Per Jansson: Perspectives on the Riksbank's monetary policy
Speech by Mr Per Jansson, Deputy Governor of the Sveriges Riksbank, at the Centre for
Business and Policy Studies, Stockholm, 7 June 2013.
* * *
Nowadays one can hardly open a newspaper without seeing headlines about the Riksbank.
Many have opinions about the monetary policy we have conducted in recent years, and the
one we are conducting now.
The opinions differ in nature. The Riksbank has conducted the monetary policy we consider
best balanced to attain the inflation target and create conditions for long-run sustainable
growth. However, some analysts have not shared the Riksbank's view of economic prospects
and have therefore reached slightly different conclusions as to how monetary policy should
have been designed. Of course, this type of difference of opinion is not particularly
remarkable in a field such as monetary policy, where decisions necessarily have to be based
on assessments.
But there are also other objections that are more a matter of principle and aimed at the very
way the Riksbank conducts its policy. Although it is not always stated explicitly, the message
is that the Riksbank is conducting a policy other than the one it is intended to conduct - that,
to put it drastically, the Riksbank has misunderstood its task and is "playing by its own rules".
It has been claimed, for instance, that the Riksbank has a tendency to be over-zealous in
combating inflation and to care too little about unemployment. Seen over a longer period of
time, inflation would thus on average have been too low and unemployment unnecessarily
high - this has also led to a discussion about the target for monetary policy.
Others argue that the Riksbank takes into consideration in its repo-rate decision factors that
should not be considered. This criticism has been mainly aimed at the Riksbank's concerns
over household debt that have contributed to monetary policy being somewhat less
expansionary in recent years than would otherwise have been the case. It has sometimes
even been claimed that the Riksbank has on its own initiative introduced new targets for
monetary policy that lie outside its statutory mandate.
Here I would like to be clear about my personal opinion: I think that the Riksbank has
succeeded well in its task of attaining low and stable inflation. I thus do not share the view
that we have been over-zealous in combating inflation. I also think that a policy that gives
consideration to the risks in the credit and housing markets is entirely compatible with our
mandate of creating conditions for stable economic growth and that this has nothing to do
with introducing new targets for monetary policy. As it would be unfortunate if the impression
that the Riksbank is exceeding its mandate takes root, I intend to use much of the time at my
disposal today to explain why I consider this not to be correct. Furthermore, the Riksbank's
aim to take risks into consideration to attain a long-run stable development of the economy is
well in line with the international discussions now taking place regarding the choice of
direction faced by central banks in the wake of the financial crisis. I would therefore also like
to broaden the perspective and put the debate here in Sweden in a larger context.
We need a nuanced discussion of the development of inflation
Let me begin with the criticism that the Riksbank has been over-zealous in combating
inflation. The actual starting point for this criticism is that CPI (consumer price index) inflation
has undershot the inflation target of 2 per cent on average since the target was introduced.
This has received considerable media attention and been debated in blogs - which is of
course not a problem in itself. It is important and absolutely necessary that the target
attainment of monetary policy is analysed and discussed to enable the Riksdag and
ultimately the Swedish people, to ensure themselves that the Riksbank is doing the job it has
been assigned to do. But for exactly this reason it is unfortunate that the reporting of the
average inflation rate has often been rather superficial and in certain cases, intentionally or
unintentionally, not entirely correct. In some extreme cases it has even been claimed that the
inflation target has in practice ceased to apply. Headlines and comments of this type hardly
contribute to a serious debate on monetary policy.
Let us begin by looking at the data and seeing how inflation has developed since the target
was introduced. As you probably know, the target was announced in January 1993, but
began to apply officially to the annual increase in the CPI with effect from 1995.1 To obtain an
inflation series that better corresponds to the one the Riksbank had access to when making
its repo-rate decisions, one has to take into account the fact that the calculation method for
the CPI was changed in 2005. Inflation has varied substantially during the period, both
overshooting and undershooting the target, but it has been 1.4 per cent on average during
the period January 1995 to December 2012, that is six tenths of a percentage point lower
than the inflation target of 2 per cent.
Some critics seem to assume that this is all the information one needs to assess monetary
policy. They argue that each tenth of a per cent below the target has entailed major costs to
the real economy, and this is enough to draw the conclusion that monetary policy has not
been able to deliver what it should.
