, which is made easier as we have a
numerical inflation target and we publish forecasts for both the inflation rate and the repo
rate. We can, for instance, announce that we are going to hold a low repo rate for a longer
period than we assumed at the monetary policy meeting in April and show how the inflation
path will then approach 2 per cent more quickly than otherwise. This would raise inflation
expectations.
A further possibility would be for the Riksbank to contribute to pushing down the rate on
government bonds, housing bonds or commercial paper by purchases in these markets.
There may also arise a portfolio balance effect if other market participants' demand for
corporate bonds, for instance, were to rise as a result of the Riksbank's purchase of
government bonds. However, there is reason to await a more detailed analysis of the need
for, and possibilities with, these measures. There are also a number of legal issues
surrounding this type of measure that must be taken into account before such measures are
implemented.
At the most recent monetary policy meeting I did not consider that it was yet time to do
anything other than cut the repo rate. What the Riksbank must consider further ahead is
whether economic developments require further interest rate cuts and whether the current
monetary policy then needs to be supported by more unconventional methods. We must be
prepared to be able to implement an alternative monetary policy if developments should so
require. However, one should be aware that the situation in the financial markets differs in
different countries, which means that not all central banks choose to take exactly the same
measures.
I would also like to mention in this context that the Riksbank is not the only institution
involved with regard to managing the alternative measures to improve the functioning of the
financial markets. It is important in this situation to analyse the financial structure in Sweden
and how one wishes this to look in the future. The measures will to some extent govern the
structure of the financial sector when the crisis is over.
There is also a discussion on whether the Riksbank should try to weaken the krona directly in
a situation where the repo rate cannot be cut further. I would like to emphasise that such
measures are not under consideration.
If inflation risks rising more quickly than expected in the future, monetary policy will
have to be tightened sooner than is indicated by the repo rate path
It is important to emphasise that the Riksbank has changed over to very expansionary
monetary policy over the past six months. The real interest rate is expected to be very
negative throughout the forecast period. This entails a powerful stimulus of the Swedish
economy. The discussion is currently dominated by the question of how we should manage
monetary policy in the prevailing recession. As monetary policy is forward-looking, it is
important not to overlook the potential inflationary impulses now being built in for the future.
Price impulses from a weak krona and from high unit labour costs are two such factors. If the
global economy recovers more quickly than we are predicting, this will also contribute to
making monetary policy less expansionary.
Before further measures are taken, there are thus many reasons to evaluate the effects of all
of the measures taken so far, and to evaluate the new information on economic activity and
the financial market situation that is received.
Continued financial crisis
Difference between 3-month interbank rate and expected
policy rate (basis spread), basis points
400 400
Sweden
Euro area
350 350
USA
United Kingdom
300 300
250 250
200 200
150 150
100 100
50 50
0 0
Jan/ 07 Apr/ 07 Jul/ 07 Oct/ 07 Jan/ 08 Apr/ 08 Jul/ 08 Oct/ 08 Jan/ 09 Apr/ 09
Economic downturn worsens in Sweden
GDP, quarterly changes in per cent calculated as annual rate,
seasonally-adjusted data
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
February
-8 -8
April
-10 -10
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Sources: Statistics Sweden and the Riksbank
Repo rate cut to 0.5 per
cent

Economic downturn worsening

Low repo rate for long period of
time

Positive growth in 2010
Low repo rate for long period of time
Per cent, quarterly averages
6 6
90%
75%
50%
5 5
Repo rate
4 4
3 3
2 2
1 1
0 0
04 05 06 07 08 09 10 11 12
Note. The uncertainty interval does not take into account the zero bound.
Source: The Riksbank
BIS Review 56/2009