Per Jansson: Swedish monetary policy after the financial crisis - myths
and facts
Speech by Mr Per Jansson, Deputy Governor of the Sveriges Riksbank, at the SvD Bank
Summit 2014, Stockholm, 3 December 2014.
* * *
"The Riksbank has in recent years conducted a monetary policy experiment where it has
aggressively, using a high repo rate, attempted to prevent household debt from rising. The
results have been more or less devastating for the Swedish economy. Eventually, the
Riksbank has realised that its policy was wrong and has made a 180 degree turn."
This is roughly how some critics have described the monetary policy conducted in recent
years. This description has received quite a bit of attention and been widely spread, and
many who follow the monetary policy debate have probably gained the impression that this is
actually what has happened. I argue that this description is wrong and I now intend to explain
why.
I shall divide the criticism into three different parts, or claims, and discuss them one by one. I
will present these claims in the form of quotations, but this does not necessarily mean they
are exact quotations. However, they capture the spirit of the criticism and I believe that those
who have followed the monetary policy debate will recognise them.
It is important to meet the criticism, for several reasons
One question one might begin with, is why it is so important to respond to these claims. It is a
natural part of the economic debate that the Riksbank is being criticised, isn't it? Wouldn't it
then be better to ignore the criticism and look ahead instead? No, I don't think so.
One important reason is that in the wake of the financial crisis there has been a discussion
on the activities and tasks of central banks, what central banks should do and how they
should do it. It is, of course, important that our debate on this here in Sweden is anchored in
reality and based on how monetary policy has actually been conducted and what it has
actually achieved.
But meeting the criticism is important not just for the discussion here in Sweden. The debate
on Swedish monetary policy also has an international interest and has been followed abroad,
not least by other central banks.1 The reason is that a central issue in the international
discussion has been to what extent central banks' policy rates should be used as a
complement to macroprudential policy, to counteract the build-up of financial imbalances, for
instance, by trying to prevent lending and housing prices from rising too quickly.2 This is what
is often called a policy of "leaning against the wind", and I will hereafter use this expression
for the sake of simplicity. Monetary policy in Sweden has in this context been regarded as
particularly interesting, as the Riksbank is one of few central banks that, at least this far, has
been explicit about taking such considerations into account in its policy-rate decisions. It
would of course be unfortunate for the continued international discussion if the conclusion of
the Swedish experiences were that when the policy of leaning against the wind was
attempted in practice, it led to a very poor, or even catastrophic, result. Because this is not
the case.
Before I continue, I would like to make it clear that my purpose here today is not to justify
every single decision the Riksbank has made. It is natural that different observers make
different assessments regarding economic developments and thus reach slightly different
conclusions regarding what exact policy should be conducted. With hindsight, it is clear that
monetary policy could have been somewhat more expansionary if we had known that
inflation would be as low as it is now. This is a natural and unavoidable consequence of the
fact that monetary policy has to be based on forecasts, which are uncertain. However, most
of the recent criticism has gone far beyond discussing this type of difference in assessments.
Instead, it has claimed that the policy conducted by the Riksbank was wrong on a more
fundamental level. This is the type of criticism I intend to focus on here.
"The Riksbank has aggressively, using a high repo rate, tried to prevent household
debt from rising"
The first part of the criticism can in turn be divided into different parts. For one thing, it claims
that the Riksbank has leaned against the wind aggressively, and for another thing that
household debt has been the main, if not the only, reason for this policy. I intend to comment
on these points one by one.
So how much has the Riksbank in practice leaned against the wind in recent years? My view
here is clear. The monetary policy conducted after the crisis has for the most part been
governed by traditional monetary policy motives, that is, the expected development of
economic activity and inflation over the coming years. Giving consideration to the risks
associated with the developments in household debt and housing prices has been part of our
assessment, but a relatively minor part.
The picture painted in the criticism has been quite different. Here the starting point is instead
that the Riksbank's concern over developments in household debt was the main motive for
raising the repo rate after the financial crisis. Much of the criticism even seems to assume
that household debt was the only motive for raising the repo rate. In a so-called
counterfactual analysis that has played a central role in the criticism, the actual policy
conducted is compared with the alternative of not raising the repo rate at all, but leaving it
unchanged at 0.25 per cent since the crisis.3 The latter is assumed to represent a policy that
does not lean against the wind.
