Cecilia Skingsley: A year of negative interest rates. Where do we stand
now?
Speech by Ms Cecilia Skingsley, Deputy Governor of the Sveriges Riksbank, at Danske
Bank, Stockholm, 7 April 2016.
* * *
Thank you to Christina Nyman, Ulf Söderström, Charlotta Edler, Marianne Sterner, Emil Brodin and Anders
Vredin for useful comments and assistance.
Thank you for inviting me here today. I intend to talk about three issues:
Is it possible to conduct a national monetary policy in a complicated international
environment? How has Swedish monetary policy been conducted in recent years? What
considerations should govern our choice of future path?
Is it possible to conduct a national monetary policy in a complicated international
environment?
I believe that most people will recognise the description of growth and the recovery following
the global financial crisis as being a disappointment in most countries. In many cases the
setbacks have been severe and prolonged, for instance, in southern Europe, while in other
cases growth has been positive but low.
Many central banks, wishing to live up to their price stability commitments, have implemented
more far-reaching and long-term measures to stimulate monetary policy than have previously
been imagined as possible.
So how did we get to where we are now, with such low interest rates?
In the long run, it is structural factors such as the conditions for growth and the willingness to
save that determine the level of the real interest rate. As a small, open economy, Sweden
must in principle accept the international real interest rate as a given. Monetary policy is not
able to affect the real interest rate to any great extent in the longer run, but it affects inflation
and inflation expectations.
In recent years, the IMF and other forecasters have revised down their forecasts for GDP on
several occasions. If one looks at real interest rates, these began to fall even before the
financial crisis and real interest rates have also fallen during periods of higher growth.
Opinions differ with regard to the causes of this slowdown. The more pessimistic line talk
about secular stagnation, where savings have increased and willingness to invest has
declined as a result, for instance, of the composition of the population, of growing income
gaps and weak technological innovations. This has in turn pushed down the interest rate
level compatible with normal resource utilisation.
The other more optimistic line say that remaining effects from the global financial crisis, such
as deleveraging and increased political uncertainty, explain the slowdown but that these
effects are transitory.1
Lower real interest rates and inflation
But it is not merely real interest rates that have fallen. In recent years, inflation has also
shown a downward trend. This trend began later than the decline in real interest rates, but
Swedish inflation began to fall slightly before that in other western countries such as the
United States and the euro area. The most recent downturn in inflation in the euro area can
to some extent be explained by the fall in energy prices. However, underlying inflation has
also fallen in the wake of both the banking crisis and the euro crisis.
It is necessary to take into account the decline in both real interest rates and inflation in the
monetary policy deliberations. The fundamental reasoning regarding the stabilisation ability
of monetary policy with a floating exchange rate is based on the assessment of a normal
nominal interest rate, simply described as an interval for a nominal interest rate that neither
speeds up nor slows down the economy. To estimate how high the normal nominal interest
rate should be, we look at the real interest rate and add to this the inflation target. If the real
interest rate is 2 per cent and the inflation target is 2 per cent, then the nominal interest rate
should be around 4 per cent. If the real interest rate rises to 3 per cent, and the inflation
target remains unchanged at 2 per cent, the nominal interest rate will be 5 per cent, and so
on.
But as I have just shown, developments are instead showing a downward trend. Lower real
interest rates and lower inflation and inflation expectations are pushing the nominal interest
rate downwards. This means that the central bank has to take stronger action for monetary
policy to have a stimulating effect.
Some important questions are raised here: What are the fall in real interest rates and the
downturn in inflation due to? Are these temporary or permanent changes? Are the central
banks over interpreting their price stability task or have they not done sufficient to cure the
low inflation? Some say that all things bad are mostly the fault of the central banks. I believe
that part of the intensive debate on monetary policy conducted both here in Sweden and
abroad is due to us economists tending to have different answers to these questions. These
answers in turn affect the opinions on what is the best policy in both the long and the short
term.
How has Swedish monetary policy been conducted in recent years?
Swedish monetary policy strategy entails stabilising inflation around the target and striving to
stabilise production and employment around paths that are sustainable in the long term.
If we look back two years, to the period before the April 2014 meeting, CPIF inflation had
been around 1 per cent for some time, which is too low given that the Riksbank wishes to
uphold confidence in the inflation target of 2 per cent as an anchor for price-setting and
wage-formation. Another observation from April 2014 was that the more long-run inflation
expectations had fallen below the 2 per cent level. It became increasingly clear over the
course of the year that further monetary policy stimulation was needed.