Do not forget how things were in the 1970s and 1980s!
My view is that one must look at the development of inflation in the right perspective and
remember how things were before the target was introduced. Let us compare inflation and
economic developments in general during the twenty years the inflation target has been in
place with the twenty years prior to its introduction. During the 1970s and 1980s, average
inflation was almost in double figures and varied substantially from year to year (see
Figure 1). Sweden was a country without a nominal anchor. There was no credible level for
inflation that price setting and wage formation could use as benchmark and the economy
was stuck in a devaluation cycle. This was a fundamental problem that the Swedish
economy was suffering when it entered the 1990s crisis.
We came out of the crisis with a whole new monetary policy regime - inflation targeting. This
policy was relatively untested internationally and it was far from clear that it would work. Such
doubts may seem surprising today, bearing in mind how natural an inflation target is now and
how inflation expectations are stably anchored around the target. And this, in turn, reflects
the most important contribution from inflation targeting - in my opinion its main merit - that it
has functioned as a nominal anchor for the economy for two decades (see Figure 2).
The reform of the monetary policy framework was not the only important change in the
Swedish economy following the crisis at the beginning of the 1990s. However, the inflation
target is definitely one of the most important explanations for inflation being on average
around 7 percentage points lower during the two decades following the crisis, compared with
the two decades prior to the crisis. In addition, inflation has been much more stable. At the
same time, growth has not been lower than before; rather it has been quite a bit higher (see
Figure 3). From this perspective, I think that one must say that inflation targeting has been a
great success.
CPIF inflation of 1.8 per cent on average is a good result
An assessment of monetary policy cannot merely be based on an analysis using hindsight
and comparing inflation outcomes with the target. There are a number of reasons why
inflation may deviate from the target, despite monetary policy being conducted accurately. It
is therefore necessary to modulate the analysis and see which factors explain why CPI
inflation has on average undershot the target.
The prices in the Swedish CPI include a component that reflects households' mortgage
interest expenditure. When mortgage rates rise, this component contributes to pushing up
CPI inflation and, vice versa, when mortgage rates fall, it pushes down inflation. Normally,
the variable mortgage rates follow the development of the repo rate fairly closely. This means
that when the Riksbank cuts the repo rate to increase activity in the economy and gradually
bring up inflation, the initial result is that CPI inflation falls, that is to say, the direct impact on
inflation is "in the wrong direction". This is why the Riksbank often allows monetary policy to
be guided by the CPIF inflation measure - a measure of underlying inflation that is not
directly affected by changes in mortgage rates and therefore is not impacted by this effect
(see Figure 4).
The fact that the CPI is impacted by changes in the interest rate in this way is of course
something the Riksbank was aware of when the inflation target was introduced. The choice
was still made to define the target in terms of the CPI, as the CPI is a broad price index that
represents normal purchases and is familiar to the general public. But as the Riksbank has
pointed out, measures of underlying inflation are also used to obtain indications of the more
lasting inflationary pressures. CPI inflation is constantly affected by temporary factors, which
there is no reason to counteract with monetary policy - for instance, the direct effect on
interest expenditure of the Riksbank's own monetary policy. Underlying measures, such as
the CPIF, have thus often been used to guide monetary policy.2
Twenty years is a long time, and one might expect that the effects of fluctuations in interest
rates on the interest-expenditure component in the CPI would offset one another. The
average inflation rate according to both the CPI and the CPIF would therefore be roughly the
same. However, this is not the case. The average rate of inflation measured in terms of the
CPIF during the period 1995-2012 is 1.8 per cent. In other words, most of the deviation in
CPI inflation from the inflation target is explained by interest rates falling more than they have
risen during the period. When this effect is discounted, there remains a deviation of two
tenths of a percentage point from the inflation target. Although this deviation should not be
ignored, it can hardly be called a major failure. From a broader historical perspective and
with a realistic attitude to the precision of monetary policy, I think that one can stick out one's
neck and say that an average CPIF inflation rate of 1.8 per cent is a pass rate, perhaps even
a pass with distinction.
