Stefan Ingves: Introduction on monetary policy
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, to the Riksdag Committee
on Finance, Stockholm, 11 November 2010.
* * *
It is always a pleasure to come here and meet the Committee on Finance. And it is a
particular pleasure to see many new faces. I had the same experience four years ago when I
had been Governor of the Riksbank for less than a year. It is particularly inspiring to have the
opportunity to discuss monetary policy with new representatives of our employer, the
Riksdag (Swedish parliament) - and it is, of course, as always interesting to discuss it with
the ones I have met before.
Just as I did four years ago, I will begin with a summary of the situation. So where do
Sweden and other countries stand today, and how did we get there? I intend to give a fairly
rough outline of my own view of the situation, without going into too many details. This is
usually the best way of conveying the essential features. It will also make it easier to put
current monetary policy in the right perspective.
Several explanations for the crisis
The past couple of years have been rather dramatic, since the financial market turmoil
erupted into an acute global crisis in autumn 2008. It will probably take some time before we
have the complete picture of why the crisis arose and how it could become so deep. But
there are a number of circumstances that almost certainly contributed, although there is still
debate on their relative significance.
Poorly adjusted regulations and insufficient oversight
One fact that definitely did play a role is that the regulations and supervision did not function
satisfactorily. One of the problems was that there was too much focus on the situation of
individual agents and too little focus on the financial system as a whole - too much micro and
too little macro, if you like. Moreover, the supervision lacked the necessary international
oversight as it was largely conducted on a domestic basis by each individual country. There
were also loopholes in the regulations that, for instance, meant that some institutions and
markets were not covered and could expand without the authorities having any real
oversight. Things were not made easier by the fact that there was also great ingenuity in the
financial markets that resulted in new financial instruments, where no one properly
understood the risks. So all in all, one can say that the deficiencies in regulation and
supervision meant that the brakes did not catch when events got out of control and the risks
became too great.
A North Atlantic property bubble...
One of the main reasons behind the financial crisis is sometimes said to be that a property
bubble arose in the United States, which then burst and spread extensively. This is largely
true, although a simplification. However, property markets in many other countries had
experienced substantial price increases over a number of years, followed by a dramatic fall in
connection with the crisis. Obvious examples of this are the United Kingdom, Ireland and
Spain. It is probably therefore more correct to talk about a North Atlantic property bubble.1
Developments in the United States may have been the trigger, but problems had already
built up in many other countries, too, and not only in the property markets.
...as a result of a long period of macroeconomic stability?
What was the driving force behind this process? Macroeconomic factors probably played an
important role. The global macroeconomic environment in the years prior to the crisis was
characterised by low interest rates, low and relatively stable inflation and high and relatively
stable growth. In brief, there was an awful lot that looked awfully good - so good that this
period was given its own name: "The Great Moderation". It is perhaps not so surprising that
in this environment of low interest rates and an apparently new era of macroeconomic
stability households and financial institutions became over-optimistic and took on too much
risk. Households were happy to borrow and financial institutions were happy to lend. Much of
this credit was used to buy houses and property prices began to soar.
...because of overly expansionary monetary policy?
There is a debate as to the role of monetary policy in creating this situation. The debate has
mainly concerned claims that the US central bank had held interest rates too low for a
number of years prior to the crisis. But other central banks, such as the European Central
Bank, also held interest rates low during this period. It is not entirely clear what role monetary
policy played - and plays in general - for the development of property prices and for risk
propensity among economic agents. This is a subject that will probably continue to be
discussed. However, on the basis of the information available at the time, there was no
obvious reason for conducting another monetary policy than the one that was actually
conducted. In the United States, for example, there was justified concern that the country
might suffer the same deflation problems as Japan, and many other countries also perceived
the threat of deflation as something to be taken very seriously.
...as a result of a global savings glut?
But there was also another and probably more important factor contributing to the low
interest rates. Since the end of the 1990s the emerging economies in Asia, particularly
China, and in the Middle East had experienced large current account surpluses, particularly
in relation to the United States, but also to other western countries. In other words, the
countries with surpluses had exported many more goods than they had imported. In return,
they had invested the surpluses in bonds and other assets in the countries with deficits. One
could say that this reflected an increased willingness to save in the world economy - a global
savings glut. This surplus contributed to pushing down long-term interest rates in the world.
At the same time, there was a lot of capital to invest in the countries with deficits. A large
share of this found its way into the property markets, where prices soared.
It is not unusual for such international imbalances to lead to problems sooner or later. The
situation is reminiscent of that which arose following the oil crises in the 1970s. The large
increases in oil prices then meant that the oil-producing countries were sitting on huge
amounts of dollars, the currency in which oil is normally traded. These so-called oil dollars, or
petrodollars, were channelled through banks in the west into loans to countries in, above all,
Latin America. However, it was gradually revealed that the loans had been granted on overly
optimistic grounds, and many countries found it increasingly difficult to pay the interest on
their debts. This led to the debt crisis at the beginning of the 1980s.
We thus now have a similar problem with global imbalances in the form of large current
account surpluses in some countries and deficits in others. The difference today is that the
surplus this time has contributed to excessive borrowing in many western countries rather
than to a debt crisis in Latin America. But the theme remains largely the same: Plenty of
money to lend, excessive optimism among lenders and borrowers and inadequate controls
and supervision - this is usually a sure recipe for a crisis.
Global challenges
So much for the causes of the financial crisis. What about its consequences? One obvious
consequence has been that many countries have needed to use fiscal policy to support the
bank sector and to maintain demand in the economy. As tax revenue has fallen as demand
has weakened so much, this has led to large budget deficits and rapidly growing government
debt. One might say that the debt problem has been transferred from the private sector to the
public sector. So to return to my earlier discussion of the debt crisis in the early 1980s, one
can perhaps say that the result of the international imbalances was once again a form of
public debt crisis.
All in all, this means that the global economy is now facing at least three major challenges:
Firstly, the regulations for the financial system need to be tightened, and supervision needs
to be more effective. The aim is, of course, to increase stability and resilience in the financial
system and reduce the risk of future crises.
Secondly, as I recently noted, many countries have experienced problems with large deficits
in their public finances. This is a problem that has now become acute, and needs to be dealt
with. We in Sweden are all too well aware of the confidence problems that can arise from
mismanaged public finances. It is of course easier to make the necessary consolidation if
private sector demand is kept up. One could say that many countries therefore need to
undergo what could be described as an internal adjustment of demand - from public to
private.2
Thirdly, an external adjustment of demand is also needed. Many countries in the western
world, and not least the United States, which was overly dependent on high domestic
demand before the crisis, must rely more on exports in the future. Correspondingly, countries
which have accumulated large current account surpluses, and in particular China, will have
to rely more on domestic demand. Thus, what is needed is a changeover from domestic to
foreign demand in some countries and the reverse changeover in other countries.
Create new regulatory systems
There is currently fairly substantial international unity on the first issue - the need for a better
regulatory framework and more effective supervision of the financial sector - even though
much of the details remain to be discussed. There has also been some progress in this field.
One example is what is known as the Basel III regulations, agreed by central banks and
financial supervisory authorities around the world some weeks ago. In brief, these involve
raising the international requirements regarding the capital and liquidity the banks must hold.
For instance, a larger share of the capital must be real equity capital. Another example is that
the EU has established a special body, the European Systemic Risk Board, which is to
identify risks in the financial system and to provide warnings and recommendations to the
countries and authorities concerned.
Public finances an acute but difficult problem
The two other challenges are rather more difficult. The problems with public finances entail a
difficult balancing act for the countries concerned. On the one hand, it is desirable that the
savings do not increase too much too soon thereby withdrawing public sector demand while
private sector demand is still weak. This could lead to a negative spiral, with falling demand
and production, where public finances are weakened rather than strengthened. On the other
hand, the deficits and the government debt must not continue to grow to the extent that
doubts arise regarding the ability to repay the debt at all. Such a situation would hardly be
preferable. A further complication is that this time there are many large countries who need
to save at the same time. The effects on the global economy could then be substantial,
particularly if the balancing act is not successful.
Adjusting the global imbalances is not made easier by the crisis
The third challenge - that some countries must begin to rely more on exports and others
more on domestic demand - was debated intensively even before the crisis. After the crisis
the problems of this global imbalance have in some way become even clearer. One means
of maintaining demand and creating scope for consolidation of public finances is to increase
exports. And one means by which exports can increase is if the currency weakens so that
the country's own goods become cheaper for other countries to buy. The problem is that all
countries cannot by definition export their way out of the crisis at the same time. All countries
can conduct an expansionary policy, but all countries' currencies cannot weaken at the same
time.
Despite this insight being relatively widespread, fears have been expressed of a currency
war, where countries deliberately try to weaken their own currencies. And if a currency war
begins, it is only a short step to a trade war, where countries begin to introduce tariffs to
protect their own manufacturing. This was what happened during the great depression of the
1930s, and it of course only made the problems worse. Such a development would be very
unfortunate and have a considerable negative impact on small economies with extensive
foreign trade, such as Sweden. At present there are major efforts being made in various
international forums to avoid the global economy spinning off in this direction.
The Swedish economy has coped relatively well
This is a general outline of the international picture. Although the world economy has begun
to recover, there is no doubt that it is facing fairly major challenges over the coming years.
But what is the situation here in Sweden? Well, in many ways things look rather good. The
Swedish economy appears to have coped fairly well in the crisis. Although production fell
more in Sweden than in many other countries, the recovery has been much quicker. The
situation now looks much more stable than in most other places.
One important reason why we have managed so well is, I believe, that it is not so long since
we experienced a crisis here in Sweden - both in the bank system and the economy as a
whole. The crisis at the beginning of the 1990s was much more isolated than the recent crisis
and can in many ways be described as "home made". But we nevertheless managed to learn
some important lessons from it.
Stable frameworks provide security...
Perhaps the most important lesson is that both monetary policy and fiscal policy need stable
long-term frameworks. The previous crisis therefore led to a number of changes in this
direction, many of them through decisions made here in the Riksdag. Unlike the situation in
the previous crisis, monetary policy is now conducted by an independent Riksbank with an
inflation target. We also have an expenditure ceiling and a surplus target in the fiscal policy
area, which are designed to prevent public finances being undermined or savings having to
be made in inappropriate situations. Sweden has been one of the countries in the front line,
both in reforming the framework of monetary policy and that of fiscal policy. Many other
countries have later made changes similar to the ones we made. It is also worth noting that
the most recent crisis, and the public finance problems it has entailed, have triggered a new
wave of interest in fiscal policy regulation.3
The stable frameworks for monetary policy and fiscal policy have in many ways functioned as
"shock absorbers" in this crisis. Unlike during the previous crisis, economic agents have been
able to assume that inflation will be fairly stable and that public finances will remain under
control. This creates a security which I believe is particularly valuable during periods like this,
when there is considerable uncertainty in general around the world. I imagine, for instance,
that households in countries with weak public finances are much more concerned about the
future.
...and make it easier to stimulate the economy
The stable frameworks have also made it easier to stimulate the economy strongly during the
crisis without anyone questioning the credibility of the inflation target or the sustainability of
our public finances. One could also say that long-term credibility and sustainability are
necessary conditions for monetary policy and fiscal policy to be able to provide short-term
stimulation. A rather worn but appropriate expression used with regard to fiscal policy is to
"save for a rainy day" during good times. We appear to have succeeded in doing so this time.
So the second of the three global challenges I listed does not actually apply to Sweden.
Better regulatory framework also important for us
One cannot rule out the possibility that our previous crisis contributed to some extent to our
bank system managing better this time than banks in many other countries. But the Swedish
banks' memories still do not appear to have been terribly long. A couple of them were carried
away by the over-optimism in the Baltic countries, and most of them would have faced much
larger problems if the Swedish authorities had not intervened so resolutely. On the positive
side, they largely avoided securities containing high-risk US mortgages. New share issues
and good earnings capacity mean that the Swedish banks now appear well-capitalised from
an international perspective.
The first challenge - the design of a better regulatory framework and more effective
supervision - is of course something to which Sweden is contributing in various ways. Our
own financial markets and banks coped relatively well on this occasion, but it is nevertheless
clear that we are also hit hard when there is international turmoil. Moreover, the financial
sector in Sweden has some distinguishing characteristics which make stability and clear
game rules particularly important. From an international perspective, the Swedish banks'
collected balance sheet totals are large in relation to our GDP, market funding comprises a
larger share than in most other countries, and funding from abroad is relatively extensive and
largely short-term.
Our own Swedish regulatory framework also needs to be renewed. For one thing, we need to
look into the division of responsibility and the powers of authority of the different government
agencies. For instance, the Riksbank is responsible for the stability of the financial system in
Sweden, but has no really effective tools to carry out this task. Finansinspektionen (the
Swedish Financial Supervisory Authority), on the other hand, has tools that could be used to
influence the banks' behaviour. But it does not have the task of counteracting
macroeconomic developments than entail risks for financial stability. Another important issue
that needs to be addressed in a new regulatory framework is how the state should manage
banks in distress.
In February we presented a report to the Riksdag proposing that the regulatory framework in
Sweden should be reviewed. We mentioned these two areas as examples of important
objects for analysis. The Riksdag has decided that an inquiry shall be made, and hopefully
this work will begin soon.
Natural explanations for Sweden's current account surplus
With regard to the third of the challenges - the changeover from exports to domestic demand
or vice versa - one can note that Sweden is one of the countries with large current account
surpluses. This has in principle been the case since the previous crisis at the beginning of
the 1990s. However, the surplus is hardly the result of a deliberate policy to build up a strong
external position. The fact that we are saving as much as we are is partly due to our public
finances being in good order and partly due to commercial decisions in the private sector.
Nor have we tried to benefit exports by holding our currency artificially low. We conduct
inflation targeting, and the exchange rate is simply left to its own devices. There are thus
natural explanations for our current account surplus and there have not been any strong
requests from abroad for us to reduce it. So really, one can say that the third challenge does
not have any direct implications for Sweden, either.
The forecast and the interest rate decision
It has thus become increasingly clear that the Swedish economy is growing strongly. Many
indicators of developments in the real economy are now at very high levels and GDP
outcomes have been surprisingly strong. How do we see developments in the coming
period? And what monetary policy is needed now?
Recoil from the crisis
To some extent, the rapid Swedish recovery is a recoil from the drastic fall in demand during
the crisis. An important part of the fall in world trade was due to the postponement of
purchases of investment goods and durable consumer goods - goods that comprise a large
part of Swedish exports. The global economic recession therefore had a strong impact on the
Swedish economy, which is very dependent on exports. World trade has now recovered,
mainly through the rapid growth in emerging economies in, for instance, Asia. Growth has
also been good in the Nordic countries. The upturn in our exports is to a great extent driven
by demand for the goods that were previously postponed. In the same way as Swedish
exports fell as markets shrank, they are now rising as the markets are growing again
(Figure 1).
Good public finances...
But to a large part the good developments concern what I just tried to convey: That we
actually acquitted ourselves fairly well this time. This includes the good public finances. Since
the end of the 1990s our national debt has shown a declining trend. There has not been any
corresponding decline in, for instance, the Eurozone and the United States (Figure 2), where
the national debt moreover began to increase substantially during the financial crisis. In
many areas it is thus necessary to tighten fiscal policy, but this does not apply to Sweden.
...and a high level of household saving gives scope for growth
But Swedish households have also acted in a way that has increased resilience during the
economic downturn. Unlike in many other countries, savings in Sweden have shown a rising
trend over the past decade (Figure 3).
During the crisis, saving increased both in Sweden and in most other countries. This is
largely due to what is known as precautionary saving as a result of increased uncertainty. In
many countries this uncertainty concerns the large deficits in public finances and what
consequences these may have for household incomes in the future. As this uncertainty can
be expected to remain over the coming years, private consumption will probably be held
back. But we do not have this situation in Sweden. Although one can note that consumer
confidence has strengthened in many areas in recent years, it is primarily in Sweden that it
has reached historically high levels (Figure 4). The combination of sound public finances and
high household savings means there is scope to reduce saving over the coming years.
Together with relatively large increases in disposable incomes, this means that private
consumption is likely to increase at a good pace.
Sweden is one of few countries in the OECD area where the labour market has clearly begun
a recovery. Moreover, the upturn in employment is on a broad front. The manufacturing
industry has once again begun recruiting and is expected to continue to do so over the
coming period. Employment in the services sector, which managed the crisis better, is also
expected to continue increasing.
Resource utilisation is rising gradually
Swedish GDP growth is expected to amount to almost 5 per cent in 2010, before gradually
falling back to around 2.5 per cent at the end of the forecast period. But as the fall in 2008
and 2009 was so great, GDP will not return to its pre-crisis level until the beginning of next
year (Figure 5). The overall assessment of resource utilisation is that it is still lower than
normal, but that it will successively rise towards normal levels during the forecast period. It is
natural to assume that the higher resource utilisation will gradually have an impact on
inflation. Although CPIF (underlying) inflation will continue to fall slightly over the coming
year, partly due to a stronger krona, it will then increase, reaching 2 per cent at the end of
2013 (Figure 6). CPI inflation will be slightly higher, as it is affected more directly by the
Riksbank's interest rate increases via households' mortgage rates.
The assessment we made a couple of weeks ago was that an increase in the repo rate of
0.25 percentage points was justified. We also assumed that we will need to continue raising
the repo rate over the coming years to stabilise inflation close to the target and to attain
normal resource utilisation. However, we do not believe that the repo rate will need to be
raised quite as quickly as we had previously assumed. The slower recovery abroad, with
lower policy rates, indicates that interest rates in Sweden will not need to be so high.
Household debts still cause concern
One factor that I personally have taken into consideration when raising the repo rate this time
and supporting the forecast for continued increases, is the development of household debt. If
this does not slow down, I believe that there is a risk of financial imbalances arising, if not
within, then beyond the forecast horizon. I believe that a gradual increase in the repo rate will
contribute to reducing this risk. Finansinspektionen's recently introduced loan restrictions are
also one step in the right direction. A future challenge will be to find an appropriate balance
between supervisory regulation and interest rate-setting.
Of course, this overall picture may have to be revised if developments do not turn out as we
are expecting. I have already pointed out that the global economy is facing fairly major
challenges. A new economic downturn abroad could lead to lower resource utilisation and
inflation in Sweden, too. Monetary policy would then need to be more expansionary than in
the forecast. But there is also a possibility that the economic upturn in Sweden turns out to
be faster and stronger than we have assumed. In this case we might need to raise the repo
rate slightly faster. But none of these alternatives is our main scenario at present.
In the pipeline: Assessment of monetary policy and inquiry into the housing market
So much for the forecast and the repo rate decision. Before I finish, I would like to mention a
couple of things that are in the pipeline. Work has now begun on the external assessment of
the Riksbank during 2005-2010, which the Committee has commissioned Professors
Charles Goodhart and Jean-Charles Rochet to carry out. The professors have already visited
the Riksbank and will be visiting us again soon. We will of course provide them with every
possible assistance. Unlike the previous external assessment, which covered the period
1995-2005, this assessment covers not only monetary policy but also our work on financial
stability. What is of particular interest this time is that the professors will analyse what
lessons can be learned from the financial crisis. The assessment will be complete in autumn
2011.
An inquiry with a shorter time span is the one concerning risks in the Swedish housing
market, which was decided at the beginning of this year. In more concrete terms, this
involves giving external experts as well as our own employees the task of analysing issues
that in different ways illustrate the relationship between the housing market and the
Riksbank's objective and aims. The inquiry as a whole should be complete at the beginning
of next year. However, as a part of this inquiry the Riksbank is organising a workshop
tomorrow with the title "Housing markets, monetary policy and financial stability", where a
number of invited international academics will present essays they have written on this topic.
We hope that this inquiry will improve our knowledge of a field that is important both to
monetary policy and the economy as a whole.
I hope that this talk has given you, and in particular the new members of the committee, an
insight into how I view the situation in Sweden and abroad. I shall now do my best to provide
good answers to any questions you may have.
BIS Review 149/2010
BIS Review 149/2010
BIS Review 149/2010