Six months later, in autumn 2014, after rate cuts totalling 75 basis points, the situation
became critical as a result of the halving of the oil price in USD. This further dampened the
already low inflation, although lower energy prices also benefit demand. On top of this, there
were clear signals that the ECB was preparing a powerful stimulation package that would
come into operation in spring 2015. Measures taken to improve the prospects for our trading
partners are of course also positive for the Swedish economy, but if the negative interest rate
differential between Sweden and the rest of the world were to increase, it could contribute to
a strengthening of the krona. This would make it even more difficult for us to attain the
inflation target.
At the beginning of 2015, the initial situation for the Riksbank was problematic. The risks of
waiting to see what happened were assessed as greater than those connected to being
proactive, as inflation had been low for a long time and inflation expectations were moving in
the wrong direction. If monetary policy had not been made more expansionary, there was a
risk that inflation expectations in the corporate and household sectors would fall further and I
did not see this is a path to higher and more normal interest rates. The Executive Board was
agreed that further stimulation was necessary. Starting from the February meeting, the repo
rate was cut below zero and the first of a series of asset purchase programmes was begun.
Furthermore, we signalled that there was a possibility of foreign exchange interventions if the
krona appreciation already forecast were so strong and rapid that it jeopardised the upturn in
inflation. We deliberately increased our focus on the development of short-run inflation, as
we had a low tolerance of poor outcomes.
What considerations should govern our choice of future path?
We are now in April 2016 and I judge that we have largely succeeded in our efforts. Growth
has become much higher than expected, although this is not merely due to monetary policy.
The trend towards declining confidence in the inflation target has turned around in that
inflation expectations have begun to rise again.
The monetary policy conducted is far from uncomplicated. In a world of minus rates it is more
difficult to assess what impact the interest rate decisions will have on different channels, that
is, how the transmission mechanism will work. It is also difficult to assess the stimulation
effects of the bond purchases.2 Moreover, the Riksbank has been clear that low interest
rates increase indebtedness among households in a way that increases vulnerability in the
Swedish economy. But most of all, I feel that our monetary policy is successful and better
than the alternative. The inflation target would have risked losing its role as anchor for
pricesetting and wage-formation if we had not cut the repo rate in 2014 and 2015.
With regard to my thoughts on going forward, I would like to begin with the monetary policy
meeting on 10 February. The report presented then stated that resource utilisation in
Sweden was assessed to be at a normal level. The members of the Board agreed that the
important thing for monetary policy is for the trend in inflation to come closer to the target and
to avoid weakening confidence in the target. The upturn in inflation is expected to continue to
be fitful and there may be surprises along the way. Whether, and if so how, monetary policy
will react depends on the causes of such surprises and how they are deemed to influence
the outlook for inflation. We were also agreed that we shall maintain a high level of
preparedness for action, even between the ordinary meetings, in case further measures are
needed to safeguard confidence in the inflation target.
Exactly how tolerant we are with regard to different outcomes may vary somewhat on an
individual basis, which is natural on a committee. In my contribution to the debate at the
meeting I wanted to say that I now have a greater tolerance for setbacks, in that we now
have a more favourable situation in Sweden. I do not see this as advocating a new monetary
policy strategy for the Riksbank. Instead I would describe it as a natural consequence of the
change in the economic situation and inflation prospects. When the analyses of data point to
resource utilisation normalising and inflation showing a trend towards the target, it is
reasonable not to make monetary policy more expansionary, but instead to see
developments in the slightly longer run. Or, as I have previously put it "it is time to take a
longer view".
Some people probably think that central banks should always take a longer view, and
normally I would agree with this. But I consider that the Riksbank was in a situation at the
end of 2014/beginning of 2015 that required greater focus on the present, in words and
deeds, to show that the Riksbank does not just talk, but also takes action to uphold
confidence in the inflation target.3
As I said in other contexts, further monetary policy stimulation must entail advantages that
are greater than the disadvantages. But I am not ruling out the possibility of further
stimulation.4 I have already referred to the reason why this may be needed in my introduction
today. The big questions, such as growth conditions, real interest rates and the behaviour of
inflation in the short and long run, have in no way been answered. My point is that the global
conditions for growth will gradually improve and that the course of inflation will normalise. But
this depends on decisions made abroad, which govern the real interest rate that we in
Sweden have to relate to.
Growth conditions in Sweden also depend on the Swedish economy's ability to constantly
transform in an orderly manner. Monetary policy can function as a bridge over to a new
normal situation. But the new normal will be determined by decisions that are beyond the
central bank's control.