Stefan Ingves: Monetary policy entails a balancing act
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank and Chairman of the Basel
Committee on Banking Supervision, to the Norrland County Administrative Board, Luleå,
4 December 2012.
* * *
Today I would like to take up some aspects of the difficult balancing act that monetary policy
has to perform and that in many respects reflect the lessons we have learned from the
financial and debt crisis.
The global economy has suffered a number of turbulent years. More than four years have
now passed since the outbreak of the global financial crisis. Unfortunately, the recovery
following this crisis came to a halt when the financial crisis developed into a debt crisis in
Europe.
The Swedish economy has coped rather well with the crisis so far. We have of course been
affected by the unease abroad and by the economic downturn, but to a much lesser extent
than many other countries. This is due to factors such as stable public finances and good
competitiveness. Another reason why Sweden has coped so well is that we have not
suffered a crash on the housing market. However, household indebtedness is very high,
which makes the households more vulnerable to a fall in housing prices and other risks. The
course of events in several countries during the financial and debt crisis shows that we must
take risks of this type seriously.
As growth prospects have weakened we have cut the repo rate over the last 12 months in
order to attain the inflation target and support economic activity. However, a lower repo rate
also increases the risk associated with household indebtedness. The decisions to cut the
repo-rate have therefore not been self-evident.
Low repo rate in Sweden over the last 12 months
In connection with the financial crisis the repo rate was lowered all the way to 0.25 per cent,
where it remained for almost a year - from mid-2009 to mid-2010. During the strong recovery
that followed the financial crisis we moved towards a normalisation of monetary policy, and
during the autumn of 2011 the repo rate reached 2 per cent. However, the financial crisis
then became a debt crisis in Europe, which has undermined economic prospects once again.
We therefore had to call a halt to the normalisation process. This year, the Riksbank has
instead cut the repo rate in a number of stages to stimulate the Swedish economy and
prevent the rate of inflation becoming too low. Historically speaking, the repo rate is now very
low (see Figure 1).
Let me now go back a little and describe how we ended up in the position we are now in with
regard to monetary policy. I also intend to take up some of the important lessons learned
from the international financial and debt crisis of recent years.
The financial crisis became a debt crisis in Europe...
The global financial crisis began about four years ago. The origins of the crisis lay in
problems on the US housing market, but after the bankruptcy of Lehman Brothers in
September 2008 the situation developed into a global financial crisis. GDP in the world as a
whole fell for the first time since the 1940s (see Figure 2). There was also a dramatic fall in
global trade (see Figure 3). This was then followed by a couple of years in which the global
economy began to recover, and global trade increased (see Figure 3).
However, it did not take long for clouds to gather on the horizon again. Problems with major
budget deficits and sovereign debts became apparent in several countries in the euro area,
primarily in Greece, but also in Ireland, Italy, Spain and Portugal (see Figure 4). In Europe,
the financial crisis was followed by a debt crisis. However, the reasons why the various
countries were hit by problems were not always the same.
In Greece, for example, public finances were far too weak at the outset to cope with such a
severe downturn as that brought about by the financial crisis. But countries like Ireland and
Spain also suffered serious problems, despite their relatively strong public finances at the
outset. How could this happen?
The problems on the US housing market originally triggered the global financial crisis. But
problems also arose on the housing markets in several other countries, such as Spain and
Ireland (see Figure 5). Public finances were hit hard when the banking sector had to be
rescued in the wake of a bursting housing bubble, in which housing prices and bank lending
had chased each other's tails to form an unsustainable spiral. This was why these countries
quickly encountered major problems in managing the growth of their sovereign debts, despite
their relatively good position at the outset.
An excessive build-up of debt - irrespective of whether it takes place in the private or the
public sector - leads to problems sooner or later. Events in the euro area in recent years
provide a frightening illustration of this.
It is clear that the euro area is facing major challenges, not only for individual countries but
for the EMU as a whole. The ECB, the EU and the IMF have implemented a range of support
measures to come to terms with the acute problems. A number of new decisions and
measures have also been announced within the EMU over the course of the year. However,
it is important to point out that responsibility for managing these problems primarily lies with
the politicians in the respective countries. Decisions are required at the national level, not
only to resolve the problem of weak public finances but also to improve competitiveness (see
Figure 6).
