SPEECH
SVERIGES RIKSBANK
DATE:
15 October 2019
SE-103 37 Stockholm
SPEAKER: (Brunkebergstorg 11)
Governor of the Riksbank Stefan Ingves
VENUE:
Money Macro and Finance Research Group, London
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Swedish monetary policy experiences
after the global financial crisis: What
lessons are there for other countries?∗
Thank you for inviting me. It is both inspiring and a privilege to be given the
opportunity to speak in more academic contexts, such as this one. Although it was a
long time since I was conducting academic research myself, I try to keep updated
on what is happening, not only because it is part of the job, but also for my own
interest. Now, about ten years on from the global financial crisis, I feel that we are
in an unusually interesting phase.
Worldwide economic events like the financial crisis, such as the Great Depression
of the 1930s and stagflation in the 1970s, often have a profound effect on both
macroeconomic thinking and practical policy. It is possible that something similar
will also happen this time, but what a new macroeconomic paradigm will look like
and what the policy implications will be is still unclear.1
For my part, the crisis that affected Sweden and a few other countries in the early
1990s is etched on my mind, not least because, back then, I headed the so-called
Bank Support Committee, which managed problems in the Swedish banking
sector.2 That crisis did not perhaps have such a profound effect on macroeconomic
thinking at the global level as it was a more local phenomenon than the latest
financial crisis. But for me, it was clear evidence of how costly crises are and how
important it is to try to avoid them. It also led to us here in Sweden implementing
several important institutional and structural changes to bring more stability and
a longer-term perspective to economic policy. This helped us to cope relatively
well with the global financial crisis later on.
I do not intend to get into the really deep and fundamental issues of the financial
crisis here today, but gladly leave these to research. However, there are lessons
and experiences on many different levels and my intention is instead to apply the
more unpretentious strategy of "starting in my own backyard". More specifically,
what I intend to do is to review three aspects concerning developments in
Sweden since the financial crisis, give my personal reflections on them and indicate
what lessons I think there are to learn.
Such a review need not be as self-indulgent and provincial as one might fear, but
should be of rather general interest. There are clear links between developments
in Sweden and the current international debate on monetary policy. Furthermore,
Sweden has for some reason often been one of the first countries to face various
new situations that have had to be dealt with. And even though other countries
have yet to encounter the challenges already faced by the Swedish economy, they
may have to do so sooner or later.3
The three aspects I would like to discuss are the following:
• The Riksbank is one of relatively few central banks that have explicitly
used the policy rate to try to counteract the build-up of financial
imbalances - a policy that is usually called "leaning against the wind". It is
probably the only central bank that has had to abandon this policy,
temporarily at least, in order to focus fully on the inflation target.
• The expansionary policy that the Riksbank has had to conduct in order to
bring inflation back to the target has, like for many others, involved active
use of the balance sheet and major communicative challenges. My
impression is that the debate over monetary policy has been slightly more
lively in Sweden than in many other inflation-targeting countries.
• A development of a slightly different kind, but that is important enough to
warrant discussion here, is that the use of cash is declining more rapidly
and today is lower in Sweden than in any other country. How have we
reasoned on this so far?
I will go through each of these points, but let me first add that I am expressing my
personal reflections here, well aware of the fact that it can be difficult from a
distance to reflect over events when you are right in the middle of them. It is
possible that my colleagues in the Executive Board of the Riksbank agree with much of
what I say, but it may also be the case that they have a different opinion in some
issues.
When you have to choose between "leaning
against the wind" and the inflation target
One of the conclusions from the global financial crisis is that financial factors and
conditions must be given higher priority in economic analysis and be considered
to a greater extent when designing economic policy. Above all, the crisis was a
signal that greater effort must be made to avoid financial imbalances causing
problems on the macro level. The most concrete expression from this was the
emergence of macroprudential policy, which, in contrast to traditional supervision of
individual banks and financial institutions, focuses on the entire financial system
and the economy as a whole.4
Some of the discussion has been about the extent to which monetary policy
should be used to counteract the build-up of financial imbalances, for example a
substantial and sustained credit expansion. A monetary policy that "leans against
the wind" may contribute to greater stability in the longer term, as the purpose of
trying to prevent financial imbalances from building up is that they should not
cause problems with financial or macroeconomic stability at some point in the
future.
