Kerstin af Jochnick: Current monetary policy and the economic situation
Speech by Ms Kerstin af Jochnick, First Deputy Governor of the Sveriges Riksbank, at the
Centre for Business and Policy Studies, Stockholm, 21 August 2015.
* * *
Accompanying figures can be found at the end of the speech.
Economic developments in Sweden look positive and the Riksbank's expansionary monetary
policy is continuing to support the upturn in inflation. I am pleased to note this as I hold an
August speech for the fourth year in a row based on the monetary policy decision in July and
discuss what has happened during the summer. Although I expect most people here follow
events on stock exchanges and other markets around the world even during the summer, I
hope that a summary of the most important events may be useful prior to assessing the
prospects for the autumn.
One can say that Greece has not entirely unexpectedly been in focus during the summer,
too. The forecasts in our July Monetary Policy Report were based on the sequence of events
not preventing a recovery in the euro area. While some work remains to be done before the
new 3-year loan programme is formally in place, my assessment is nevertheless that
developments so far are in line with the assumptions we made in July.
Developments in global economic activity since July also support our assessment that we
would see a gradual strengthening of growth and that the weak global growth during the first
quarter of the year was temporary.
The Swedish statistics received also support our view that economic activity in Sweden is
gradually improving and that inflation is continuing to rise. Unemployment was lower than
expected in June, while GDP growth was higher than expected in the second quarter.
Although inflation was somewhat lower than we expected in June, it was higher than
expected in July.
The low interest rates entail risks that could cause problems in the Swedish economy further
ahead. A high level of indebtedness among households and rapidly rising housing prices
could make the Swedish economy vulnerable if there were to be a slowdown in economic
activity for some reason. The Government should therefore quickly ensure that Sweden has
a framework for macroprudential policy and that Finansinspektionen (the Swedish Financial
Supervisory Authority) has a clear mandate to conduct this policy.
The assessment and the decision in July
The global recovery is continuing after a temporary fall at the beginning of the year,
but some concerns remain
I would like to begin by looking back at our assessments prior to the decision in July. The
year began with unusually weak figures for both global production and world trade. This was
partly because growth slowed down substantially in the United States, the United Kingdom,
China and several commodity-exporting countries. However, we assessed that this was
largely due to temporary factors and that growth would in future be good, see Figure 1.
There are several factors that point to a favourable development in the global economy going
forward. One factor is the oil price, which has fallen substantially over the past year. This can
be expected to have a positive effect on growth in the countries that do not produce oil. For
instance, it provides scope for increased consumption in these countries, which could favour
global growth.
Another factor is that the relatively large fiscal policy restraint in the large developed
economies in recent years appears to be over. During 2015 and 2016, the restraints will be
relatively small. Fiscal policy will not therefore have the same restrictive effect on GDP
growth in the years ahead as before.
A further factor that affects developments in the global economy is the expansionary
monetary policy around the world. The policy gives continued support to credit granting and
helps to push up inflation expectations, which benefits both consumption and investment.
This is particularly true of the euro area, where inflation expectations have now started to rise
and lending has begun to show a more positive trend. Many countries also have an unmet
need to invest, following the financial crisis, and this can be met as the credit supply
improves.
The assessment was thus that there are several factors pointing towards a favourable
development in the global economy going forward, but there still remain some causes for
concern. The funding crisis in Greece has still not been resolved, and the situation in Russia
and Ukraine is also creating continued uncertainty.
Rising global inflation in the years ahead
Internationally, inflation has fallen in recent years and is under the inflation target in many
countries, see Figure 2. The falling oil price over the past year has contributed to this
downward trend. However, the effects of the falling oil price on inflation are expected to
gradually decline. Unemployment is also falling in many parts of the world and this trend is
expected to continue in the years ahead. This contributes to a higher rate of wage increase
and rising demand for goods and services. International inflation can therefore be expected
to rise in the coming years.
Recovery in the rest of the world contributing to a broad upturn in Sweden
Sweden is a small, open economy and therefore dependent on what happens in the rest of
the world. The weak international demand following the financial crisis has thus led to weak
development for Swedish exports. But a continued recovery abroad will benefit Swedish
exports and growth going forward.
Domestic demand is expected to continue growing relatively fast, partly due to relatively
strong private consumption. The rising wealth level in the household sector and the low
interest rates create scope for relatively high growth in consumption. The global recovery
also increases the need for investment in the business sector and contributes to stronger
growth in investment. The demand for housing remains strong, which helps maintain the
level of housing investment. All in all, the increasingly strong demand, both domestic and
international, means that GDP growth will be higher than the historical average over the
coming years, see Figure 3.