As the problems have worsened the recovery that began after the financial crisis in 2008 has
ground to a halt, and our assessment in the Monetary Policy Report published in October is
that GDP will actually fall in the euro area in 2012.
...which is having a major impact on the Swedish economy
Sweden is what we usually call a small, open economy. We are highly affected by
developments abroad. This high dependence on economic activity abroad has led to
considerable fluctuations in production in recent years. The fall in GDP in 2009 was the
largest since World War II, but growth in 2010 was the highest for 40 years. The recent weak
development of economic activity in the euro area has once again dampened growth
prospects in Sweden.
An important explanation of why the Swedish economy is affected so much by what happens
abroad is that we are highly dependent on the demand for the goods and services that we
export to other countries. The euro area is our largest export market and problems in the
euro area therefore have a major impact on the demand for Swedish exports. One way for
Swedish export companies to reduce this impact is to turn to new markets instead, but this is
a very slow process (see Figure 7). The euro area will continue to be easily the largest export
market for Sweden for the foreseeable future.
Uncertainty abroad affects households and companies in Sweden. One way of illustrating
this is to look at the Economic Tendency Survey of the National Institute of Economic
Research, which shows the households' and companies' aggregated expectations for the
period immediately ahead. All in all, this survey has been at a low level throughout the year,
which indicates that Swedish companies and households are now less confident about the
future (see Figure 8).
The Swedish economy has coped relatively well...
Over the last 12 months, growth in Sweden has thus been much more subdued than during
the strong recovery in 2010 and early 2011. Sweden has nevertheless withstood the
problems abroad relatively well, and the Swedish economy continued to grow at a good rate
during the first six months of this year.1 This is partly because the development of domestic
demand has been relatively stable.
There are several reasons why Sweden has coped so well. Sweden's stable public finances,
for example, have meant that fiscal-policy consolidation, which has otherwise dominated the
economic-policy agenda in several other countries, has not been necessary in Sweden.
Competitiveness has also developed well. This can be seen very clearly if we look again at
Figure 6. There are also a number of explanations for this positive development. We have
had a period in which productivity grew very strongly in Sweden for several consecutive
years, inflation has been low and stable and pay formation has improved significantly
compared with the period prior to the introduction of the inflation target.
The fact that the Swedish economy has been strong has also led to a resilient Swedish
labour market, and the number of those employed has continued to increase somewhat
during the year. However, the supply of labour has also increased, so that the fall in
unemployment we have seen since the start of 2010 was interrupted at the end of 2011.
Unemployment in Sweden is now just below 8 per cent per cent (see Figure 9).
...but high household indebtedness constitutes a risk
Another reason why the Swedish economy has coped so well is that we have not suffered a
crash on the housing market or in other areas of the financial sector. Nevertheless,
developments in Sweden have given cause for concern. Housing prices have risen
significantly in Sweden over the last 15 years in both an international and historical
perspective (see Figure 5). The same applies to household indebtedness (see Figure 6). It is
not surprising that there is a link between these factors as a large proportion of the banks'
lending to households has been used to buy housing. I and several of my previous
colleagues on the Executive Board warned about the risks associated with household
indebtedness and housing prices in Sweden long before the financial crisis. One could say
that the crisis has given these issues renewed and increased currency.
A positive factor is that the rate of increase in lending to households has slowed down
recently following the very high rates of increase we saw in the years before the financial
crisis. Housing prices have also levelled out recently. Both monetary policy and the mortgage
cap have probably played a role in subduing lending to households.2
However, the debt ratio, that is debt as a percentage of disposable income, is still very high
and higher than in many of the countries that have had problems in recent years as a result
of substantial falls in housing prices (see Figure 12). A high level of household indebtedness
can have serious consequences. When the households have large debts they become
vulnerable. For example, a substantial fall in housing prices could give rise to extensive debt
consolidation on the part of the households, which would risk leading to weak consumption
demand and high unemployment. Ultimately of course this would also lead to the risk of
higher loan losses at the banks and risks to financial stability.3
It is true that the households' total assets exceed their debts by a broad margin. However,
these assets are largely illiquid, which means that they would be hard to convert into cash if
the households needed to reduce their debts quickly (see Figure 13).