Most people agree that monetary policy should not have the main responsibility
for preventing financial imbalances, but that this should rest on micro- and
macroprudential policy and a well-designed regulatory framework. A central issue is,
however, what support to prudential policy and the regulatory framework
monetary policy needs to provide so that they can fulfil their tasks.5 I do not believe it is
possible to completely ignore financial stability when conducting monetary policy.
Different views in research and among central banks
There is on the one hand a growing research-related literature on whether central
banks should "lean against the wind" - or conduct "prudential monetary policy",
as it is sometimes called and which perhaps is a more telling term.6 There is on
the other hand a more practical policy discussion. I do not intend to go into the
research literature, but just note that it entails investigating a number of effects
and trying to weight them against each other: How effective the policy rate is in
counteracting the build-up of financial imbalances, how effective other tools are
and for how long they are effective - that is, how easily they can be
circumvented7, how much of a negative impact a higher policy rate has on the rest of the
economy and how great the cost is of the crisis that is possibly avoided or
mitigated. To investigate this, theoretical models and simulations in quantified models
have been used.8
It is perhaps not particularly surprising that whether it is considered a good or a
bad idea to use monetary policy to counteract financial imbalances largely
depends on the assumptions made and how the model is designed. My
interpretation of the literature is that it is not leaning clearly in either direction.9
Taking a step away from the research literature, what does it look like in practice?
As academic research has not come to any clear conclusion, it is perhaps not so
surprising that central banks have slightly different opinions. Many central banks,
for example the US Federal Reserve, seem sceptical to using the policy rate to
counteract financial imbalances, other than possibly as an absolutely last resort, if
nothing else proves effective.10 But there are also central banks that have made a
"leaning against the wind" policy into an integrated part of the monetary policy
set-up. Perhaps the clearest current example is Norges Bank. Norges Bank's remit
refers, on the one hand, to regulations and the supervision of financial institutions
being the most important means of preventing shocks in the financial system. But
it also says that: "If there are signs that financial imbalances are building up,
consideration of stable production and employment in some situations may lead to
the interest rate being held slightly higher than it otherwise would have been".11
Why the Riksbank stopped "leaning against the wind"
Up until a few years ago, Sweden conducted a similar policy to Norway. A
development that worried us, and that we thought we needed to deal with, was that
household debt and housing prices had been rising rather rapidly for some time.
Even though the policy we conducted was mainly governed by traditional
monetary policy motives, that is, the expected development of economic activity and
inflation over the next few years, the risks associated with the development of
household debt and housing prices were part of our assessment. To help dampen
this development, the repo rate was therefore set slightly higher than would
otherwise have been the case. There was thus an element of "leaning against the
wind" in the policy, especially during the years after the financial crisis.12
However, these fears also influenced the policy before the crisis, something I talked
about at the conference in Jackson Hole in 2007.13
So what happened and why did we stop "leaning against the wind"? A few years
after the financial crisis, it was clear that inflation had not risen in the way the
Riksbank had anticipated, but instead was surprisingly low. During the first half of
2013, for example, the average of Swedish forecasters expected inflation to reach
around 1.5 per cent in 2014. The outcome was almost one percentage point
lower, that is, one and a half percentage points below the target.
The period during which inflation undershot the target thereby became gradually
more prolonged. In mid-2014, inflation had been continuously below target since
2010, and periodically quite far below (see Figure 1). Once inflation had undershot
the target for a while, inflation expectations also began to fall, including long-term
expectations. Thus, economic agents did not expect inflation to meet the target
even five years ahead (see Figure 2). In wage formation as well, there were signs
that the inflation target was beginning to be of less significance.
In other words, a risk began to build up that the role of the inflation target as
benchmark for price-setting and wage formation would begin to weaken - that
the nominal anchor that has been an important part of the favourable
developments in Sweden since the early-1990s crisis would begin to slip. As the
basic premise of inflation targeting policy is to anchor long-term inflation
expectations at the target, this development made it urgent to bring inflation back
up towards 2 per cent fairly rapidly. It was therefore clear that the Riksbank
needed to focus entirely on the task of maintaining confidence in the inflation
target. Consequently, there was no longer any scope for conducting a policy that
"leans against the wind". As a result, the Riksbank cut the policy rate quite rapidly
down to -0.50 per cent and also began to purchase substantial volumes of
government bonds, particularly in relation to the size of the sovereign debt.