The Riksbank and other economic analysts made similar forecasts
So what support do I have for my view that concern over household debt has only had a
limited influence on the repo-rate decisions? To begin with, one can look at the Riksbank's
motives as stated in the press releases following the monetary policy meetings. If one does
this, it is pretty clear that the focus has been on economic activity and inflation in the coming
years. Certainly, it is often mentioned at the same time that the policy conducted is expected
to contribute to less risk of imbalances building up with regard to indebtedness and housing
prices, but more as a side-effect and not as a main reason. The overall impression is that the
policy would have been marginally different if this risk had not been addressed - not that it
would have been completely different.
One can also look at the discussions that were conducted within the Riksbank. It is a
wellknown fact that there were differing opinions within the Riksbank, but how different were
they? The situation in July 2011 is an example. The repo rate had then been raised to 2 per
cent, the highest level it reached before it was reduced again. The minutes of the monetary
policy meeting show the Executive Board members' view of the appropriate monetary policy
in the years ahead. In Figure 1, the dotted blue line shows the future repo-rate path
advocated by a majority of Executive Board members, while the dotted yellow line shows the
path advocated by the two members who argued that monetary policy should be more
expansionary. One of these, Lars Svensson, is the Riksbank's most outspoken critic in
recent times and also the originator of the counterfactual analysis I mentioned earlier.
It is clear that opinions differed. But it is also clear that the differences concerned at what
pace the repo rate should be raised and not that any member advocated that the repo rate
should never have been raised after the crisis, but remained at 0.25 per cent. Of course, it
would have been difficult at that time to advocate a large cut immediately or in the near
future. But if one really thought that the repo rate should have been 0.25 per cent, it is
difficult to understand why one would advocate a repo-rate path that did not turn down at all
over the coming three years, but rose throughout the entire forecast period and reached
3.8 per cent in the middle of 2014.4
So what was the view outside of the Riksbank? At around the same time, in June 2011, the
National Institute of Economic Research forecast that the repo rate would be 3 per cent at
the end of 2012 and that at the end of 2014 - that is, around now - it would be just over
4 per cent.5 The NIER's forecasts are often something of a benchmark for other analysts and
on this occasion, too, they were a good reflection of how most analysts perceived the
situation. The forecast for the repo rate was also fairly well in line with the Riksbank's view
(see Figure 2). This policy was considered compatible with a balanced resource utilisation in
2014 and a CPIF inflation rate close to 2 per cent in 2013-2015. It is thus obvious that this is
a picture of a policy that was essentially governed by traditional monetary policy motives and
where concern over household debt certainly did not play a major role.
How did international analysts view the Swedish economy at this point in time? The OECD's
Economic Outlook in May 2011 expected the robust growth to continue, with increases in
real GDP of on average 3.3 per cent in 2010-2015. It was expected that the policy rate
would need to be raised gradually as economic activity improved.6 A similar assessment was
made by the International Monetary Fund (IMF) in July 2011. GDP growth was assumed to
gradually decline to 3 per cent in 2014, when inflation was expected to amount to 2 per cent
(measured in terms of the HICP). It was assumed that the interest-rate increases that had
begun would need to continue.7
One conclusion I draw from this is that many unexpected events have occurred in recent
years. The situation today is rather different than all analysts - both on the Executive Board
of the Riksbank and outside the bank - were expecting at this time. I shall return to this later.
Another conclusion is that the general picture was that the Riksbank's policy was on the
whole well-motivated and essentially based on traditional monetary policy deliberations.
Although there were different opinions on exactly how high the repo rate should be, as there
always are, the policy was thus not perceived as odd or conspicuous. Neither the Riksbank
nor any other analyst perceived the monetary policy conducted to be leaning against the
wind to any large extent, and the general impression was definitely not that the repo rate
should have been left at the level to which it was cut during the financial crisis, that is,
0.25 per cent.