Calculations of costs in terms of number of unemployed must be taken with a rather
large pinch of salt
This leads me in to the discussion on the costs to the real economy of inflation on average
undershooting the target. One calculation has been presented by my former Executive Board
colleague, Lars E.O. Svensson, who arrived at an average cost corresponding to 38,000
persons unnecessarily unemployed.3 Another figure regarding the costs of the monetary
policy conducted that has attracted some attention is that 60,000 fewer people would have
been unemployed if the repo rate had been kept at the rate of 0.25 per cent, to which it was
cut during the financial crisis, until today.4 I will return to this particular calculation later on.
As I mentioned in my introduction, it is important to assess monetary policy and to analyse
potential consequences of deviations from the inflation target. But one must also be aware of
the impact of such analyses and that there is a clear risk that apparently exact figures will be
regarded as concrete truths in the debate. All calculations of this nature are based on strong
assumptions and are very uncertain, something that is easily forgotten or just ignored.
Take the calculations that I mentioned earlier. Without going into detail, one can note that
they only focus on what CPI inflation has been on average - the costs in terms of
unnecessary unemployment have arisen solely because the average CPI inflation rate has
been below 2 per cent. Supposedly, the idea is that this could have been avoided if the
Riksbank had cut the repo rate more and brought inflation up to 2 per cent.
But is this all there is to it? Remember, the important thing here is that CPI inflation is 2 per
cent. So the Riksbank should actually have raised rather than cut the repo rate. The direct
effect would then have been that CPI inflation would have been higher through the effects on
the interest-expenditure component of the CPI. Of course, this would also have had a
dampening effect on activity in the economy and on the inflation rate that is not affected
directly by changes in mortgage rates, namely CPIF inflation. But this could have been
compensated with more and larger interest rate increases and CPI inflation could thus have
been kept at 2 per cent. CPIF inflation would then fall increasingly, but this would not matter
as the calculation assumes that it is solely the average CPI inflation rate that creates the
unnecessary unemployment.
Before anyone thinks that I have gone over to the dark side, let me say that this would of
course have been an absurd and destructive monetary policy. But it illustrates the difficulty of
interpreting the results of calculations that solely focus on the average of CPI inflation.
Söderström and Vredin (2013) discuss this, among other things, in an analysis of inflation,
unemployment and monetary policy. One conclusion of their analysis is that the link between
CPI inflation and unemployment has many causes and that it in itself therefore does not give
much guidance as to how well monetary policy has been conducted. They also make an
alternative calculation of the effects of monetary policy on unemployment, based on the
deviation in CPIF inflation from 2 per cent and reach a figure of around 12,000 unemployed
on average. But the main message in their analysis is that calculations of this type must
necessarily be based on a number of more or less realistic assumptions of how the economy
functions. It is therefore important to take the figures produced with a fairly large pinch of
salt.5
Recent criticism
As I noted in my introduction, in addition to the criticism of the historical attainment of the
inflation target, there has also been criticism of the policy conducted in recent years. This
claims that the Riksbank has considered factors in its repo-rate decisions that should not
have been considered. The main focus of this criticism has been that the Riksbank has
concerned itself with household debt and developments on the housing market and thus not
conducted a sufficiently expansionary monetary policy. Sometimes it has even been claimed
that the Riksbank has introduced a new target that contravenes its mandate and that the
Riksbank has begun to conduct "housing policy".
This is of course an attempt to take the argument to its extreme. Monetary policy has
constantly been aimed at bringing inflation back on target and creating conditions for
longrun stable growth in the Swedish economy. The reason why the Riksbank has conducted the
policy it has conducted is that it has tried to reduce the risk of excessive debt and overly
inflated housing prices. Swedish household debt has shown a sharp upward trend over the
past 15 years or so and is now very high, both from an historical and an international
perspective (see Figure 5). If housing prices were for some reason to fall heavily in a
situation with high debt levels, households would find that their earlier calculations no longer
held and that their balance sheets did not look the way they expected. This could in turn start
a process whereby households try to get rid of some of their debt. This would mean that their
income would for some time to come be used for amortisation rather than consumption and
investment - we would experience a fall in demand in the economy.6 One important reason
for the recovery from the crisis being so slow in a number of countries is probably that
households have a large "debt overhang" they are trying to get rid of.7
If one were to have this type of development, it would most probably mean that
unemployment rose sharply and it would probably also be difficult to attain the inflation target
for quite a long time to come. In the countries where housing prices have fallen in connection
with the crisis, unemployment has increased quite substantially (see Figure 6). Excessive
debt thus constitutes a threat to macroeconomic stability and price stability, and
counteracting risks in this area is therefore entirely in line with the Riksbank's mandate and
objectives.8
The idea behind the Riksbank's policy
The idea behind the Riksbank's policy can be illustrated with the aid of two stylised scenarios
(see Figure 7). Either one conducts a more expansionary monetary policy, as represented by
the blue line, which endeavours to bring inflation up to the target within a relatively short time
and to quickly reduce unemployment. However, this policy means that lending to households
will increase and prices in the housing market will rise, ultimately to untenable levels. When
housing prices fall at a later stage, inflation will therefore undershoot the target substantially
and unemployment will be far above its long-run equilibrium level. All in all, target attainment
will therefore not be very good.
