Stefan Ingves: Introduction on monetary policy
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, to the Riksdag Committee
on Finance, Stockholm, 3 March 2011.
* * *
I was here as recently as two days ago to discuss the development of housing prices and
household indebtedness. Today, I am here to discuss monetary policy.1 After several years
of crisis management, it feels positive to return to discussing more "usual" monetary policy
issues. When I was here a year ago, I showed a picture of a skater on the ice. Having been
out on thin ice, I considered we had returned to thicker ice. Today, I would instead say that
we're back on dry land. To use a different metaphor, Sweden, with its small, open economy,
could be described as being a small boat on a wide ocean. The financial crisis required
"Sailboat Sweden" to navigate some dramatically stormy waters. After such a traumatic
experience, it is natural to try to lift your gaze and ask certain all-embracing questions:

Where have we come from?

Where are we now?

Where are we going?
Personally, I would be just a little worried if I found myself aboard a boat without knowing
where I boarded it, its current position or final destination. Let me therefore attempt to give
you my answers to these questions as they concern Sweden's economy.
Where have we come from?
The years before the financial crisis - the calm before the storm
From about the middle of the 1990s until the outbreak of the financial crisis, economic
development both in Sweden and abroad was characterised by positive growth and low
inflation. Fluctuations in production and inflation decreased, at the same time as productivity
growth in Sweden and elsewhere increased. There are many ways of illustrating this
development, but one way would be to examine government bond rates in Sweden, the euro
area and the United States (see Slide 1). Certain clear patterns can be detected. These
include decreased interest rate levels and a reduction of fluctuation in these over time. In
addition, from the mid-1990s, interest rates in various countries developed in a strikingly
similar manner. This strong development can be further illustrated by growth in the world
economy, which fluctuated between 2 and 5 per cent and averaged almost 4 per cent (see
Slide 2). All in all, developments from the mid-1990s until the start of the financial crisis can
be compared to a voyage through relatively calm waters, to return to our nautical analogy.
But then the storm broke.
Sweden's economy during the financial crisis - what happened?
Happily, we can now start talking about the financial crisis as something we have left behind
us. It is also much easier now to see the implications of the crisis for Sweden than it was
while the crisis was in progress. One way of emphasising the drama of the financial crisis is
to look at GDP in the world as a whole, which decreased for the first time since the 1940s
(see Slide 2). With an economy in free fall in many parts of the world, policy rates dropped
with full force (see Slide 3). At the same time, very extensive fiscal easing was implemented
in many countries. Furthermore, both governments and central banks launched various
support measures to avoid a collapse of the financial system.
Today, we know that, in the end, the financial crisis mainly manifested itself in Sweden in the
form of decreased demand from abroad. World trade declined sharply, as did Sweden's
exports (see Slide 4). The uncertain situation meant that the currencies of many smaller
economies were weakened in relation to the US dollar and euro. To a great extent, this also
applied to the Swedish krona, which reached its lowest point ever (see Slide 5). Despite the
weakened krona, the decrease in exports was extremely severe. It is natural to ask why. One
explanation is that a large part of the decline in world trade affected investment goods and
durable consumer goods such as cars. The purchase of these goods could easily be
postponed when the crisis broke out. Such product groups represent an important part of
Sweden's exports. In could thus be said that Sweden was impacted particularly severely due
to the composition of its exports. As I mentioned in my introduction, Sweden is a small, open
economy that is highly dependent on exports. During 2009, GDP fell by over 5 per cent, the
sharpest decline since the Second World War.
Even if the krona was heavily weakened, this was not enough to prevent a major fall in
exports. On the other hand, there are many indications that the weakening of the krona
contributed strongly towards preventing inflation from becoming excessively low. Unlike
abroad, where inflation became negative, inflation in Sweden remained around the target
even during the most acute phase of the crisis (see Slide 6). Note that inflation in Sweden
here disregards changes in mortgage interest expenditure - it is measured using the CPIF.
This approach corresponds better with the way that inflation is measured abroad.2
Developments in Sweden during the financial crisis differ in several regards from the crisis
we experienced during the 1990s, when major problems were present in the Swedish
economy before the crisis erupted. Inflation was very high and the credit market had recently
been deregulated. This led to overheating tendencies and the fixed exchange rate eventually
needed to be abandoned. In somewhat simplified terms, I usually describe the crisis of the
1990s like this: "things were quite OK abroad, but Sweden was not OK".
This time, the crisis had its origins in problems on the US housing market, which then had
unanticipated consequences. With the bankruptcy of Lehman Brothers in September 2008,
these events turned into a global financial crisis. And in several other countries, such as
Spain and Ireland, problems arose on the housing market. At the same time, the public
finances of several countries were not in sufficiently good shape to handle a crisis like this.