Few other tools are in place - monetary policy has its part to play
We can also examine the issue of indebtedness more generally by reviewing the history of
stabilisation policy in Sweden. During the period with a fixed exchange rate prior to 1992,
when responsibility for stabilisation policy lay with fiscal policy, it was not considered that the
sovereign debt imposed any limitations on fiscal policy. This eventually led to the sovereign
debt becoming unsustainable, and we had to reform the framework for public finances. We
gradually managed to put public finances into much better shape and to achieve a falling
tend in the sovereign debt as a percentage of GDP (see Figure 4). After the fixed exchange
rate regime was abandoned in November 1992, we also needed new rules for monetary
policy. The inflation target was the solution adopted. Inflation has been low and stable since
the mid-1990s and the expectations of the public and the market participants have been
anchored around the target of two per cent (see Figure 11). We can thus claim that the
current framework for stabilisation policy has enabled us to gain control over the sovereign
debt and inflation. However, there is no natural limitation of the indebtedness of the private
sector and this becomes a particularly important issue when the repo rate is low.
This has led to major problems on two previous occasions. In the 1990s, there was an
excessive expansion of credit and many loans were used to fund the purchase of commercial
properties. More recently, we imported problems via the banks' excessive lending in the
Baltic countries. Today I am talking most about household indebtedness, but the issue is a
general one. We need to focus more than previously on debts and the stock of debts in our
analysis apparatus.
More specifically-targeted tools are possibly more effective than the repo rate to deal with
household indebtedness, for example amortisation requirements and higher risk weights for
mortgages. Higher risk weights for mortgages mean that the banks must hold more capital
for their mortgages. This is something that the Riksbank has pointed out earlier on a number
of occasions and that we analyse in more detail in our latest Financial Stability Report. The
issue has also been discussed by the council for cooperation on macroprudential policy set
up jointly by Finansinspektionen and the Riksbank. Finansinspektionen recently proposed a
floor of 15 per cent for risk weights for mortgages in Sweden.4
However, of the conceivable concrete measures for preventing risks on the housing market
in Sweden, the mortgage cap is practically the only one in place today.5 Unfortunately
experience, including the experience gained during the Swedish crisis of the 1990s, has
shown that it can be difficult to reach practical decisions on measures to promote financial
stability.
A point that I have made in many different contexts is worth repeating: the less others do, the
more monetary policy has to do. As you know, the Riksbank has two objectives for its
operations: "a safe and efficient payment system", which we usually interpret as financial
stability, and "price stability", which the Riksbank has formulated as an inflation target of two
per cent. I believe that one of the most important lessons of the financial crisis is that these
two objectives are interlinked. Financial stability is a precondition for monetary policy being
able to work as intended, while monetary policy can affect financial stability. It is therefore
rather natural to take the risk of financial imbalances into account in monetary policy.
However, there must be a reasonable connection between alternative regulations and
monetary policy. Regulations can be described as an indirectly-targeted means of raising or
lowering interest rates in a certain social sector. If the regulations deviate significantly from
the monetary policy that is being conducted, distortions and contradictory messages will
arise after a while in the financial sector. New control problems will emerge, for example
through the appearance of shadow banks or through excessive borrowing abroad. As is so
often the case, it is a question of finding the right balance.
A low repo rate is justified, but how low?
The economic situation over the last 12 months, that is the weak development of economic
activity abroad and the low inflationary pressures, has made it necessary to gradually lower
the repo rate in order to enable inflation to rise towards the target of 2 per cent and to
normalise resource utilisation (see Figure 1).
This means that we have a very low repo rate today, which is also reflected in lower interest
rates for households and companies (see Figure 10). Determining how low the repo rate
should be entails balancing many different factors against each other. As I said earlier, I
believe that we must take the risks associated with financial imbalances into account in our
monetary policy decisions as the level of household indebtedness is so high.
Why not lower the repo rate more when unemployment is high?