Good prospects for inflation in Sweden to continue to rise
Inflation in Sweden is still low, just like in many other countries, see Figure 4. However, CPIF
inflation excluding energy has been rising for some time and several different indicators point
to it continuing to rise.
The ever-stronger global economy leads to both higher international prices and higher
demand for Swedish goods and services. Domestic demand also becomes higher and
contributes to rising price pressures. The weakening of the Swedish krona over the past year
has meant that imports of goods and services has become more expensive, which tends to
increase consumer prices. The weaker exchange rate has not yet had a full impact on prices
yet, either. Import prices are expected to rise further for a time before the contribution to
higher inflation from the exchange rate wanes.
A more expansionary monetary policy supports the upturn in inflation
The Riksbank has implemented strong measures to reduce interest rates in general in the
Swedish economy and thereby make monetary policy more expansionary. The repo rate has
been cut to negative levels. We have also made extensive purchases of Swedish
government bonds. Although it is difficult to distinguish the effects of different measures on
the economy, our assessment is that the impact of monetary policy is essentially functioning
as expected. The interest rates charged to households and companies on loans with short
maturities have fallen more or less in line with the repo rate. Data from the financial markets
also imply that the asset purchases have had the intended effect. Our intention with this
expansionary monetary policy has been to increase the rate of inflation so it approaches the
target of 2 per cent. As I mentioned earlier, underlying inflation has also shown an upward
trend for some time now, at the same time as economic activity has strengthened and the
situation on the labour market has gradually improved.
But although developments are mainly heading in the right direction, there is still
considerable uncertainty. Economic activity became stronger in the euro area, but several
countries were still being held back by high indebtedness and as yet unresolved structural
problems. The course of events in Greece also entails a tangible risk. If the situation
deteriorates, unease may spread to other countries in the monetary union. Uncertainty over
how the krona will develop is another risk. The relatively strong fluctuations on the foreign
exchange market are making it difficult to assess how the exchange rate will continue to
develop. A too strong exchange rate would risk halting the upturn in inflation that has begun.
Given this, we assessed in July that monetary policy needed to be even more expansionary
to ensure that inflation continues to rise towards the target of 2 per cent. We therefore
decided to cut the repo rate by 0.1 percentage points to -0.35 per cent, see Figure 5. We
also resolved to extend the purchases of government bonds by a further SEK 45 billion until
the end of the year, see Figure 6. The purchases decided upon in April are expected to be
concluded in September, at which point the new purchases will be initiated. At the end of the
year, the Riksbank is expected to have purchased nominal government bonds for a total of
SEK 135 billion. This corresponds to around 20 per cent of the outstanding stock of nominal
government bonds and around 4 per cent of GDP.1 If the ECB continues to buy government
bonds at the same rate as so far, their purchases at the end of the year will correspond to
around 7 per cent of the stock and, there too, to 4 per cent of GDP.
The Riksbank has been portrayed as particularly "strict" in relation to other central banks, as
we charge a negative interest rate to the banks when they deposit money with us. I would
like to emphasise that the Riksbank is not endeavouring to be kind or strict. The rate-setting
with regard to the banks' deposits with the Riksbank is part of the monetary policy
transmission mechanism and a means of further cutting interest rates in the Swedish
economy so that inflation will continue to rise towards the target. In this way, we contribute to
price-setting and wage-formation in society functioning better, which gives the right
conditions for a good development of the economy.
It may be worth pointing out that the Riksbank is not in any way unique in this context. Our
central bank colleagues in, for instance, Switzerland and Denmark have similar systems,
although some details differ. For instance, the Swiss central bank has chosen to limit how
much of the bank's deposits should be subject to a negative interest rate and part of the
deposits in the Danish central bank is also interest-free. However, the effective interest rate
the banks in these countries pay is nevertheless in line with what the Swedish banks pay.
I can also note that the four major Swedish banks made profits of almost SEK 44 billion
during the first half of the year. In the same period, they have had to pay around
SEK 90 million on their deposits with the Riksbank, as a result of the negative interest rates.
Developments during the summer
Focus on Greece
As you know, at the beginning of July the Greek people voted no to the proposed measures
presented by the country's creditors in a general referendum. However, shortly thereafter the
Greek parliament nevertheless decided to make extensive reforms and savings. They have
thus been able to reach an agreement of principle regarding a third loan programme and
negotiations are currently under way regarding the details of this programme.