This was not true of the Swedish economy. Thanks to regulations on surplus targets and
expenditure ceilings, Sweden's public finances were in good shape before the crisis broke
out. Unlike during the crisis of the 1990s, the situation could now be described as follows:
"things were not OK abroad, but Sweden was OK".
There are also other differences if the current situation is compared with the crisis of the
1990s. Back then, there were no elements of lending to the banks by the Riksbank. On the
other hand, loan losses among the Swedish banks were enormous, as I clearly remember
from my position as head of the Swedish Bank Support Authority at the time. Now, the
situation has rather been the opposite: comprehensive lending from the Riksbank, but very
limited loan losses on the home market for the banks. How can this be explained? Well - as
a reflection of the nature of the crisis. Back then, in the early 1990s, the banks had suffered
loan losses in the commercial property sector, which impacted on profitability in the banking
sector and led to a degree of restructuring aimed at maintaining capital adequacy; it was a
solvency crisis, rather than a liquidity crisis. This time, in conjunction with the financial crisis,
an acute shortage of liquidity instead arose in the banks when the functioning of the capital
markets became impaired. A further sign that the financial crisis is behind us is that the
Riksbank has now wound up all of the extraordinary measures adopted during the crisis.
It was not entirely easy to understand the development of the financial crisis while it was
unfolding. Today, however, the view is much clearer. This brings us to the question of where
we are today.
Where are we now?
Strong recovery after the crisis
The Swedish economy has recovered very strongly from the financial crisis. The growth of
GDP in Sweden is very high from both a historical and an international perspective.
According to new figures, GDP growth amounted to 5.5 per cent in 2010 (see Slide 2).3 This
is the strongest growth seen since 1970. There have thus been very wide fluctuations in the
economy in recent years. After developments in 2009, which entailed the sharpest fall in
GDP since the Second World War, we have instead experienced, in 2010, the greatest
increase of GDP in 40 years. Sweden is now among those economies with the highest GDP
growth rates in the world. At the same time, the indicators are very strong, suggesting
continued high levels of growth throughout early 2011.
Exports, which decreased so drastically during the crisis, are showing very high growth
figures (see Slide 4). One natural explanation is that world trade is now growing and Sweden
has a high percentage of exports. This is the case even though the recovery in the United
States and euro area is proceeding relatively sluggishly.
From what I have just said, it is easy to conclude that the "emerging economies" have a high
demand for Swedish exports and have heavily increased their proportion of these. This
explanation is only partially correct. If we look at which countries Swedish exports go to, the
United States and Europe remain completely dominant (see Slide 7).4 However, over a
longer period, the United States has decreased its share in favour of the BRIC countries
(Brazil, Russia, India and China). There are many indications that the significance of the
emerging economies for Swedish exports will continue to increase in the period ahead. This
is an example of an important gradual change that has taken place independently of the
financial crisis and which will affect developments in the future. It could perhaps be said that
the crisis has contributed towards shedding light upon the increased significance of the
emerging economies, as these are now driving the recovery of the global economy.
Interestingly enough, the composition of products in Sweden's exports, which was a
disadvantage for Sweden when the crisis erupted, has now been turned into an advantage.
There is a natural explanation for this: just as purchases of goods of this type (large amounts
of which are exported by Sweden) were easy to postpone, so are they also easy to resume.
However, over the last year or so, the krona has appreciated considerably, reducing the
impetus previously provided by the weakened exchange rate (see Slide 5).
At the same time, exports are far from being the only part of the Swedish economy that has
grown. Domestic demand in the form of consumption and investments has developed very
strongly. So why is the growth of domestic demand also so high in Sweden, compared, for
example, with the United States and the euro area? There are several explanations for this.
To start with, Sweden's public finances are in good shape in an international comparison,
which means that there will be no need for fiscal policy tightening in the period ahead. In
addition, household saving in Sweden was high before the crisis broke out. Saving increased
further in conjunction with the crisis, presumably due to the general uncertainty prevailing.
Moreover, household confidence has recovered strongly, as various types of survey have
shown. Together with relatively sizable incomes, this has made it possible for consumption to
recover. A further favourable factor is that, in the end, the Swedish financial system was
never fully drawn into the financial crisis.
Towards a normalisation of GDP and inflation - even for the repo rate
Let me refer back to Slide 3, which shows the policy rates of Sweden, the euro area and the
United States. The policy rates of both the United States and the euro area remain on
extremely low levels. This emphasises that the situation in these countries is far from being
"business as usual". Part of this can be explained by the development of public finances. In
the euro area, unease remains high over how countries such as Greece, Portugal and
Ireland will cope with their long-term commitments. One of the forms taken by this unease is
that of rising government bond rates in these countries, which is further increasing the
burden of debt (see Slide 8). The high levels of public debt are partially a consequence of the
fiscal policy stimulation packages introduced during the crisis. In many cases, the situation
has been exacerbated by the excessively weak development of public finances in the years
leading up to the crisis.