One of the arguments put forward for further repo-rate cuts is that unemployment is high (see
Figure 14). I have a lot of understanding for this argument. So why not cut the repo rate
more? Here I would like to point out once again that we have lowered the repo rate and the
repo-rate path several times over the last 12 months, partly with particular reference to
unemployment. However, our analysis shows that the relatively high rate of unemployment
also reflects structural problems. For example, there are signs that the matching of
job-seekers with job vacancies has deteriorated in recent years, which makes it difficult to
reduce unemployment. Figure 15 clearly shows that while the number of unemployed in
non-vulnerable groups has fallen in recent years, the number of unemployed in the more
vulnerable groups has instead increased.6 This illustrates the matching problems on the
Swedish labour market.
But even while focusing on unemployment, monetary policy must take a long-term view and
strive to avoid problems further ahead. A low repo rate may provide short-term gains, but "if
we go too far down that road" problems will be waiting for us, including problems regarding
unemployment. Figure 16 shows the development of unemployment in a number of countries
that have been hit by major adjustments on the housing market. Many factors have
contributed to these adjustments, but access to cheap loans during the upturn is one of
them. There are thus risks associated with setting the repo rate too low and this applies not
least to unemployment, although perhaps beyond the rather short economic horizon that
normally attracts almost all the attention.
An appropriate balance
I have now provided some background to some aspects of the difficult balancing act that we
must perform when determining monetary policy. Let me conclude by illustrating this with
reference to our latest monetary policy decision and our latest forecast for the repo rate.
Here we have achieved what I believe is an appropriate balance. The weaker economic
prospects and the low inflationary pressures justify keeping the repo rate low. This will help
inflation to rise towards the target of 2 per cent and to strengthen economic activity (see
Figure 17). However, we also need to take into account the risks associated with household
indebtedness in our repo rate decisions. Our balancing act in October resulted in an
unchanged repo rate, but a downward adjustment of the forecast for the repo rate (see
Figure 18). Such a monetary policy means that we can, on the one hand, attain the inflation
target and stabilise employment in the long term and, on the other hand, take the risks
associated with financial imbalances into account. However, monetary policy alone cannot
eliminate the risks associated with household indebtedness that I have discussed today. It is
important to have a wide-ranging discussion among several authorities in Sweden on the
need for additional measures.
Figures
Figure 1. Repo rate
Per cent, daily data
5 5
4 4
3 3
2 2
1 1
0 0
06 07 08 09 10 11 12
Source: The Riksbank
Figure 2. GDP growth in Sweden and the world
Annual percentage change, calendar-adjusted data
8 8
6 6
4 4
2 2
0 0
-2 -2
-4 -4
Sweden
The world
-6 -6
80 85 90 95 00 05 10 15
Note. The broken line and bars refer to the Riksbank's forecast in MPR October 2012.
Sources: IMF, Statistics Sweden and the Riksbank
Figure 3. World trade index
Index, 2000 = 100, seasonally-adjusted
180 180
170 170
160 160
150 150
140 140
130 130
120 120
05 06 07 08 09 10 11 12
Source: CBP Netherlands Bureau for Economic Policy Analysis
Figure 4. Sovereign debts in various countries
Gross public debt as a percentage of GDP
200 200
Greece
Ireland
Italy
Spain
160 160
Sweden
Portugal
120 120
80 80
40 40
0 0
90 92 94 96 98 00 02 04 06 08 10 12 14
Note. The broken lines represent IMF forecasts.
Source: The IMF
Figure 5. Real housing prices in various countries
Index, 1996 Q1 = 100
300 300
Ireland
Spain
250 250
USA
Sweden
200 200
150 150
100 100
50 50
0 0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: Reuters EcoWin
Figure 6. Unit labour costs in relation to the euro average
Percentage change since 1997
40 40
30 30
20 20
10 10
0 0
-10 -10
-20 -20
-30 -30
Portugal Ireland Italy Greece Spain Sweden Germany
Note. In the case of Sweden unit labour costs are converted to euro.
Sources: The OECD and the Riksbank.
Figure 7. Sweden's export markets
Percentage of Sweden's total exports of goods
45 45
40 2000 40
35 2011 35
30 30
25 25
20 20
15 15
10 10
5 5
0 0
Euro area USA UK Denmark+Norway BRIC
Note. BRIC refers to Brazil, Russia, India and China. These figures do not total 100 per
cent, as not all countries have been included.
Source: Statistics Sweden
Figure 8. Economic Tendency Survey of the
National Institute of Economic Research
Index, average = 100, standard deviation = 10
120 120
110 110
100 100
90 90
80 80
The Economic Tendency Indicator
Mean
+/- one standard deviation
70 70
00 02 04 06 08 10 12
Source: National Institute of Economic Research
Figure 9. Labour force, employment and unemployment
1000s and percentage of the labour force, 15-74 age group
5 200 12
Labour force (left)
Employed (left)
Unemployment (right)
5 000 10
4 800 8
4 600 6
4 400 4
4 200 2
4 000 0
01 03 05 07 09 11
Source: Statistics Sweden
Figure 10. Repo rate, mortgage rates for households and
bank interest rates for companies
Per cent
7 7
Average bank interest rate for companies
Average mortgage rate
Repo rate
6 6
5 5
4 4
3 3
2 2
1 1
0 0
06 07 08 09 10 11 12
Note. Per cent, monthly averages. Average mortgage rates for households and bank
interest rates for companies on new agreements, and the repo rate
Sources: Statistics Sweden and the Riksbank
Figure 11. Inflation expectations of money market agents
Annual percentage change
14 14
Inflation expectations
CPI
12 12
10 10
8 8
6 6
4 4
2 2
0 0
-2 -2
90 92 94 96 98 00 02 04 06 08 10 12 14 16
Sources: Statistics Sweden and TNS SIFO Prospera
Figure 12. Household debt ratio
Percentage of disposable income
225 225
Ireland
Spain
200 200
USA
Sweden
175 175
150 150
125 125
100 100
75 75
50 50
86 90 94 98 02 06 10
Sources: Eurostat, national central banks and the Riksbank
Figure 13. Household assets and debts in Sweden
Percentage of disposable income
700 700
Total wealth
Real wealth
600 600
Liquid wealth
500 500
Debts
400 400
300 300
200 200
100 100
0 0
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
Note. There is no regular publication of official data for total household wealth and its
components. The series are based on the Riksbank's estimate of the households' financial
and real wealth. Real wealth is the households' wealth in housing. Liquid wealth mainly
consists of household assets in cash, bank deposits, bonds and shares.
Sources: Statistics Sweden and the Riksbank
Figure 14. Unemployment
Percentage of labour force, 15-74 age group, seasonally adjusted data
12 12
Average 1980-1991
Average 1999-2012 Q3
Outcome
10 10
8 8
6 6
4 4
2 2
0 0
80 85 90 95 00 05 10
Source: Statistics Sweden
Figure 15. Number of unemployed in vulnerable groups and
total of other registered unemployed
Total number of unemployed individuals registered with Employment Office
250 000 250 000
Vulnerable groups
Other groups
200 000 200 000
150 000 150 000
100 000 100 000
50 000 50 000
04 06 08 10 12
Note. Trend-adjusted values. Number of remaining job-seekers at end of month.
Source: Employment Office
Figure 16. Unemployment and the development of the housing market
Unemployed as a percentage of the labour force, index 2007=100. The figures in
brackets present the fall in real housing prices from the peak to the trough.
350 350
Ireland (-40.5 per cent)
Spain (-22.5 per cent)
300 300
USA (-22.7 per cent)
Sweden (-0.0 per cent)
250 250
200 200
150 150
100 100
50 50
00 02 04 06 08 10
Source: The OECD
Figure 17. Inflation in Sweden
Annual percentage change The CPIF is the CPI with a fixed mortgage rate.
5 5
CPIF
4 4
CPI
3 3
2 2
1 1
0 0
-1 -1
-2 -2
06 08 10 12 14
Note. The CPIF is the CPI with a fixed mortgage rate.
Sources: Statistics Sweden and the Riksbank
Figure 18. Repo rate
Per cent, quarterly averages
5 5
September
October
4 4
3 3
2 2
1 1
0 0
06 08 10 12 14
Source: The Riksbank