However, it will be some time before we can fully understand what effects the summer's
discussion on the future of Greece will have on the monetary union and the development of
the euro area. On the one hand, it was a relief that the euro area succeeded in reaching a
new agreement with Greece. On the other hand, confidence in the euro area and in Greece
may have been damaged further, which creates uncertainty and may further delay the growth
that the area so needs.
There is still the question of whether Greece will succeed in recovering without needing to
write off some of its debts. Here, for instance, the IMF has been very clear that such
writedowns are necessary to create reasonable conditions for a recovery.
So far, the crisis has not led to any major turbulence on the financial markets, or to any other
significantly negative effects in other countries. This means that developments as a whole
can be said to be in line with our assessments.
With regard to the euro area as a whole, optimism among households and companies has
been somewhat subdued in recent months, probably as a result of the crisis in Greece.
However, the most recent survey in July indicates that optimism among companies is rising
again, which may be due to the third loan programme for Greece appearing to be within
reach. GDP growth in the euro area in the second quarter, compared with the same quarter
last year, was 1.2 per cent according to our forecast.
US developments still looking good
We see continued signs of good economic growth in the United States. GDP rose by just
over two per cent in the second quarter, compared with the same quarter last year, see
Figure 7, entirely in line with our forecast. Household consumption remains strong. Exports
also rose significantly in the second quarter despite the dollar appreciating for a period of
time. The housing market is continuing to recover and this creates an increasing number of
jobs. Unemployment fell to its lowest level since 2008.
The US Federal Reserve signalled at the end of July that it still has plans to raise its policy
rate this year. The labour market is expected to be able to develop better than was
previously believed an only a "few" further improvements are needed before monetary policy
may need to be tightened.
However, although most signs are pointing in the right direction in the US economy, the
recent statistics on wage developments have been at relatively low rates of increase. Over
the past twelve months, wages have not increased by more than around 2 per cent. Inflation
is also still at a low level, which reflects earlier downswings in energy prices and falling prices
on non-energy-related imports.
Relatively calm on the financial markets
Despite the fears one might have had prior to the summer with regard to developments on
the financial markets, there have not on the whole been any major fluctuations in interest
rates and exchange rates. The krona weakened roughly as expected in connection with the
repo-rate decision in early July. Since then it has weakened further, and then strengthened,
but it is still in line with our forecast, see Figure 8. However, one should not draw any major
conclusions regarding the krona, given the weak trade in the summer months.
Nor have there been any major fluctuations on the stock markets in Sweden, the euro area
(with the exception of Greece) and the United States. The stock market values are
approximately as they were in the beginning of July, see Figure 9. Stock market
developments in China, on the other hand, have been more dramatic with heavy stock
market falls since the middle of July. The downturn should nevertheless be regarded in the
light of equity prices rising by around 100 per cent during the first half of this year. Despite
the heavy fall, equity prices are still much higher than at the beginning of the year. The fall in
equity prices is not expected to have any major effects on growth in China.
The Chinese central bank's decision to devaluate its currency came as a surprise to the
market. The motive given for the devaluation was that the yuan had strengthened
substantially in recent years. However, another motive may be that the Chinese regime
wants to create the conditions for the yuan to eventually become a reserve currency. This is
bearing in mind that the guidelines for the daily pricing of the currency were also moved
toward a more market-based way of valuing the yuan in connection with the devaluation.
However, there is also a possibility that the devaluation is a sign that the Chinese economy is
weaker than we previously thought.
The fall in the oil price may contribute to lower inflation abroad
The oil price has fallen by around 10 dollars a barrel since the beginning of July, see
Figure 10. It has thus become lower than we had forecast. Forward pricing also indicates a
lower oil price in the coming years than we had expected. International inflation may thus be
slightly lower than our earlier assessment. But the lower oil price can also be positive for
growth and demand in the oil-importing countries, which could counteract the direct
downward effect on inflation.
Swedish economy is continuing to perform strongly
According to the preliminary version of the National Accounts, GDP grew by 3.0 per cent
during the second quarter compared with the same quarter last year, see Figure 7, which
was more than both the market and we had expected. Despite GDP growth being a little
stronger than expected, both consumption and investment were slightly weaker, which was
counteracted by unexpectedly weak imports. The number of hours worked developed
roughly as expected, which means that labour productivity was stronger than we assumed in
the July Monetary Policy Report.