This of course did not mean that we ceased to concern ourselves with the
problems associated with debt and housing prices. Throughout this entire period,
we have highlighted this development in our communication as a significant risk
in the Swedish economy that needs to be dealt with but that we do not have the
scope to address under the prevailing circumstances.
I would say that it is largely differences in confidence in the inflation target that
explain why Norway, for example, has been able to conduct a different monetary
policy to the one pursued in Sweden after the financial crisis. Confidence in the
target does not seem to have been threatened in the same way in Norway as in
Sweden. But when it is threatened, I think it is very difficult to refrain from
redirecting the policy and prioritising the inflation target.
Naturally to prioritise the inflation target when
confidence in it is threatened
As far as I am aware, this confidence effect has so far not been considered very
much in the research, if at all. The costs of "leaning against the wind" are typically
assumed to arise in the short term, in the form of lower inflation and growth. But
it might also be the case that confidence in the inflation target risks being lost in
special circumstances. Re-establishing it may require a prolonged and costly
process, which should also be taken into account. It is such fears that largely explain
the policy conducted by the Riksbank in recent years.
Does a policy that "leans against the wind" require there to be confidence in the
inflation target? It is probably possible to construct theoretical and quantified
examples in which the recession that is prevented or mitigated by "leaning against
the wind" is sufficiently long and deep for it to be worth taking the cost of losing,
and having to re-establish, confidence in the inflation target. But in practice, it is
very difficult to imagine how a central bank, seeing that confidence in the inflation
target is being eroded, could stick to a tighter policy and risk inflation
expectations staying permanently low in order to perhaps prevent a financial crisis
sometime in the future.
I am not saying that this is a reason to never conduct a policy that "leans against
the wind". On the contrary, I am personally in favour of the idea as such, and can
well imagine formally integrating such a policy into the monetary policy set-up, in
the way it has been done in Norway. But one can argue a policy that "leans
against the wind" is in practice a "fair-weather" policy - windy but sunny, in other
words. Only as long as confidence in the inflation target is intact, there is scope to
use monetary policy to counteract financial imbalances. I would say that this is
one of the lessons worth highlighting from developments in Sweden after the
financial crisis.
An expansionary policy with communicative
challenges
So how have things gone since? The more expansionary policy gradually started to
have an effect. Growth rose and employment increased. Inflation started to rise in
2015 and in 2017 returned to the inflation target of 2 per cent. Since then, it has
remained close to target, although most recently it has decreased slightly.
Inflation expectations also turned upwards, both short-term and long-term (Figure 3).
Furthermore, developments in Sweden have been generally positive in an
international perspective, regarding both employment and growth (see Figure 4).
Intensive debate despite good target attainment
The fact that macroeconomic developments have largely been favourable for
some time does not mean that everything is hunky-dory, which one might have
expected. As I have already indicated, the expansionary policy has given rise to
intensive debate. Perhaps the debate has been livelier and monetary policy more
brought into question than in many other countries with similar frameworks. A
comparison could be the debate in the United States. But in contrast to in the US,
it has not been a question in Sweden of political pressure to conduct a more
expansionary policy but rather about pressure from opinion-makers and debaters to
conduct a less expansionary policy.
Part of the explanation might be that there has been a relatively large discrepancy
in Sweden between, on the one hand, the policy required to maintain confidence
in the inflation target and, on the other, the policy that would have been justified
by developments in the economy otherwise. If the Riksbank had not needed to
take confidence in the inflation target into consideration, but only the
developments in the real economy with a positive output gap and a strong employment
trend, the policy would most probably have been less expansionary. Certainly,
other central banks too have kept policy rates negative for a long time, including
the European Central Bank. This has caused some criticism in certain euro
countries, but the expansionary policy has been motivated not only by low inflation but
also by relatively weak developments in the real economy in the euro area as a
whole.
Effects on the housing market and the exchange rate
stumbling blocks
A few different things have bubbled up to the surface in the Swedish debate but
there have been two main themes, as I see it. One is connected to what I was just
talking about, that is that the Riksbank, about five years ago, had to choose
between continuing to "lean against the wind" and maintaining confidence in the
inflation target.
The more expansionary policy that the Riksbank then began to conduct of course
did not make things easier, but instead stimulated the increase in debt and
housing prices further. However, the Swedish Financial Supervisory Authority,
Finansinspektionen, which has had the responsibility for macroprudential policy
since 2014, has taken measures and as a result of this, and possible for other
reasons, prices have slowed (see Figure 5). Although lending to households has
continued to increase, this has dampened criticism against the effects of the
expansionary policy on debt and housing prices. A gradual slowdown in the rate of
increase in debt accumulation has probably also played a role.
Recently, the discussion has instead focused on the development of the Swedish
krona. The expansionary monetary policy has, via the normal exchange rate
channel, contributed to a depreciation of the krona.
But in countries with inflation targets, like Sweden, it is the inflation target that
should anchor long-term expectations while the exchange rate will vary. In recent
years, the krona has developed in a similar way as the currencies of other small
open economies, although it has been relative weak very recently (see Figure 6).
Neither is there reason to believe that Swedish inflation relative to abroad will
cause a trend depreciation of the krona exchange rate, as virtually all countries in
the world have an inflation target of more or less exactly 2 per cent, just like in
Sweden.
This is of course in itself no guarantee that we will not see trends in the krona
exchange rate. Such trends can namely also depend on the fact that the real
exchange rate, that is, the nominal exchange rate adjusted for relative price levels
between Sweden and other countries, is not necessarily constant. If price devel-
opments are approximately the same as abroad, the adjustment of the real
exchange rate will occur via trends in the nominal exchange rate. Importantly
though, trends in the real exchange rate are determined by structural factors,
such as differences in productivity growth among countries.
Challenges in communication
This is how the debate has been framed. One observation is that the monetary
policy conducted by the Riksbank has been the subject of lively discussion, despite
its sole purpose having been to fulfil the remit the bank has from the Swedish
Parliament, the Riksdag. Furthermore, in recent years the Riksbank has managed its
remit well, from a purely objective perspective.
I draw two conclusions from this. First, the debate seems to be about the remit
itself, even if this is not always apparent. It seems people want the Riksbank to do
something other than what it has been tasked to do. Second, maybe we at the
Riksbank have not managed to communicate well enough why we have the remit
we have, why we need to conduct the policy we have conducted and what the
benefits are of having an inflation target of 2 per cent compared with other
monetary policy objectives.
The fact that the communication has faced challenges is in a way natural. Once a
monetary policy framework has been in force for long enough, the benefits of it
tend no longer to be so obvious. In addition, if developments have been
favourable, as has been the case since inflation targeting was introduced, it is easy for
demands and expectations to rise. It is also easy to place greater focus on the
drawbacks, which exist in all frameworks. For example, it is not so difficult to
communicate that high and variable inflation is bad, as was the case when inflation
targeting was introduced in the early 1990s. But when memories of those problems
have faded, it is not as easy to convey that an inflation target is also supposed to
prevent inflation being too low, that is, the importance of there not only being
common expectations in society as to how much prices and wages will rise, but
also that these expectations are anchored far enough above zero. Although this
argument - that the inflation target should be sufficiently high - is crucial, it is
after all also relatively abstract.
There are above all two relationships that I think make it important to maintain
confidence in the inflation target of 2 per cent - which is what our policy in recent
years has aimed to do - and which indicate that the target should not be lower.
One is that the conditions for wage formation to effectively allocate resources in
the economy can deteriorate when average inflation is too low. The reason is that
it has proved difficult in practice to lower nominal wages. If inflation is low and
nominal wages cannot be lowered, it becomes difficult to adjust real wages
among different professions, companies and sectors. This can ultimately bring
about both higher unemployment and poorer productivity growth in the
economy. These problems can be mitigated if there is some inflation.
Another advantage of a target of 2 per cent, which has been particularly apparent
in recent years, is that a very low average rate of inflation would make it more
difficult for monetary policy to counteract recessions. If inflation on average is very
low in a world of low real interest rates, like today, the average nominal interest
rate will also be very low. The lower the interest rate is in normal conditions, the
less scope there is to lower it before it reaches its lower bound. It will thus
become more difficult to counteract future economic downturns with interest rate
cuts. Thus, if you do not like negative interest rates, you should not advocate a
lower inflation target, as that would involve the repo rate needing to be negative
more often and for longer periods. There is a widespread international discussion
on whether a target of 2 per cent, which most developed countries have now,
really provides sufficient scope to conduct a monetary policy that is as expansionary
as it sometimes needs to be.14
But in day-to-day monetary policy communication, these relatively abstract
arguments about the benefits of a credible and sufficiently high inflation target have
to compete with observations that are significantly more concrete for economic
agents: that the policy rate has been negative for rather a long time - in itself an
exceptional circumstance historically - in a situation where output and
employment have generally developed well, and the expansionary policy has helped
lending continue to rise and led to a depreciation of the exchange rate.
Regular overviews of the remit important for
understanding and legitimacy
What lessons can be learnt from this? To begin with, I think that it is quite a useful
observation that a central bank with an inflation target may sometimes have to
conduct a policy that is so exceptional as to bring the policy's legitimacy into
question, despite the aim of it being to fulfil the remit that the central bank has been
instructed to pursue. Bearing in mind the current international economic
environment with low real interest rates and powers that are having a restraining effect
on inflation, this is something that an increasing number of countries may
experience in the period ahead.
A lesson to be learnt from this is, in my view, that regular public reviews of the
monetary policy remit as such are a good thing, so that it becomes clear what the
central bank's task actually is and that it only does what it is intended to do. This
would contribute to both better understanding and greater legitimacy for the
policy conducted by the central bank.
It should be added here that the Riksbank' monetary policy is evaluated every
year, that is, how the Riksbank has performed its remit. The Riksdag Committee
on Finance performs an annual review based on background material such as the
"Account of monetary policy", a report compiled and published by the Riksbank.15
In addition, the Committee on Finance occasionally hires external experts to
review Swedish monetary policy. So far three such reviews have been conducted: By
Francesco Giavazzi and Frederic Mishkin for the period 1995-2005, by Charles
Goodhart and Jean-Charles Rochet for the period 2005-2010 and by Marvin
Goodfriend and Mervyn King for the period 2010-2015.16 Although these external
reviews have sometimes touched upon issues related to the policy objective, their
main purpose has been to evaluate the monetary policy conducted, based on the
existing policy objective. These reviews are undoubtedly valuable and fulfil their
purpose effectively, but it is something else I have in mind here.
Canada has chosen a system with reviews of the central bank's remit every fifth
year.17 The latest review from 2016 analysed, among other things, whether the
level of the inflation target was the most appropriate.18 It is possible that the
interval between the reviews could also be slightly longer, as monetary policy
objectives probably have quite a long "durability" and perhaps do not need to be
reviewed quite so often.
Such regular reviews would probably not lead to substantial changes over time,
which has not been the case in Canada either. But now and then, the conclusion
may be that a change to the monetary policy objective would be preferable,
which would of course be entirely appropriate. The important thing is that the
remit is formulated via objective and scientific examination and scrutiny and not
determined by short-term political motives or subjective opinion moulding in the
media.
Before any system of regular reviews is introduced, legal aspects must of course
be considered. As far as Sweden is concerned, this means, for example, that both
the remit and its terms must be compatible with EU law, which states, among
other things, that the central bank shall maintain price stability. Although this puts
restrictions on the possible remits of central banks, there are nevertheless some
degrees of freedom as regards the exact policy formulation. That the central bank
should aim at maintaining price stability defined in one way or another is of
course only natural. The terms of the reviews must also consider that the central
bank shall perform its remit without influence from the Member State's
parliament, government or any other body.
If Sweden had had a system of recurrent reviews of the policy objective, the at
times almost surprisingly heated debate over recent years would probably have
been more balanced. The issues raised in the debate had then been publicly
examined in these reviews in an objective and scientific way, and it would have been
clear that the Riksbank is not "running its own race", decoupled from its remit. To
motivate the policy conducted by a central bank, it is of course significantly easier
to rely on a review of the remit from at most just a few years ago than, as in
Sweden's case, on a system that was determined more than 25 years ago and whose
status and meaning today seem unclear to many.
I think that a procedure of regular reviews of the remit could also be a way of
counteracting the forces in many parts of the world looking to make central banks
less independent. It would make it clearer that central banks act based on the
remit they have and do not just do as they please, which seems not to be such an
unusual opinion these days.
The declining use of cash
So let me go on to my third point concerning something entirely different; namely
the Riksbank's role as the guarantor of the payment system and the silent, yet
sweeping, revolution taking place on the Swedish payment market.
Very seldom, perhaps just once a century or so, fundamental changes take place
in a country's payment system. These changes can sometimes be just as
important as the changes in macroeconomic thinking that seem to occur at intervals
of a few decades or so.
Massive changes have of course taken place in the payment system through the
centuries. But if we just look at the last two hundred years or so and the
Riksbank's role as the supplier of banknotes and coins, there are a couple of
milestones worth noting. Both concern efforts to guarantee the Riksbank's monopoly
on providing the country with cash by way of legislation.19
In 1809, Sweden's payment system was in a state of major disorder.20 To finance a
war 20 years earlier, large volumes of so-called "riksgäld" notes, paper money
with no underlying coverage, were issued alongside the banknotes from the
Riksbank (then named the Bank of the Estates of the Realm). In addition to creating
inflation, this meant that Sweden had two parallel coin systems that created
uncertainty, gave rise to speculation and led to personal losses.21 The new
Instrument of Government in 1809, which also gave the government and the Riksdag a
greater role in relation to the Crown, therefore stated that the Riksdag would
have the sole right to issue banknotes as legal tender via the Riksbank.
About one hundred years later, in 1904, the so-called banknote monopoly came
into force, which led (again) to the Riksbank obtaining the sole right to issue cash.
The competition this time came from the savings and commercial banks that
emerged during the 1800s and that had begun issuing their own banknotes.22 The
banknote monopoly can be seen as an expression of the fact that banks and the
Riksbank started to refine their roles at this time. The Riksbank ceded regular
banking operations to the emerging banking sector, and started itself to take on
more the role of central bank - the bank of the banks rather than of the general
public - and guarantor of the monetary and payment system.23
The Riksbank is considering an e-krona
A little more than 100 years later, the question of the Riksbank's issuance of cash
has once again become topical, but for an entirely different reason. This time, it is
not a question of other competing with the Riksbank on banknote issuance, but of
the general public's use of cash having declined at a very rapid rate, so much so
that it is now lower than in any other country (see Figure 7). This development is
due to a combination of banks introducing new technology that is cheaper than
handling cash and of most people in Sweden perceiving these solutions to be
more convenient. But a drawback to this development is that if it continues,
Sweden may find itself in a few years' time in a position where cash is no longer
generally accepted by households and retailers. Technological development may in
other words make physical banknotes irrelevant.
This raises a number of fundamental issues about the payment system which we
have not previously needed to consider. If cash were to be completely phased out
within a not-too-distant future, there would, basically for the first time in modern
Swedish history, no longer be a means of payment whose value is guaranteed by
the state, via the Riksbank. We would therefore face a situation where all means
of payment available to the general public are issued by private actors, on a
payment market that is highly concentrated. This could make it more difficult for the
Riksbank to perform its remit of promoting a safe and efficient payment system.
In light of this, the Riksbank has been looking into the scope for issuing a new
form of digital cash, a so-called e-krona, for some time. In this age of
digitalisation, with several already existing so-called cryptocurrencies and others, such as
Libra, on the cusp of being introduced, the Riksbank is far from the only central
bank looking at the issue of digital central bank money. But as cash use is
declining so rapidly in Sweden, there is more pressure on us than on other countries to
come to a conclusion.
The Riksbank has presented its work on the e-krona in two reports.24 There are
naturally a large number of aspects to consider - economic, legal, technical and
even almost philosophical. I would like to say a few words here about how an
ekrona might affect the scope for conducting monet