A strange assumption
Given this, it is very strange to claim that an evaluation of the Riksbank's policy should rely
on the assumption that the alternative of not leaning against the wind would be to hold the
repo rate at 0.25 until today. If no one perceived it as such at the time, it appears very
strange to paint this picture retrospectively. Basing an analysis on such an assumption is
therefore not a reasonable way of evaluating the advantages and disadvantages of leaning
against the wind. One needs to assume not just that the Riksbank has lied about its motives,
but also that well-known and prominent external economic analysts have said one thing but
really meant another.
Nevertheless, this is the starting point for the counterfactual analysis many appear to rely on
when drawing conclusions about the Riksbank's monetary policy.8 In Sweden, this analysis
has been given considerable scope, for instance on Dagens Nyheter newspaper's editorial
pages, where the Riksbank's policy has been described as more or less incomprehensible
and contrary to the prevailing opinion at that time - an "interest-rate increasing experiment in
summer 2010".9
One might think it is strange that the claim that the Riksbank's repo-rate increases were only
about leaning against the wind, and moreover that the increases were made contrary to
prevailing opinion, has become so widely spread. After all, one does not need to make a
more in-depth check of the facts than I have provided here to see that neither claim is
correct. It doesn't require very much digging to be able to conclude that not only the
Riksbank but also external domestic and international economic analysts found it natural,
even after the repo rate had been raised to 2 per cent, that the increases would continue -
and this without any particular reference to household debt. According to, for instance,
Dagens Nyheter newspaper's editorial pages, the policy was instead "an interest-rate
increasing experiment", based on the Riksbank governors spreading "misleading pictures of
the future".10 The only explanation I can think of for this claim nevertheless being repeated
and referred to so often and so uncritically, is that people simply assume that it must be true
because it has been expressed with such emphasis and intensity.
A hazardous policy
But claiming that it has all been about leaning against the wind is not only a misleading
description of the policy conducted and the motives behind it. There is also good reason to
wonder whether a policy whereby the repo rate had remained unchanged since the crisis
might not have been rather risky, regardless of what one claims it would have represented.
According to the counterfactual analysis, there were only gains and no problems: inflation
would have been close to the target and employment would have been higher if the repo rate
had not been raised. But I also believe that there would have been a major risk of other, less
pleasant things happening that is disregarded in the analysis, consciously or unconsciously.
8
See, for instance, Visco (2014): "An actual example of the debate on the macro-prudential use of the policy
rate relates to the tightening of monetary policy by the Sveriges Riksbank that began in July 2010 and peaked
in July 2011. Deemed a leaning-against-the-wind move out of concern for financial stability, and specifically
the risk that maintaining a lower repo rate could have increased the already high ratio of household debt to
disposable income, this policy stance has been questioned on the basis of a counterfactual analysis
emphasising the macroeconomic costs in terms of below-target inflation and higher unemployment." Another
example is the Financial Times (2014): "Sweden's central bank has been lambasted by critics for trying to use
interest rates to combat signs of a housing bubble. It lifted rates in 2010 and 2011 as it publicly worried about
what it saw as high household debt levels." A further example here is Münchau (2014), who says that the
Riksbank "raised interest rates to rein in a domestic housing bubble."
9
Wolodarski (2014).
10
Wolodarski (2014).
Something that has received considerable attention since the crisis is that a lot of things can
happen with regard to expectations and risk-taking in an economy where interest rates are
very low for a long period of time. Expectations regarding, for instance, how high interest
rates will be in the future and how the housing market will develop in the years to come can
become distorted, and risk-taking in the economy in general could increase in a way that
may create problems.11 This is something that cannot be captured in a good way in the
economic models available today.12 But this should not be an excuse to completely disregard
such aspects.
In the alternative path that is assumed to represent a policy that does not lean against the
wind, the repo rate would have been close to zero since July 2009, that is, for more than five
years. This in an economy that began to recover from the crisis very quickly and where the
temperature on the housing market cooled only temporarily. We can see today, when the
repo rate has once again been cut to very low levels, that housing prices have begun anew
to soar (see Figure 3).13 Lending to households increased by almost 10 per cent a year when
the repo rate increases began in July 2010 (see Figure 4). And lending has begun to rise
once again as the repo rate has been cut.
