SPEECH
SVERIGES RIKSBANK
DATE:
13/11/2019
SE-103 37 Stockholm
SPEAKER: (Brunkebergstorg 11)
Deputy Governor Martin Flodén
VENUE:
Örebro University and Kommuninvest, Örebro
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Monetary policy in a changing world*
Over the past year it has become increasingly clear that economic growth is
slowing down, both in Sweden and abroad. It is not surprising that growth is slightly
lower than during the strong years 2014-2018. But there have recently been
increasing signs that the slowdown will be larger and occur faster than we at the
Riksbank have been expecting.
To determine how monetary policy should react to this, we need to understand
why growth is falling. Is it due to weaker cyclical economic activity, or to deeper,
structural changes in the economy?
Today I intend to first briefly discuss some structural changes that may have had
significance for economic developments in recent years. These are changes that
may have entailed lower underlying interest rates and growth and lower
inflationary pressures, and which may affect the conditions for the Riksbank's work going
forward.
After that, I will say a few words about the possibilities open to monetary policy if
economic developments become weaker than we have forecast. In conclusion, I
would like to say a few words about climate change, one of the structural changes
that affects the way the economy functions. How is the Riksbank's work affected
by climate change and how can the Riksbank contribute to greener financial
markets?
The economy changes
The international economic playing field has changed in many ways in recent
years. Let me give some examples:
• The geopolitical situation has deteriorated and nationalistic tendencies have
become more common. This has led to increased protectionism and new
trade barriers. After many decades of increased international trade and
international capital flows, globalisation has now taken a step back.1
•
China has emerged as an increasingly important actor on the world market.
This has led, for instance, to increased saving in the world economy and
contributed to lower interest rates.2
•
Life expectancy has increased and we anticipate spending a longer period in
retirement. Population growth is falling in the major economies. As a result,
GDP growth and investment needs are lower, but we wish to save more. All of
this contributes to lower interest rates.
• Digitalisation means that we do our shopping in new ways. E-commerce is
becoming increasingly common and websites for price comparison are used
regularly. Consumption is shifting from goods to services and experiences, often
with low marginal costs in production. This leads to increased price
competition and to inflationary pressures being lower temporarily. But despite the
rapid technological changes, the productivity growth figures have fallen both
in Sweden and abroad.3
• We are becoming increasingly aware of the problems linked to climate
change. This also contributes to changing our consumption and production
patterns. The adjustment to such changes may be difficult and may also lead
to the measured GDP growth being lower. But this adjustment can also in
many ways lead to new markets and new opportunities opening up and to
new, large-scale investment needs arising.
Why are economies slowing down now?
We would normally believe that structural changes occur slowly and that they
therefore should not be behind a rapid change in the sentiment of the economy.
But there are nevertheless many indications that the subdued economic growth
and the rapid fall in confidence shown by the indicators over the past year have
several links to the structural changes.
When the number of trade barriers increases, the opportunities to benefit from
economies of scale and international specialisation decline. The uncertainty
regarding the rules for international trade dampens the willingness to invest. The
uncertainty regarding future regulations and taxation of, for instance, diesel and
petrol driven cars reduces demand for them. The intensive discussions on the
climate impact of air travel may dampen demand for air travel. In Sweden, for
instance, travel by domestic flight has declined.
Monetary policy cannot affect these structural changes or ensure that we attain a
certain level of economic growth. Some of the changes are unavoidable, for
instance because of technological advances. Other changes are due to political
choices and priorities.
But the structural changes affect the conditions for monetary policy. The low real
interest rates have reduced the scope for monetary policy to manage economic
fluctuations. Policy rates in many countries cannot be cut much from the current
levels. The possibilities to push down interest rates with further quantitative
easing are limited. If policy cannot be made more expansionary in other ways, the
structural changes, combined with a normal economic downturn may lead to the
economies getting stuck in a situation with unnecessarily low growth.4
Fiscal policy will play a larger role in
stabilisation policy
In the debate, and especially internationally, many suggestions have been put
forward on how to make monetary policy more expansionary with other means.