During the summer (June and July) unemployment has become lower than we predicted, at
the same time as the labour force and employment showed weaker development than
expected. However, the labour market surveys statistics are particularly uncertain during the
summer months, which makes it difficult to draw any definite conclusions. Further outcomes
are needed to be able to determine whether the earlier positive development in employment
and the labour force has really been subdued.
Our forward-looking indicators regarding demand for labour on the whole point to the labour
market continuing to improve in the coming period. The number of redundancies is still low
and newly-registered vacancies at the Swedish employment service are at a high level.
Employment plans in the National Institute of Economic Research's Business Tendency
Survey rose somewhat in July, after having fallen earlier in the year, and indicate rising
employment in the business sector.
The National Institute of Economic Research's Economic Tendency Surveys, which
summarise companies' and households' views of the Swedish economy, rose in July, see
Figure 11. This is the third month in a row that the indicator exceeds the historical average
and thus points to a somewhat stronger growth than normal in the Swedish economy.
Households' confidence in the economy as a whole slowed down further in July, although the
view of their own economy is still more positive than normal.
Inflation expectations according to money market participants in Prospera's survey 1, 2, and
5 years ahead have remained broadly unchanged during the summer. Long-run inflation
expectations 5 years ahead remain at around 1.8 per cent.
CPIF inflation was measured at 0.6 per cent in June and at 0.9 per cent in July, see
Figure 12. The outcome in June was lower than our forecast. It is difficult to point to any
individual component that contributed to the forecasting error - goods prices services prices
and food prices all increased somewhat slower than expected. The outcome in July, on the
other hand, was higher than our forecast. It was in particular the volatile air travel and
package holidays that were higher than anticipated, although food and clothing prices were
higher than expected. All in all, the outcomes over the summer have been in line with our
forecasts.
Low interest rates entail risks
Increasing debt levels and rising housing prices
The low interest rates contribute to household debt as a percentage of disposable income
continuing to increase and to housing prices continuing to rise. This creates risks that can
threaten future economic developments. If there were to be an economic slowdown for any
reason, this could be significantly strengthened when indebted households are forced to cut
back on consumption and other expenditure, particularly if housing prices were also to fall in
connection with this. It is therefore important that household debts do not continue to
increase. Their debts have increased more than their disposable incomes since the middle of
the 1990s and the debt ratio is now at just over 170 per cent, which is a record-high level,
see Figure 13.
As can be seen in Figure 14, housing prices, and especially prices of tenant-owned
apartments, have risen sharply in the past ten years. Prices of tenant-owned apartments
have more than doubled since 2005. We can also see that prices of tenant-owned
apartments have increased substantially in relation to the consumer price index in the past
ten years, but even in relation to disposable income the increase is significant.
This development indicates that there are structural problems in the Swedish housing
market. The fact that the rental market functions poorly is a problem. Another problem is that
too little housing is being built. Figure 15 shows that the population has increased much
more than the number of completed homes over the past ten years, which is an indication
that housing construction has been too low. Despite housing investment now increasing, it is
important that structural problems on the housing market are discussed so that we can
obtain greater efficiency on this market in the longer run. Several inquiries have put forward
proposals regarding what needs to be done, most recently this was done in an annex to the
Long Term Survey of the Swedish Economy. Not having an efficient housing market is not
merely a problem for indebtedness, it can also comprise a threat to a healthy development of
society and it can create conflicts between the generations.
The Riksbank has long pointed out the risks linked to the high level of household
indebtedness and has previously also weighed in them in the repo-rate decisions to some
extent, by setting the rate somewhat higher than would otherwise have been the case.
However, the effect these considerations have actually had on monetary policy - the amount
by which the repo rate has actually been set higher - has been exaggerated substantially.
There are quite simply limits as to how far the policy rate can be used for this purpose. And
let me emphasise that the main focus for monetary policy has always been to bring inflation
back on target and to attain a good development in the real economy.
Credibility for the inflation target a binding restriction
One condition for a central bank to be able to use the policy rate to counteract financial
imbalances is that confidence in the inflation target is solidly established and that inflation
expectations are firmly anchored around the target. This is a very important condition and I
would claim that it is a binding restriction, that is, if it is not met, the central bank will have no
scope to take other considerations.
When the Riksbank gave consideration in its monetary policy decisions to the risks linked to
indebtedness and housing prices rising too fast a few years ago there were no reasons to
question confidence in the inflation target. It was firmly established and long-term inflation
expectations were just over 2 per cent.