Another important element here is that there was no framework for macroprudential policy for
most of the time when the repo rate, according to this alternative, should have been at
0.25 per cent. It was not until August 2013 that the allocation of responsibility for
macroprudential policy was clarified and the Swedish government had set formal guidelines
for this.14 As yet, it remains to be seen how well this framework will actually work in practice.
Given this, advocating a repo rate of 0.25 per cent for more than five years and entirely
disregarding the risks of distorted expectations and problems with developments in housing
prices is quite remarkable. Had this policy been implemented, I believe that the situation
today would have been much more worrying than it is - and as we know, the situation today
is hardly without problems.
Two relevant questions
Before I continue I would like to take up two questions it is natural to ask in this context. As I
have noted, the repo-rate decisions have mainly been governed by traditional monetary
policy motives, and consideration to risks associated with the development of household debt
and housing prices has played a fairly subordinate role. But what exactly do I mean by "a
fairly subordinate role"? That is the first question.
11
Summers (2014) writes, for instance: "[A] strategy that relies on interest rates significantly below growth rates
for long periods of time virtually guarantees the emergence of substantial bubbles and dangerous build-ups in
leverage." For a review of the links between monetary policy and financial imbalances, as well as further
references to the literature, see Adrian and Lang (2014).
12
This is discussed, for instance, in Blanchard (2014). One problem with counterfactual estimates where
economic policy changes a lot is that they are sensitive to what is known as the Lucas critique. This states that
it is very difficult to quantify the effects of a completely different policy (for instance, a much lower interest rate
over a long period of time) in a reliable manner. The reason for this is precisely that the expectations of the
economic agents change.
13
Remarkably, an excessively low repo rate was something that Dagens Nyheter's editorial pages warned
against in December 2009, when Lars Svensson entered a reservation against holding the repo rate at
0.25 per cent and advocated cutting it to zero and they commented on his "input to the Executive Board of the
Riksbank being reminiscent of a captain slavishly following his nautical chart, even when the ship hits an
iceberg. It was one thing to cut the repo rate in an acute situation during the crisis to ward off a depression.
But now that the economy has begun to recover, a zero interest rate would only add fuel to the housing price
fire." (See Wolodarski, 2009).
14
Of course, some measures were taken earlier, but the introduction of the framework must nevertheless be
regarded as an important condition for being able to conduct macroprudential policy systematically.
Unfortunately, I believe one must accept that this cannot be quantified in a very precise way.
I can only note for my own part that if I had not found the developments in household debt
and on the housing market problematic, I would have advocated a somewhat more
expansionary policy - but definitely not that the repo rate should remain at 0.25 ever since
the crisis. But it is difficult to be more precise than this. For example, it is not possible to
argue at a given monetary policy meeting that "of the 25 basis points I feel the repo rate
should be raised, 5 points are aimed at dampening risks linked to household debt and
housing prices. The remaining 20 basis points are aimed at stabilising inflation and economic
activity in the short run". Monetary policy decision-making just does not work like this.
Moreover, the Executive Board consists of six individuals. Each of them has very likely had
his or her own view of what role the risks linked to debt and housing prices have played in
their decisions. It is therefore not possible to respond to the question of how much the
Riksbank has leaned against the wind with a quantified measure. But what I am quite
convinced of is that none of those deciding on the repo rate has had as their main reason,
much less their only reason, that monetary policy must lean against the wind.
The second question is whether the policy of leaning against the wind has had any tangible
effect, given that consideration to risks linked to the development of household debt and
housing prices, as I said, has played a fairly subordinate role in policy-making. I am
convinced that the policy has played an important role, despite the element of leaning
against the wind being much more modest than the critics claim. The Riksbank's strategy
has been to combine a marginally higher repo rate with communication that emphasises the
fact that we perceive the development of high growth in credit and rising house prices to be
worrying. The slightly higher repo rate does have some effect in itself, but perhaps its main
function is as a concrete reminder of the risks, and it has thereby been an important part of
the communication. In my opinion, this has had an impact, not least in increasing general
awareness of the problems. The discussion of these questions now going on underlines that
this has been the case.
More extensive problem than just indebtedness
After thus having responded to the first part of the first claim - that the Riksbank has leaned
aggressively against the wind - I intend to move on to the second part, namely that the
purpose of the policy of leaning against the wind has been to limit household debt.