There is talk of coordinating fiscal and monetary policy, "helicopter money",
"modern monetary theory" and the purchase of specific private assets.5 What this
means in more concrete terms, is that central banks should start giving out money
to individual households, to the treasury, or that they should subsidise the private
business sector, tasks which would usually fall to fiscal policy rather than
monetary policy.
To determine whether it is a good idea for central banks to step into the field of
fiscal policy, we need to clarify the difference between the government's and the
central bank's finances. Is there a difference between money issued by the central
bank and bonds issued by the government? Is there a difference between the
central bank's and the government's access to liquid funds?
Although both central bank money and government bonds are a form of claim on
the same counterpart in the same currency, there are nevertheless some
differences that in certain situations can be important. The first difference concerns
liquidity. Central banks create liquidity on their own by issuing banknotes or by
increasing the commercial banks' balances in their central bank accounts. A central
bank can thus always "pay" if it wants to. However, in a country with an
independent central bank, the government does not have access to a credit line that
can be extended freely. To obtain access to more liquidity, the government must
instead issue bonds and sell them on a market.
The second difference concerns the exposure to credit risk when holding central
bank money or government bonds. Both the central bank and the central
government can default on their payments in two ways: by not repaying the debt, or by
inflating away the debt. It does happen that countries fail to repay their debts. If
the debt lies with the central bank, it is more likely that it will be inflated away.
Based on this reasoning, are there situations where the central bank should step
into areas similar to fiscal policy? Yes, there could be such situations. One might
be if an acute shortage of liquidity arises, for instance, during a financial crisis.
Central banks are better than government at creating liquidity quickly.6 Another
situation is if the market begins pricing a higher credit risk in government bonds
than in central bank money. If one wants the credit risk to be transformed into an
inflation risk, it may be desirable for the central bank to step in and support the
government's funding, for instance by buying government bonds or through direct
transfers to the treasury. A similar situation may arise in a monetary union if there
is no fiscal policy at union level.
But we are not close to one of these situations in Sweden today. Our public
finances are in good shape. National debt is low. Fiscal policy is then best handled
by the government, not by the central bank.
The Riksbank's monetary policy is already expansionary and contributing to
supporting demand in the Swedish economy. But there are limited possibilities to
make monetary policy even more expansionary, in my opinion. There are,
however, good possibilities to make fiscal policy more expansionary. I therefore
believe that fiscal policy will play a larger role in stabilisation policy if economic
activity weakens further in the coming years.
Climate change entails new economic and
financial risks
Climate change is one of the structural changes I have talked about today. I have
noted that Örebro was one of the first municipalities in Sweden that issued a
green bond. Here at Kommuninvest, in Örebro, I think that it may be appropriate
to conclude by elaborating on what I see as the Riksbank's role in the work to
achieve greener financial markets.
Climate change affects the way the economy functions. Its impact is most clear in
the insurance sector, as a direct consequence of the risks of climate-related
damage. The risks may also increase on the financial markets when various branches
are forced into major changeovers as a result of demand, taxation or regulations
being changed.7 Monetary policy can also be affected more directly, for instance if
economic data becomes more difficult to interpret when the effects of the
weather lead to larger fluctuations in prices and production.8
It is important that the Riksbank understands these changes, both to be able to
conduct an effective monetary policy and to be able to identify risks on the
financial markets. In other words: the Riksbank must be able to manage the economic
consequences of climate change.
Should the Riksbank buy green bonds?
Another question that is sometimes discussed is whether the central banks
themselves should try to affect climate change. This usually involves two different
directions. The first is regulating the financial markets to steer investments in a
more sustainable direction. In many countries it is the central bank that is
responsible for this type of regulation, but in Sweden it is the responsibility of
Finansinspektionen (the Swedish financial supervisory authority). The Riksbank does not
have any of these tools at its disposal.