The second alternative, as represented by the red line, entails a less expansionary policy
that lets it take a little longer to return to the inflation target and reduces unemployment more
slowly - and in the short-term perspective therefore leads to poorer target attainment.
However, this policy also means that one avoids debt becoming excessively high and
housing prices accelerating out of control. One thus also avoids the turbulence that arises
from a subsequent fall in housing prices and target attainment is better in a longer-term
perspective. This policy is usually described as monetary policy "leaning against the wind".
It should be emphasised that this is of course an exaggerated and highly stylised example
aimed at proving a point of principle. In reality, the deliberations we have to make are much
more complex.9 Monetary policy is not a question of choosing between two alternatives that
will occur with certainty if one conducts a specific policy; it entails weighing the risks and
probabilities of various scenarios against one another. In this case, the risk of a really poor
development further ahead must be balanced against short-term costs. One is forced, so to
speak, to pay an "insurance premium" in that a slightly less expansionary monetary policy in
the short term leads to slightly lower inflation and slightly higher unemployment. A particularly
difficult situation arises if a weak development of the real economy means that the short-term
costs of conducting a less expansionary policy appear to be large at the same time as the
risks linked to credit granting and the housing market increase.
To summarise: in principle, there is no doubt that the Riksbank according to its mandate may
take into consideration risks linked to a rapid increase in household debt. Such risks can
constitute a threat to both the stability of the macro economy and inflation. To me, saying that
the Riksbank has no mandate to take these risks into account therefore appears rather odd.
As the Governor of the Bank of England, Mervyn King, has put it: "Monetary policy cannot
just 'mop up' after a crisis. Risks must be dealt with beforehand. I do not see this as
inconsistent with inflation targeting because it is the stability of inflation over long periods, not
year to year changes, which is crucial to economic success."10 Similar thoughts are expressed
in the IMF's Article IV consultation for Sweden: "[I]f mortgage credit growth increases
unsustainably, the Riksbank might have to raise the interest rate path relative to that
warranted by short-run macroeconomic considerations alone."11
Is it meaningful to consider risks linked to household debt in monetary policy?
If one is thinking about giving consideration to risks linked to household debt when
formulating monetary policy, it is reasonable to first take a stance on a number of specific
questions.12 Does the repo rate have an effect on the variables one wishes to influence,
housing prices and lending? How large are the risks linked to household debt? And finally,
are there other tools at hand that are better-suited to managing these risks?
The answers to these questions are important for determining whether it is justified taking the
risks linked to household debt into account in monetary policy. It is also precisely these
questions that have been discussed in the general debate on the role of monetary policy in
this context. I therefore intend to discuss these questions one by one and in relative detail.
Can the repo rate affect housing prices and lending?
It is probably true that the effect of a typical change in the policy rate on housing prices and
lending to households is on average not very large. In addition, the policy rate is a blunt
instrument when it comes to influencing housing prices and lending, as it is an interest rate
that applies to the whole economy. This is why more specific tools, what are known as
macroprudential tools, are generally perceived as more appropriate than the policy rate for
counteracting this type of specific imbalances.