As I have pointed out, the element of leaning against the wind has not been particularly
large, but has been there to some extent. However, it is too easy to say that this has only
been aimed at getting households to borrow less, or as it is sometimes portrayed, that the
Riksbank has a target as to how high debt may become in relation to income, for example.
Even though developments in household debts are definitely an important part of the
problem, the picture is much more complex. A fairer description is that the Riksbank has tried
to do its bit to slow down a trend where housing prices and indebtedness have been rising
rapidly and simultaneously for quite a long time now - where there appears to be some
slowdown in periods of weaker economic activity, but where the direction is upwards, no
matter what the economic situation, and there are few signs that this trend will be dampened.
The longer such a trend continues, the greater the risk that it will be broken in the same
abrupt way as in many countries in connection with the financial crisis - that is, when
housing prices and debt finally adjust downwards, it is in a dramatic manner, with substantial
price falls and drops in consumption, with large and long-lasting negative effects on the
economy.15 In general, there is solid empirical support for the idea that the more households
and companies borrow during an economic upturn, the greater the risk that this upturn will be
followed by a deep recession and a very slow recovery.16
One can make a few reflections here. One is that the macroeconomic instability resulting
from this type of development could make it more difficult for the Riksbank to stabilise
economic activity and inflation in a sustainable manner. It is therefore hardly remarkable that
the Riksbank has tried to counteract it, and it is difficult to see that this is something outside
of our mandate, as some have claimed.
Another reflection is that, as the problems with a trend of rising household debt and housing
prices affects many parts of the economy, it is necessary for several policy areas to
cooperate to be able to achieve a lasting solution. Regardless of what measures are taken,
neither monetary policy that leans against the wind nor macroprudential policy are sufficient
on their own - and probably not even these two combined. Other policy areas, and especially
housing policy, need to be included in the equation. This is something that the Riksbank has
highlighted and discussed on other occasions and I do not intend to discuss it further here.17
A third reflection is that when it comes to the risks of a development of this type, the critics
have not been very clear, in my view. At the same time as they have put a lot of effort into
criticising the Riksbank's policy, they have often said very little about how they themselves
view the potential risks and how they should be managed.18 A common argument has been,
to simplify somewhat: "Firstly, the risks probably aren't so great, and if there are risks they
can always be managed effectively by macroprudential policy." Here I think one ought to be
able to demand greater clarity from the critics.
Do they think that there is no problem with this kind of upward trend? Or will the trend slow
down on its own before problems arise, and, if so, what mechanisms will achieve this? If it
slows down but at a level where debt and house prices are elevated, what risks will this
entail? Is the fact that housing prices and lending have now begun to accelerate after the
Riksbank cut the repo rate nothing to worry about? If there are nevertheless risks, how
should they be managed? If macroprudential policy is so effective, exactly what measures
should be implemented? And what dosage is appropriate? Are macroprudential policy
measures enough, or do other policy areas also need to be involved? These questions are
very relevant ones and I wish they had been given as much attention in the debate as the
Riksbank's monetary policy.
"The results of the policy have been devastating for the Swedish economy"
The picture that critics like to paint is of a high repo rate pushing down demand and creating
a more or less deflationist situation in the Swedish economy. This is something that some
international analysts in particular seem to have latched onto, interpreting the situation in
Sweden today to be similar to that in Japan in the 1990s.19
It should already be clear from what I have discussed so far that this is a misleading
description. As monetary policy has not leaned against the wind to any great extent, this can
hardly have had any particularly devastating effect on the economy. With what is by now a
rather worn but at the same time very telling likeness, the Riksbank has not during this period
hit the repo-rate brake, but rather eased up on the accelerator somewhat.
No deflationist development driven by a weak real economy
This picture is confirmed if one examines how, for instance, GDP and employment have
developed since the crisis. Figure 5 summarises the percentage change in GDP per capita
and the employment rate in relation to the pre-crisis figures in the countries Sweden is
normally compared with.
As can be seen, Sweden is not right at the top, but nor is it very far from it. There are only a
few countries, according to these statistics only New Zealand and Germany, that have had a
better development in both GDP and employment, that is, that are above and to the right of
Sweden in the figure.