Several countries are now facing a difficult balancing act. On one hand, significant fiscal
policy tightening will be necessary for a long time to come in order to reduce public debt to a
more reasonable level. On the other hand, this tightening must not be so comprehensive as
to threaten the economic recovery. Hopefully the planned European Financial Stability
Facility will have a beneficial effect, but the public finance problems will characterise
developments for a long time to come, one way or another.
The United States also has a large and growing central government debt, and it will require
comprehensive fiscal policy tightening to gain control over this development. One advantage
is that US government bond rates are still low (see Slide 1). Moreover, asset purchases by
the US central bank have contributed towards keeping interest rates down. These expansive
financial conditions, together with high profits within the corporate sector, suggest that the
recovery will pick up further speed, despite the need for fiscal policy tightening.
On the other hand, problems remain on the housing market, which are dampening household
demand and restraining the recovery. Many households have seen the value of their homes
decrease sharply, with homes now being worth less than mortgages in many cases. In such
a situation, many households are choosing to strengthen their balance sheets by restraining
consumption in favour of saving. Furthermore, house sales entail a serious risk of incurring
losses. In turn, this may mean that the unemployed are less willing to move to regions in
which there exist job opportunities. The labour market may thus have become less flexible,
and long-term unemployment in the United States may have risen as a consequence of the
crisis.
Happily, in Sweden, the level of GDP seems to have returned to about the same level as
prevailed before the crisis erupted. Our overall assessment is that resource utilisation is on
the way to becoming normalised. However, I would like to point out that it is very difficult to
measure resource utilisation, as this cannot be directly observed. Different measures also
provide somewhat different pictures. While a number of measures indicate that resource
utilisation has already returned to normal, other measures continue to point to a certain
degree of spare capacity. There are many indications that unemployment has the potential to
decrease a bit more before any "bottleneck problems" arise in the labour market (see
Slide 9).
CPIF inflation has shown significantly more stable development than CPI, which includes the
effects on mortgage interest expenditure of the drastic interest rate cuts implemented during
the crisis, as well as the recent interest rate increases. Inflationary pressures are starting to
increase in tandem with the economic recovery. This means that the repo rate has also been
increased from the very low level of 0.25 per cent that prevailed one year ago to 1.5 per cent
today. This allows us to safeguard the balance of Sweden's economy and simultaneously
attain the inflation target of 2 per cent.
Where are we going?
Having come this far, it may be appropriate to stop and spend a moment reflecting over the
financial crisis and long-term economic development. As I mentioned in my introduction, the
period from the mid-1990s until the financial crisis was characterised by good growth, low
inflation and decreasing variation in output and prices. In addition, the financial crisis was
preceded by a period of about 60 years of unbroken growth in the world economy. So we
could ask ourselves: are crises of the type we have just experienced "improbable events"
that take place perhaps once in fifty years and something we just have to accept? My answer
is both yes and no. We have learned that financial crises are extremely costly. Governments
and central banks are now busy discussing different measures both to reduce the likelihood
of crises arising and to mitigate the consequences of any such crises. This work is very
important, but unfortunately will not mean that, as of now, there will never be any more
crises.
So what should we do to ensure that it takes as long as possible until the next crisis breaks
out? To start with, it is important to develop the financial regulatory framework both in
Sweden and abroad, so as to boost the resilience of the financial system. Work on this is
currently in full swing, but it will take several years before we will be able to gain a clearer
view of how such a new regulatory framework may look. However, regardless of how it may
look, it will affect the conditions for monetary policy, one way or another. It is thus important
for central banks to continually monitor and analyse changes in the financial regulatory
system. The financial crisis has also emphasised the need to better incorporate the financial
markets' significance into the macroeconomic assessment that guides monetary policy.
Future developments - the stable development of Sweden's economy requires the
repo rate to be raised
The recovery of Sweden's economy after the financial crisis has now made a lot of progress.
Output has largely returned to the pre-crisis level, and unemployment is in retreat. Our
assessment of developments is that the high growth rate in the economy will gradually
decrease in the period ahead and will approach normal levels. Underlying inflation is
increasing and will be close to target by the end of the forecast period (see Slide 10). It could
be said that the Swedish economy, including monetary policy, is in a process of
normalisation. This also means that issues that were being analysed before the crisis
erupted, such as commodity prices and the development of the krona, are again on the
agenda, now that the need for acute crisis management has decreased. One example of this
is formed by the alternative scenarios in the last monetary policy report, which dealt with both
the stronger krona and commodity prices, which are now rising rapidly on the world market
(see Slide 11). I will return to these scenarios later.
Another sign of normalisation can be seen in the occasional differences between the
Riksbank's repo rate forecast and different measures of market expectations of the repo rate.