The second direction concerns the central bank's own investments. After the
financial crisis, many central banks, including the Riksbank, built up large balance
sheets through asset purchases. Shouldn't these purchases reward sustainable
assets, for instance by focusing on green bonds?
This is a question faced by central banks today, and the answer is not evident. I
shall try to describe my views on this. But I would like to point out that these are
preliminary views. I am happy to listen to arguments against them.
The Riksbank's assets can be roughly divided into two parts. We have a portfolio
of Swedish securities (almost SEK 400 billion), that has been built up through
quantitative easing for monetary policy purposes. And we have foreign exchange
reserves (just over SEK 500 billion) that we hold for contingency purposes.9
The Swedish portfolio consists solely of government bonds. This is partly to hold
down financial risks, and partly because monetary policy, apart from determining
the general interest-rate level, should disturb pricing on the financial markets as
little as possible. The state is the Riksbank's principal. It would therefore seem
inappropriate to me if the Riksbank chose government bonds to attempt to give the
government incentive to work towards a more sustainable development. I
therefore do not think that the Riksbank should treat green Swedish government bonds
any differently from other Swedish government bonds.10
The conditions for active climate consideration are slightly better in our work with
the foreign exchange reserves. To ensure that the foreign exchange reserves fulfil
their purpose, they need to consist of assets that can be rapidly converted to
money even when the markets are not functioning properly. Our assessment is
that the foreign exchange reserves best correspond to this need if they consist of
75 per cent US government bonds, 20 per cent German and 5 per cent British,
Danish and Norwegian government bonds.
But to attain a higher yield and reduce the financial risk, the Executive Board has
decided that a limited part of the foreign exchange reserves can be invested in
other assets. The condition is that these are assets with a high credit rating and
good liquidity, issued by central governments, provinces or intergovernmental
organisations.11
The Riksbank gives consideration to the
climate in its investments
Last year we stated in our risk and investment policy that we would also give
consideration to sustainability aspects when choosing assets. The Riksbank has not
yet fully decided how sustainability aspects should be taken into consideration in
the investment decisions. There are two main lines to choose between: either we
choose which assets or which issuers we want to have in the foreign exchange
reserves.
The choice between assets would mean trying to invest some of the foreign
exchange reserves in particularly climate-friendly assets, such as green bonds. I have
doubts about this type of strategy, primarily as our investments are largely in
bonds issued by central and federal governments. It is difficult to earmark money
for special projects in government budgets.
The Riksbank rejects issuers with a large
climate footprint
I believe it is better to instead focus on the issuers, and to make an overall
assessment of how they work to promote a sustainable climate. Indicators of this could
be, for instance, their greenhouse gas emissions. This is how we are now
beginning to give consideration to sustainability in our new risk and investment policy.
We will not invest in assets issued by issuers with a large climate footprint when
we are choosing other assets than those best corresponding to our policy need.
This has some consequences for the holdings in our foreign exchange reserves.
The Riksbank has invested around 8 per cent of the foreign exchange reserves in
Australian and Canadian central and federal government bonds, as they give
relatively high yield and a good diversification of risk, at the same time as being
traded on liquid markets.
But Australia and Canada are countries that are not known for good climate work.
Greenhouse gas emissions per capita are among the highest in the world, but vary
considerably between the different states. For instance, greenhouse gas intensity
is more than three times higher in production in Alberta than in Ontario and
Quebec. As a result of the new investment policy, we sold our holdings of bonds
issued by Alberta in the spring. For the same reason, we have recently sold our
holdings in bonds issued by the Australian states of Queensland and Western
Australia.
The Riksbank needs to develop its work on how to take climate change into
consideration in asset management. For instance, we need broader and deeper
analysis of the issuers' climate footprint. At the same time, one must remember that
the foreign exchange reserves are unavoidably dominated by US and German
government bonds. The Riksbank's contribution to a better development of the
climate will therefore remain small. This is entirely natural. The important decisions
on how climate change should be counteracted in Sweden are political and should
be taken by the government and the Riksdag (parliament).
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