But the effect of the policy rate most likely varies quite substantially depending on the
circumstances prevailing at a specific time. In some situations it may be enough to make
fairly limited increases to subdue an overly rapid upswing in the housing market, for instance,
if the central bank combines these increases with communication emphasising that current
developments are perceived as cause for concern.13 Small interest rate increases then
function more as a concrete "reminder" that the central bank is concerned over
developments, but it is rather the communication in itself that has the dampening effect. In
this case, the impact on the rest of the economy need not be so great either. The fact that
communication on monetary policy can play an important role in this context is emphasised
by, for instance, Mark Carney, Governor of the Bank of Canada and soon to be Governor of
the Bank of England: "[P]rivate agents may choose to accumulate less debt if they
understand that a broad-based build-up of debt is likely to cause the central bank to raise
interest rates."14
Monetary policy is expansionary
It should be fairly clear that it is precisely this type of "signalling strategy" that the Riksbank
has used. Monetary policy since the crisis has not entailed using sky-high interest rates to
stop an upswing in lending and housing prices, at any cost. What we have tried to do is to
find a suitable balance to be able to support the recovery, without "pressing too hard on the
accelerator", thereby contributing at least at the margin to a calmer development in house
prices and lending to households. It can hardly be claimed that the policy conducted by the
Riksbank during the recovery from the crisis has been tight or that the current policy rate
level does not contribute to boosting economic activity.
I also think that in this context it is useful to look at the international debate. Although the
general view is that macroprudential instruments are normally preferable for counteracting
this type of imbalance, there is also a lively debate on what role the policy rate should play.15
In this debate, it is not assumed that the policy rate is entirely ineffective and insignificant,
and "the jury is still out".
A dubious counterfactual experiment
I would like to give an example from the Swedish debate, where I believe one has taken the
potential of monetary policy to influence expectations too lightly. As I mentioned earlier, it has
been claimed that up to 60,000 more people would have had jobs if the Riksbank had
conducted a different monetary policy after the crisis and kept the repo rate at the level of
0.25 per cent to which it was cut in July 2009.16
When the Riksbank began to raise the repo rate in the middle of 2010, the situation was such
that the Swedish economy had recovered surprisingly quickly from the crisis. Growth was
record high, about 6 per cent in annualised terms in the first quarter, and basically all leading
indicators of economic activity were pointing upwards. Household lending, which had
increased at double figures in terms of annual changes prior to the crisis, had begun to slow
down, but the increase in credit was still 9 per cent, far above the increase in disposable
income. At the same time, inflation measured in terms of the CPIF was close to 2 per cent.
I find it difficult to see that it would have been realistic to declare in this situation that the repo
rate would not be raised, but would remain at 0.25 per cent for the foreseeable future. The
expectations this would have created among households and on the credit and housing
markets would most likely have been very difficult to manage. Such a policy might be
appropriate to try to "kick-start" an economy that has suffered a severe crisis, where housing
prices have already fallen and households are trying to reduce their debt. But for countries
that are not in this situation, and where debt and housing prices remain high and are
increasing, it does not appear to be a realistic policy.
How large are the risks linked to household debt?
Let me now move on to the next question, which concerns the actual size of the risks linked
to household debt in Sweden.
It is true that there are estimates suggesting that the housing market in Sweden is not
overvalued. Some of these estimates have been made by the Riksbank itself. This could mean
that the high level of debt among Swedish households is not such a large problem, either.
But there are also estimates that suggest an overvaluation.17 And when there is so much at
stake, there are good reasons, as I see it, to be particularly cautious.
After all, it was not the case that the corresponding estimates prior to the crisis showed any
impending problems in the countries that have now been hit so hard. As Stefan Gerlach,
Deputy Governor of the Central Bank of Ireland, noted recently, it is always easy to gain
support for the opinion that housing prices are currently correctly valued - even if this soon
proves to be incorrect.18 In Ireland, the opinion immediately prior to the crisis was that
housing prices were not abnormally high and that the banks were stable and
wellconsolidated. I am convinced that this was how most countries, which have suffered
problems, viewed their situation.19
Nor does the size of household wealth appear to have had any decisive significance for the
impact of the crisis. The countries that have been hit hardest include ones with both stronger
and weaker wealth positions than Sweden (see Figure 8). The reason why a strong wealth
position does not necessarily provide a good protection is probably that a large part of the
wealth mass is not very liquid and thus its use as a buffer in times of crisis is limited. This
applies in particular if the crisis leads to a fall in housing prices. A high level of wealth is thus
no guarantee for avoiding problems; the best strategy is of course to try to prevent a crisis
from arising at all.
It may of course be the case that we in Sweden really are different. But I am sceptical to this.
I think it is very risky to rely on this being the case. Now that we have seen that the costs in
many countries have been so high, I at least draw the conclusion that there is reason to try to
reduce the risk that we may also find ourselves in this situation, even if it is not the most
likely development. As I mentioned earlier, monetary policy is to a large extent about
managing risk. I have not so far felt that the short-term gains of a slightly more expansionary
policy are sufficient to compensate for the threat of losses further ahead in a really bad
scenario.20 But, once again, it is a question of balance and things may change over time. The
policy we have conducted has actually been expansionary and mainly concerned sending
signals that developments give cause for concern. At some point the "insurance premium"
becomes too large, but I do not think this can be said to have happened yet.
17
For a comprehensive survey of the valuation of the Swedish housing market, see Sørensen (2013), in which
the following conclusion is drawn (p. 71-72): "[A] cautious reading of the evidence gives reason to expect
downward pressure on Swedish real house prices in the years to come. And if the Swedish economy were to
be hit by a large negative shock, the downward adjustment of house prices could become more rapid than the
analysis ... would suggest."
18
See Dagens Industri (2013b).
19
Bernanke (2010) describes the difficulties experienced by the Federal Reserve in determining whether or not
the housing market in the United States was over-valued.
20
Similar ideas can be found in, for instance, Blanchard, Dell'Ariccia and Mauro (2013), p. 7: "[G]iven what we
have learned about the costs of inaction, higher type I errors (assuming that it is a bubble and acting
accordingly, when in fact the increase reflects fundamentals) in exchange for lower type II errors (assuming
the increase reflects fundamentals, when in fact it is a bubble) may well be justified."
Are better instruments than the policy rate already available?
The third question concerns the access to other tools than the repo rate for managing risk.
Those who are critical of using the repo rate claim that there are already other and
bettersuited instruments available.
I consider this criticism to be a little strange and to make too many assumptions in advance.
It seems to assume that there is already a framework for macroprudential policy in place in
Sweden, which clearly states what instruments are to be used and by whom. Let us assume,
for instance, that the Riksbank had held the policy rate at 0.25 per cent up until now, as was
the case in the counterfactual experiment I mentioned earlier, and that this had meant that
lending to households and housing prices had begun to rise sharply again. Would it really
have been obvious how this should have been managed and by whom? Bearing in mind how
the risks in this field have been allowed to increase in Sweden over the past 15 years, I
doubt that this would have been the case.
In other words, I believe we are still a long way from a satisfactory situation. I am quite
convinced that for this to work the allocation of responsibility must first be clearly specified
and there must be clear guidelines for what should be done. However, a potential framework
for macroprudential policy is only under investigation. The Financial Crisis Committee has
presented a partial report that was recently circulated for consultation. But it is not likely that
a complete solution will be in place in the very near future.
Different views on macroprudential tasks
Judging by the consultation responses to the Financial Crisis Committee's partial report,
opinions are relatively divided as to what role macroprudential policy should play with regard
to the development the Riksbank has tried to manage in recent years. There is a possibility
that excessive debt could result in a conspicuously weak macroeconomic development
without any threat to the stability of the banking system. Some of those consulted consider
that macroprudential policy does not have a role to play in reducing these types of risk, given
that they do not present a clear threat to the stability of the banking system.21 With this type of
solution monetary policy would not obtain the support from macroprudential policy needed to
be relieved of "leaning against the wind". Indeed, my impression is that macroprudential
policy is often assumed to focus on the stability of the banking system. This means that risks
in the credit and housing markets that do not clearly threaten the banking system, but could
nevertheless lead to major macroeconomic problems, would risk being overlooked.
There is a lot that remains to be investigated and decided on before a practical framework for
macroprudential policy is in place. My impression is that, compared with many other
countries, we have if anything fallen a little behind. This is unfortunate, as the situation in
Sweden, as I noted earlier, is actually slightly more sensitive than that in many other
countries, where housing prices have already fallen and households have