During the financial crisis, there was unusually great uncertainty regarding where the
economy was going and how various monetary policy measures would affect developments.
Consequently, it was not surprising that different analysts arrived at different conclusions
regarding the future development of the repo rate. During 2009, most measures of market
expectations indicated that participants expected earlier repo rate increases than were
indicated by the Riksbank's repo rate path. The situation in 2010 was the opposite: that is,
the market expected slower increases of the repo rate than were suggested by the repo rate
path. The direction of Sweden's economy is now clearer and this may explain why different
measures of market expectations have moved closer to the Riksbank's forecast (see
Slide 12).
All in all, the monetary policy stance suggests a gradual increase of the repo rate towards
more normal levels (see Slide 12). This is a precondition for the balanced development of the
Swedish economy. As I mentioned two days ago, housing prices and debts among
households have increased heavily for a longer time. The rate of increase of household
debts has far exceeded the rate of increase of incomes. If this development continues,
imbalances may arise in the Swedish economy over the long term. Consequently, in this
regards, the normalisation of the repo rate level may also contribute to promoting a stable
economic development in the future.
Even if the development of Sweden's economy is favourable, it is naturally not risk-free.
What risks can we see at present?
Firstly, the krona may appreciate more than we had expected. The assessment we have
made is that the krona, to a significant extent, already reflects the high growth rate of GDP
and the strong state of public finances, for example. However, I would like to point out that
forecasts of exchange rates are always associated with significant uncertainty. It cannot be
ruled out that the favourable development of the Swedish economy has led many investors
to reappraise their view of investing money in Sweden. So could an excessively strong
exchange rate form a problem? Yes, it may form a "problem" in so far as demand for
Swedish exports will decrease and inflation may not increase in line with expectations, as
imported goods become cheaper. Should this be the case, it may not be necessary to
increase the repo rate as rapidly. An alternative scenario in February's Monetary Policy
Report examines this possibility. But let me clearly emphasise that the Riksbank has no
target for the level of the exchange rate. Monetary policy is governed by the inflation target,
even if the exchange rate is an important determining factor for inflation.
Secondly, as I mentioned, commodity prices have increased very steeply over the last year
(see Slide 11). To a certain extent, although far from completely, this price rise has been
counteracted by the appreciation of the krona. If commodity prices increase as a result of
rising demand, this price increase will probably be more permanent than one resulting from
supply shocks - that is factors obstructing output.5 It seems likely that the strong economic
development of the emerging economies - with increased demand for intermediate goods as
a result - can largely explain the increase of commodity prices over the last year. The very
recent unease in North Africa has contributed to rising oil prices and has more of the
character of a supply shock. All in all, the increase of commodity prices may have greater
contagion effects on prices in the rest of the economy than we have estimated.
Thirdly: even if unemployment has decreased over the last year, it is still relatively high.
Despite this, a certain degree of labour shortages can already be discerned in several
sectors. Shortages have even risen rapidly in the manufacturing sector, where employment
fell the most during the crisis. Only one-fifth of the jobs lost in the manufacturing industry
have again been filled. This may have effects on wage formation and inflation. In our
forecast, wages will increase by 3-3.5 per cent over the coming three years. Labour
shortages in combination with a strong economic climate may lead to a situation in which
wages increase at a faster rate. In that case, inflation will be higher and it may be necessary
to raise the repo rate more rapidly.
Having discussed these risks, it may be worthwhile to point out that they are only risks. Our
main scenario for future developments suggests the stable recovery of the Swedish economy
and gradual increases of the repo rate.
Conclusion
Let me now summarise the basis for the future direction of monetary policy. Following the
financial crisis, Sweden's economy has shown a strong recovery. Growth is currently high,
but is expected to decline successively. The labour market is on the road to recovery, and
unemployment is falling. Prices are increasing on the world's commodity markets,
contributing to rising inflation. Resource utilisation is on the way up, also contributing to the
increase of inflationary pressures in Sweden in the period ahead.
All in all, it can be said that the financial crisis is now behind us and that the situation is in the
process of normalisation. This also requires a normalisation of monetary policy in the form of
rising repo rates in the years ahead.
In this context, allow me to clarify an important issue linked with the forecast for Sweden's
economy. As I have mentioned, our assessment is that growth in the Swedish economy
- following its very bumpy journey during the financial crisis - will gradually decrease (see
Slide 2). Whether the forecast for Sweden's GDP growth "levels off" at 2, 2.5 or 3 per cent
will be determined by the workings of the economy, by the development of output and more.
Monetary policy cannot influence long-term growth rates or the long-term level of
unemployment.
The inflation target and monetary policy are thus, in themselves, no guarantee of high
growth, but they create the right conditions for consumption and investment decisions and
reduce uncertainty over future price changes. And this is a strong foundation.



BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches