Barbro Wickman-Parak: Economic analysis requires a cool head - my
view of developments in Sweden and abroad
Speech by Ms Barbro Wickman-Parak, Deputy Governor of the Sveriges Riksbank, at a
meeting, Luleå, 15 May 2012.
* * *
I would like to thank Magnus Wiberg at the Monetary Policy Department of the Riksbank for help with writing this
speech.
When we at the Riksbank decided on the repo rate almost exactly one month ago, I was one
of the majority who wanted to hold the repo rate unchanged at 1.5 per cent and to keep the
repo-rate path set at the February meeting. With regard to developments abroad, I pointed
out that there was every reason to express caution with regard to international economic
activity in the coming period. I also pointed out that we should continue to expect fairly
sudden and dramatic changes on the financial markets. At the time of the April meeting we
had seen the financial unease accelerate after a period of stabilisation at the beginning of the
year. The focus was on concerns regarding Spain. Now the outcome of the elections in
Greece has sent even larger shockwaves through the global financial markets, and this leads
to other debt-ridden countries, such as Spain, being hit by greater unease.
Let me say right now that neither I nor anyone else can know with any degree of certainty
what this will entail. We have assumed in our forecasts that the euro crisis will be resolved in
an orderly manner so we can avoid the abrupt downturn that came in the wake of the
Lehman Brothers crash in autumn 2008. Personally, I am not prepared to entirely abandon
this assumption. Monetary policy must be based on forecasts, and basing these on
disaster scenarios is not reasonable. We must continue in the same way as before,
making forecasts that are based on incoming statistics and giving consideration to the
risks of a poorer development in the euro area. Our forecasts for the Swedish economy
and monetary policy need to be gradually adjusted to this. If there is a sharp downturn in
the economy we are prepared to act quickly and forcefully. We demonstrated this during
the crisis period 2008-2009.
There is currently considerable focus on the euro crisis, but there is reason to point out that
there are other risks, albeit less dramatic, to take into account. I will come back to these.
There are also possibilities that growth in the world around us will be better in the slightly
longer run than we are now envisaging. We are currently experience a confidence crisis with
political overtones. This also means that if the political measures gradually gain credibility,
confidence may return quickly and the economy may recover more strongly than we are
predicting. This has happened before.
With regard to Sweden, in April we could see some positive signs in economic developments
after the unexpectedly severe fall in GDP in the last quarter of 2011. The statistics we had for
the beginning of the year pointed towards the fall being temporary. We did not make any
major changes to the forecast for growth we had made in February. Nor was there any
reason to change the forecast for inflation. So far, we have not seen any new statistics that
should cause us to change the economic outlook we presented in April, in my opinion.
I am one of those people who closely scrutinise the statistics to form an opinion of the
economic situation and driving forces behind developments. My long experience in this field
has taught me that it is important not to have blind faith in the accuracy of the measures we
use to assess the economic situation. It is important not to read too much into individual
figures, but to gradually adjust our forecasts as new statistics justify this. This approach to
making forecasts reduces the risk of going in the wrong direction. The experiences of recent
years provide a good illustration. But of course one should also be prepared to make larger
adjustments if the circumstances so require. Our actions in autumn 2008 provide a good
example of this. I have on many occasions expressed my view that monetary policy should
normally be conducted on the basis of gradual adjustment. This is based on my reasoning as
described above.
In other words, I believe it is always a good idea to "keep a cool head" in the context of
forecasting, even when the storm winds are blowing.
Meagre growth in the euro area, but better elsewhere
Developments in the euro area are subject to the problems with sovereign debt and growth is
currently weak. In our most recent Monetary Policy Update we assume there will be a small
decline in euro area GDP growth this year and a weak increase next year. It is these meagre
prospects and concern that developments could be even worse that affect a lot of the
economic reporting at present. However, we assume in our forecasts that it will be possible
to resolve the problems with public finances and banking systems in an orderly manner,
without an aggravated crisis causing an even sharper fall like the one we saw after the
Lehman Brothers crash in autumn 2008. Even if the situation does not deteriorate so much,
the necessary deleveraging in the euro area may take longer than we are assuming. I shall
return later to the risk of a more prolonged debt reduction that would involve postponing the
weak recovery we are expecting to see in the euro area.
Since the monetary policy meeting there has been considerable focus on Spain. Standard &
Poor's have downgraded the credit rating for Spain and GDP has fallen for the second
quarter in a row. The main concern is the problems in the banking system, and the need for
capital injections from the public sector has been highlighted. This type of support measure is
complicated by the need to address the budget deficit. The outcome of the election in Greece
and the uncertainty over whether a government can be formed, and if it would then be able to
present the savings needed for the next payment of the support loan from the EU and the
IMF, have also sent shockwaves through the financial markets. This means that the unease
on the financial markets has increased once again.
With regard to the statistics reflecting real economic developments in the euro area, the
confidence indicator showed weaker confidence for the euro area as a whole. The
purchasing managers' index for Germany has also weakened, but at the same time other
German statistics have been stronger than expected. This applies, for instance, to the IFO
indicator, as well as to production in industry.
It is natural for us to focus on the parts of the world that are facing major problems regarding
growth. But it is also important to remember that the situation is not as gloomy in all of the
euro area countries, as illustrated by Germany. It is also important to note that the US
economy has continued to strengthen, albeit at a slow rate. The situation on the labour
market is improving slowly but surely and this has contributed to increased confidence
among US households. Although the most recent labour market statistics for April point to
weaker growth in jobs, at the same time the statistics on job growth were revised upwards for
the previous months.
In Japan, fiscal policy investments in rebuilding after the tsunami last year will contribute to
growth in Japan being slightly higher than we thought in February. In China, the economy is
expected to grow by more than 8 per cent in 2012.
The overall picture we saw ahead of us in April looked fairly good. Personally, I emphasised
the improved prospects for the United States as a possible reason for feeling slightly greater
confidence in our international forecast. Global GDP is expected to grow at a rate that
roughly corresponds to the historical average. The statistics received since the repo-rate
decision in April have so far not had any dramatic effect on this picture. But the risk of a
poorer development remains and at present there is greater nervousness on the financial
markets than there was in April.
International risks
Even if the euro crisis does not trigger a total collapse in the international economy, there are
a number of risks in the world economy that could lead to poorer economic prospects than
we predict in our April Update. The first risk is that the deleveraging in the euro area will take
longer than expected, and affect the Swedish export industry through lower demand. The
second risk is that the United States will not rise to its fiscal policy challenges, which could
hamper the continued strengthening of the global economy. Let me discuss these risks in
more detail.
A third risk that is often discussed concerns the slowdown on the Chinese property market. I
shall not go into this in any great depth here; I shall merely note that if property prices were
to fall uncontrollably, China has the scope to implement fiscal and monetary policy
stimulation, in that they have a low national debt of around 25 per cent of GDP and a high
policy rate of almost 7 per cent.1 The debate on the Chinese economy is otherwise often
fairly categorical. It concerns either overheating or an imminent crash. If we look back at
earlier developments, we can see that they have successfully managed to avoid both of
these extremes. My assessment is that there is good scope for them to do so this time, too.
The euro area - prolonged deleveraging
In the euro area, it is mainly the Greek debt that has received attention. But, as well all know,
other euro area countries have also suffered debt problems; for instance, Ireland, Portugal
and Spain. Italy also has a high national debt, but this is a problem it has had for a long time.
The following figure shows how public debt as a percentage of GDP has developed in these
countries and the IMF's forecast until the end of 2017.
Figure 1
Development of public debt ratio
Percentage of GDP
180 180
Greece
Ireland
Portugal
Spain
140 140
Italy
100 100
60 60
20 20
00 02 04 06 08 10 12 14 16
Note. Public debt is shown as a percentage of GDP on the vertical axis.
Source: IMF Fiscal Monitor.
Given the high level of debt, the need for deleveraging in the euro area has recently become
a question that is much discussed in various contexts.
Deleveraging - course of events and earlier experiences
Experiences of the Swedish and Finnish banking crisis in the 1990s show that the process of
deleveraging can take more than a decade. It can generally be divided into two phases.2
During the first phase, the consolidation phase, households and companies reduce their
debts. This means that households reduce their consumption and companies reduce their
investment, which entails a weak or negative GDP growth. As a result, public debt
increases, as the expenditure for social welfare increases and tax revenue declines. In
Sweden, for instance, public debt increased from 46 per cent of GDP to 83 per cent during
the period 1990-1994,3 that is, the period when households, banks and companies
reduced their debts. During the second phase, the recovery phase, GDP growth increases
and public debt then also decreases, as higher growth leads to lower public expenditure
on social welfare and to higher tax revenue. In Sweden, for example, the higher growth
after 1996 contributed to reducing the public debt ratio by as much as 28 percentage
points during the period 1996-2008.4
However, there are major differences in the conditions for the Swedish deleveraging and the
consolidation of public finances in the euro area that has now begun. Swedish public debt
amounted to only 46 per cent of GDP during the initial phase of the debt consolidation. The
average for Greece, Ireland, Italy, Portugal and Spain, on the other hand, is still a good
112 per cent.5 The Swedish recovery phase was also driven to a large extent by strong
growth in exports, which was in turn partly due to the krona being allowed to float and quickly
depreciating in this period. As a large percentage of trade in the euro area is internal, and
they have a single currency and therefore cannot depreciate in relation to another currency in
the euro area, there is a risk that the recovery in the debt-ridden euro countries will be more
prolonged. The recovery in Sweden was also facilitated by international growth that was
stronger than it is now.
I would like to point out that our cautious forecasts for growth in the euro area are because
we are assuming there will be tangible effects from the tightening that is necessary to bring
down the public debt ratio. However, there is a risk that the deleveraging will take longer than
we have assumed. A prolonged debt consolidation with savings imposed simultaneously in
several euro area countries would have a negative effect on the surrounding world through
lower trade and demand. This would have effects on the Swedish export industry, which is
dependent on trade with the euro area.
Good competitiveness - lower public debt
At the same time, deleveraging at present involves a difficult balancing act, as extensive
savings measures risk strangling consumption and leading to a downward trend, with a fall in
growth. It is a major challenge to find an appropriate balance between reducing expenditure
and raising taxes to alleviate the effects on growth. Structural reforms of the product and
labour markets are also necessary to improve competitiveness and ultimately growth
potential. This is easier said than done, however, as such measures may be painful in the
short term and politically difficult to implement. But countries that can create the right
conditions for better competitiveness can hopefully also reduce the pressure on public
finances. If one studies Figure 2, there appears to be a connection between good
competitiveness and a lower public debt ratio.
Figure 2
Relationship between competitiveness and public debt ratio
7
6
Sweden
Finland
USA
Denmark Germany
5
Norway
Ireland
Italy
Spain
Portugal
4
Greece
3
2
1
0
20 40 60 80 100 120 140 160 180
Note. The public debt ratio is shown as a percentage of GDP on the horizontal axis.
Sources: World Economic Forum 2011 and IMF Fiscal Monitor April 2012.
The vertical axis measures the respective country's competitiveness as defined by the World
Economic Forum 2011,6 while the horizontal axis measures the current level of public debt
as a share of GDP. A higher value on the vertical axis means that a country has a better
competitiveness. There may, of course, be many factors that affect the public debt ratio, but
according to the figure it would appear that countries with good competitiveness also tend to
have a lower public debt ratio.
At the same time as it will take a while for the euro area countries to bring down their debt
levels, it is important to point out that these countries are not alone in facing budget
consolidation. The United States is also facing the challenge of improving its public finances.
USA - fiscal policy challenges
The US public debt amounted to 103 per cent of GDP in 2011, and is expected to rise to
107 per cent in 2012 and 110 per cent in 2013. As a comparison, the average public debt for
the 14 largest euro area countries amounted to 80 per cent in 2011, while the forecast for
2012 and 2013 is 82 and 84 per cent respectively.7 The well-known economists Reinhart and
Rogoff conclude in an extensive study that a public debt exceeding 90 per cent of GDP
entails risks to long-term growth and stability.8 When public debt reaches these levels,
economic growth is rarely sufficient to reduce the debt, in their opinion.
The US economy is thus facing substantial fiscal policy challenges. At the same time, there
is great uncertainty surrounding fiscal policy as there is a political deadlock between the
Democrats and the Republicans in Congress that may remain after the presidential election
in 2012. The uncertainty has caused analysts to talk about the US economy facing a fiscal
cliff next year. The concern applies on the one had to whether earlier income tax cuts and
reductions in payroll taxes will be extended beyond the end of the year, and on the other
hand is linked to the automatic expenditure cuts that will come into force at the turn of the
year unless Congress can agree on long-term sustainable budget consolidation. All in all,
these automatic tax increases and cuts in public expenditure entail a tightening during 2013
of 3-4 per cent of GDP. A further element of uncertainty is the result of the presidential
election in November. If the results of the election are inconclusive and no party gains a clear
majority, there is a major risk that the political deadlock will persist.
The lack of credible budget solutions at present, and the low confidence in the political
system's ability to deal with the fiscal policy challenge, could led to companies and
households beginning to act with greater caution. This would subdue growth in the world
economy. We have given consideration to these risks in our forecast, but it is of course
possible that the situation will be more problematic than we have assumed.
Realistic to believe in an orderly resolution of the euro crisis?
The risks I spoke of earlier are ones that monetary policy normally faces and has to relate to.
Forecasts change over time and monetary policy has to be adjusted accordingly. We would
have a completely different situation, however, if the euro crisis were to worsen dramatically,
and there was substantial turmoil on the financial markets and economic activity suddenly
dived. In these situations monetary policy needs to adjust to a crisis situation, and we are
prepared for this.
As a central bank, we need to be prepared to deal with many unexpected events. And we
must make an assessment in our forecasts of the probability of these events occurring. A
central assumption in our forecasts is that the financial market turbulence will gradually
decline and that confidence will gradually improve in the corporate and household sectors.
This does not mean that we believe that the road ahead will be straight and narrow. We have
to assume that confidence in the countries' ability to resolve their problems will vary over
time, and during the process different countries will come under focus.
When we summarise the measures taken since the worst phase of the crisis last autumn, the
European Central Bank's two three-year loans to European banks were one measure that
provided immediate relief. An acute liquidity crisis was avoided and the loans have also
prevented a tighter credit crunch than would otherwise have been the case. However, they
do not solve the long-term problems faced by many euro area countries, which was not really
their aim, either. The loans have given many countries the breathing space to implement
reforms, however, and it is important that they make use of this.
At the same time the EU countries have agreed on a number of measures for stricter budget
discipline. For example, reforms have been decided on that will strengthen the current fiscal
policy regulations. These are measures that do not have an immediate effect, but which
nevertheless manifest a political will that should create long-term confidence in a crisis that
has largely political overtones.
When we held our monetary policy meeting in April, Greece had been granted a second
support package by the EU and the IMF, and had reached an agreement with private lenders
on a debt write-down in return for promises of fiscal policy tightening. The euro area
countries had also agreed to increase the capacity of their rescue funds, which was a step in
the right direction.9 After that, an agreement was reached at the IMS spring meeting to
reinforce the IMF's resources with USD 430 billion for lending to crisis-torn countries.
Building up these financial "firewalls" is an important step in creating confidence in the
financial system.
There is often impatience with regard to the sluggishness of the political processes dealing
with type of problems we are now seeing in the euro area. But the different steps that have
been gradually taken on a political level should, as I see it, be able to alleviate a confidence
crisis that is largely political. This would point to an orderly resolution of the euro crisis. It
then remains to be seen whether the crisis flaring up around Greece now can have more
farreaching consequences. In a worried, nervous climate even a problem that only affects one
small country can have contagion effects.
Could things go better than we are forecasting?
I have earlier listed various downside risks. Are there any conditions under which growth
might be better than we are forecasting? My assessment is that this is the case, although
things look uncertain right now and we cannot expect any rapid improvements. I think it is
worth pointing out that we only expect a cautious recovery in growth in the euro area from
the end of 2012 and onwards. What we are now seeing is a confidence crisis of gigantic
proportions, but it also means that if political measures can build up confidence step by step,
the economy in the euro area can recover with greater force than we are predicting. As I
mentioned earlier, there are countries in the euro area with good fundamental conditions for
a stronger recovery.
In the United States there are good conditions for a better outcome. In this situation growth
can be somewhat stronger than the fairly modest growth we are predicting. Particularly if
housing construction picks up again, after several years of adjustment. The driving force
behind growth can be very strong, as earlier economic upswings have shown.
The situation in Sweden - some positive signs
What is the situation in Sweden? The weak growth abroad at the end of last year led to an
unexpectedly severe slowdown in Swedish exports. This means that the fall in GDP growth
in the fourth quarter of last year was larger than we had predicted. The weak year-end has
an impact on GDP growth for 2012, which was revised down in April in relation to the
forecast made in February.
At first glance, the GDP figure may appear ominous. But unlike exports, domestic demand
during the fourth quarter was in line with the Riksbank's forecast. Developments in the retail
trade sector and indicators of confidence in the corporate and household sectors pointed to
demand beginning to increase again. In addition, exports of goods increased strongly in
January and recovered a large part of the fall that took place in the fourth quarter of 2011.
When I weighed together the figures received since the monetary policy meeting in February,
my assessment was that Sweden's economic prospects had brightened. This may appear
strange if one looks at the growth forecast in the Monetary Policy Update and sees that the
growth forecast for 2013 and 2014 is slightly weaker than in February. But this is because at
the end of February Statistics Sweden revised up the number of hours worked, which leads
to a lower productivity trend and a lower growth trend for GDP. This means that the outlook
for economic activity and resource utilisation remained largely the same as in February.
The same applied to inflation prospects. The actual CPIF inflation rate, that is, the CPI with a
fixed mortgage rate, has undershot the inflation target, but one should also look at the
reasons for this. The strong appreciation of the krona that followed in the wake of the
Lehman crash is one important reason. Low unit labour costs are another reason, but here
there is now a turnaround, with labour costs being expected to rise faster during the forecast
period than in the past two years. If one looks at the CPI, the most recent figures are
moreover in line with the inflation target. In this context, I think that a little too much focus
may be given to current inflation in the monetary policy debate, particularly given that it takes
time for monetary policy to have an impact on inflation.
My overall assessment in April was therefore that the repo-rate path from February was still
appropriate. This entails a very expansionary monetary policy with a negative real repo rate
for most of the forecast period.
As I have mentioned, we saw indications at our meeting in April that the fall in growth at the
end of last year was temporary, and we revised up our assessment of growth in the first
quarter of this year. Since the monetary policy meeting we have received quite a lot of new
information. For example we now know that Swedish exports of goods increased slightly
during the first quarter after the steep fall in the fourth quarter of last year. According to
Statistics Sweden's figures, employment was higher and unemployment lower than in our
most recent forecast. The National Institute of Economic Research's Economic Tendency
Survey also showed a large increase during the first quarter and the retail trade index, which
rose strongly in February, continued to rise in March. All in all, new information received
since the most recent monetary policy meeting shows no tendency to revise the forecast for
Swedish growth during the first quarter. Still, I will wait to make an overall assessment of the
new statistics until our next monetary policy meeting in July.
Monetary policy in uncertain times
I have described my views of the situation in Sweden and abroad. I have also pointed to a
number of risks that could lead to a different development than the one we forecast in the
Monetary Policy Update. We try to determine the probability of the risks on the basis of
incoming statistics. This gives us a picture of what can be regarded as a main scenario and
what can be regarded as an alternative scenario. How should a monetary policymaker weigh
up new and often contradictory information about the economy that indicates different paths
of development? I shall conclude with a few reflections on this.
As an economic forecaster, one is confronted by a constant flow of new statistics that often
point in different directions. Let me illustrate this by describing the circumstances of our most
recent monetary policy decision in April. Statistics Sweden had scarcely published a GDP
figure for the fourth quarter that was weaker than expected, when the National Institute of
Economic Research published a very strong Economic Tendency Survey for March. Nor is it
unusual for statistics to be revised in a way that changes history and throws new light on the
initial situation in the economy. As I mentioned earlier, Statistics Sweden revised up the
figures for the number of hours worked in connection with the publication of the GDP
statistics for the fourth quarter of 2011. This revision entails lower productivity growth for
2010 and 2011 than was reported earlier, and thus a new outlook on the future productivity
growth trend, which has significance for monetary policy.
New and contradictory statistics and revisions of this type create uncertainty regarding the
current economic climate. Personally, I am one of those people who closely scrutinise the
statistics to form an opinion of the economic situation and the driving forces behind
developments. But my long experience in this field has taught me that it is important not to
have blind faith in the accuracy of the measures we use to assess the economic situation. As
economic statistics are very uncertain, it is important not to read too much into individual
figures and to keep a cool head when sentiment fluctuates after an unexpectedly high or low
figure. This slightly conservative approach to forecasting has been, and is, my guiding star as
an economic forecaster. Gradual adjustments to the forecast reduce the risk of taking a
wrong turn and being forced to repeatedly revise the forecasts. As monetary policy is
governed by forecasts, this can lead to fluctuations in the interest-rate policy. This in turn
creates uncertainty for participants in the economy when they make their own decisions. I
consider that the forecasts we have made in recent years are a good illustration of the
gradual changes in the forecasts that I have mentioned. But of course one should always be
prepared to make larger adjustments if the circumstances so require. Autumn 2008 is a good
example of this.
I have on many occasions, at monetary policy meetings and in speeches, put forward the
view that policy rate adjustments should normally be made gradually as a result of the
uncertainty connected to forecasts and economic statistics. The well-known economists
Orphanides and Williams say in an essay that this uncertainty indicates that one should not
allow monetary policy to be influenced by contradictory information and statistics that are
constantly revised.10 Instead, one should normally allow monetary policy to change gradually.
This limits the impact of contradictory information and statistics that are often revised.
Former Federal Reserve Chairman, Alan Greenspan, said "Uncertainty is not just an
important feature of the monetary landscape; it is the defining characteristic of that
landscape." I can only agree with him.