Some claim that the development of unemployment has been less favourable. But here we
must bear in mind the fact that the labour force in Sweden has increased relatively
substantially during the period. This is essentially positive, but in the short run it will also
contribute, purely mathematically, to keeping up the unemployment figures. The differences
in this respect in relation to the United States, for instance, are fairly striking. The
United States has had a more favourable development in unemployment, but quite a lot of
this can be explained by the fact that labour force participation in the States has actually
declined (see Figure 6).
Of course, the relatively good development is not solely due to the monetary policy
conducted by the Riksbank. Economic policy in general plays a large role, as does the fact
that Sweden was not hit so hard by the crisis, for reasons not necessarily related to the
policy conducted. It is also possible to have different views regarding exactly how good one
thinks developments have been. But at a very minimum, it should be clear that it is difficult to
find support in actual figures for an overly tight, "aggressive" monetary policy having sent the
economy into a state of deflation, driven by poor development in the real economy.
If one looks ahead, then? Could it not be the case that the Swedish economy has managed
fairly well so far, but that things will go badly in the future, as a result of the policy
conducted? Of course, one cannot make any guarantees with regard to the future, but one
can in any case note that the National Institute of Economic Research, the Ministry of
Finance and the Riksbank are all currently forecasting growth of around 2 per cent this year
and around 3 per cent in 2015-2016. This is hardly the picture of an economy in a state of
recession or crisis.
Low inflation difficult to predict - for the Riksbank and others
But what about inflation? It has become very low and prices have even fallen at times, at
least when measured in terms of the CPI. Is this not a sign that the policy has failed and that
the repo rate should never have been raised?
It is important to understand two things here. Firstly, it should be clear from what I have just
described that the low inflation is not a result of an economy that has been brought to its
knees. The picture of high interest rates causing a more or less recession-like state that has
in turn resulted in low inflation, and sometimes deflation, is thus incorrect.
Secondly, as I have also mentioned, a lot has happened in recent years that has had an
effect on inflation. Remember the National Institute of Economic Research's forecast in the
middle of 2011, which I mentioned earlier. In this, the repo rate was expected to continue to
rise, from the 2 per cent level it was at then, to around 4 per cent in 2014. This policy was
considered compatible with an inflation rate of around 2 per cent in 2013-2015. The reason I
am returning to this forecast is that I don't think anyone would question that the National
Institute of Economic Research is a serious and competent forecaster - and it can scarcely
be accused of deliberately spreading "misleading pictures of the future". And as I said, the
National Institute of Economic Research's forecasts were not in any way unique, but
reflected well how forecasters in general viewed the situation.
Anyone who claims to have predicted the current low inflation back when the repo rate
increases began in 2010 must thus have had much greater insight than all of the Swedish
and international analysts. I would rather argue that this instead is a good illustration of the
fact that things have happened in the economy, which could not be predicted and which have
pushed down inflation in an unexpected manner.
Unexpected international economic slowdown in 2011 and even lower inflation in
2013-2014
I would like to give examples of two occasions in recent years when developments have
turned out rather differently than expected. The first is the slowdown in international
economic activity that became apparent during the second half of 2011. Global growth
prospects deteriorated in connection with increased unease over the sovereign debt
problems in the United States and euro area. Uncertainty over the future led to increased
pessimism among households and companies and also affected the financial markets.
Towards the end of the year, there were clear signs that growth in the Swedish economy had
also slowed down, partly due to reduced demand for Swedish exports. Figure 7 shows how
the Riksbank and other analysts revised down their forecasts for the increase in Swedish
exports in 2012 during the second half of 2011.
The second occasion is when inflation began to fall from already low levels during the latter
part of 2013 and the beginning of 2014. This happened in connection with a sequence of
negative inflation surprises indicating that the underlying inflationary pressures in the
economy had fallen. For example, inflation had appeared unusually low for a time in relation
to the increase in unit labour costs (see Figure 8). Even after that, inflation has been lower
than expected, most recently in September this year. Figure 9 shows how the forecasts for
CPIF inflation in 2014 have been revised down from just over 1 per cent to around 0.5 per
cent.
It is clear in both of these examples that it is the general picture that has changed, not that
the Riksbank suddenly realised something that everyone else had know