However, what has happened since then is that the Riksbank and other analysts have on
several occasions been surprised by inflation being lower than expected and have therefore
been forced to gradually revise down their inflation forecasts. As the period with an inflation
rate undershooting the target has become longer, economic agents have adjusted their
inflation expectations downwards. During 2013 and 2014, for instance, the five-year inflation
expectations in Prospera's survey showed more or less a falling trend to just under 2 per
cent. The further long-term expectations deviate from the target, and the larger the deviation,
the greater is the risk that the inflation target will begin to lose its role as benchmark for
pricesetting and wage formation. In this way, expectations can have an impact on actual inflation,
which risks reducing expectations further, and so on, in a self-reinforcing negative process. It
can be very difficult to get out of this situation.
This is how the rapid cuts in the repo rate since the middle of 2014, and the purchases of
government bonds that have recently been a complementary part of monetary policy, should
be regarded. The Riksbank is the authority that has the explicit responsibility for attaining the
inflation target. Although we must also act to ensure the financial system is stable and
functions efficiently, through the wording in the Sveriges Riksbank Act on "promoting a safe
and efficient payments system", the latter is a task that we share with the Government,
Finansinspektionen and the Swedish National Debt Office. And the first line of defence with
regard to counteracting the emergence of financial imbalances is macroprudential policy,
including the tools for which Finansinspektionen has been given chief responsibility.
Finansinspektionen's mandate and tools for macroprudential policy need clarification
in law
It is therefore very unfortunate that there appear to be doubts with regard to the legal
possibility for Finansinspektionen to use some of the tools - as in the case of the
amortisation requirement.2 The decision to give Finansinspektionen the responsibility for
macroprudential policy was preceded by a fairly intensive debate, where other possible
solutions were also discussed. One can therefore assume that the decision finally reached
actually reflects the solution desired from a political point of view. It is then of course
essential that one also ensures that Finansinspektionen is equipped with the most efficient
tools possible to be able to manage its task in a good way. And if one later discovers that
there are doubts regarding some parts of the mandate, it is of course important that these
are remedied without delay.
To avoid a future economic downturn from being deeper than normal as a result of the high
indebtedness, it is therefore essential that the Government quickly ensures that Sweden has
an efficient framework for macroprudential policy and that Finansinspektionen has a clear
mandate. It is almost seven years since the financial crisis broke out. One of the major
lessons learnt from the crisis is the importance of an efficient macroprudential policy that
enables early identification of financial imbalances and rapid implementation of necessary
measures. There is broad agreement on which imbalances have built up in the Swedish
economy, but there also appears to be what is known as an inaction bias, which means that
no authority has taken adequate measures. What is needed here is a system where
macroprudential policy fulfils an important role and can, in an interplay with fiscal and
monetary policy, counteract the emergence of financial imbalances.
The Riksbank's assessment is that an amortisation requirement corresponding to at least
Finansinspektionen's proposal needs to be introduced as soon as possible. However, further
measures in addition to this are needed to reduce households' willingness to take on debt.
Feasible measures include a reduction in the tax deduction allowed on interest payments,
the introduction of a debt-to-value limit and stricter requirements for the banks' credit
assessments of individual households. More structural measures are also needed to
increase the supply of housing and lead to a more efficiently-functioning housing market as I
have already mentioned. But such reforms can only be introduced gradually and it will
therefore take time before they can have any significant effect on household indebtedness.
Next monetary policy decision presented on 3 September
To summarise, I consider it is of the utmost importance that the mandate for macroprudential
policy is clarified and that the application of the different tools does not come to a standstill.
There is currently widespread awareness that a long-term sustainable solution requires a
holistic approach that involves several policy areas. Nevertheless, there is a risk that more
comprehensive measures and reforms are perceived as so unwieldy and difficult to manage
that politicians would rather wait and hope for the best. One possible way forward to ensure
something happens and to increase our knowledge in this field would therefore be a strategy
that combines different possible measures on a smaller scale.3 Even a journey of a thousand
miles begins with just one step, and it is important to take this step.
With regard to the statistics received over the summer, both in Sweden and abroad, they
agree fairly well with the assessments we made in July. Economic developments in Sweden
still look good and the expansionary monetary policy is supporting the upward trend in
inflation. And if it were necessary, there is a high level of preparedness to make monetary
policy even more expansionary. We are now working on producing an overall assessment of
the situation in the Swedish economy, and in connection with the publication of the monetary
policy decision on 3 September, we will present new forecasts.
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