Cecilia Skingsley: Reasonable expectations of monetary policy
Speech by Ms Cecilia Skingsley, Deputy Governor of the Sveriges Riksbank, at Danske
Bank, Stockholm, 19 September 2013.
* * *
This is not the first time I will present my view of monetary policy in Sweden. I have done so
in many different contexts during my 20 years as a professional economist, for instance as a
columnist for "Dagens Industri" or, most recently, as Chief Economist at Swedbank. Now,
however, I am here as one of the new members of the Executive Board of the Riksbank. It is
of course quite a different thing to be one of the six people responsible for the monetary
policy decisions than to be an external analyst. It is of course also the case that the
experience I have gained marks my monetary policy stance and colours my view of what it is
reasonable to expect of monetary policy in practice. Today I intend to talk about my thinking
at the two latest monetary policy meetings and about my thinking on monetary policy in
principle.
Monetary policy through my eyes
It is now two weeks or so since I took part in my second monetary policy meeting as a
member of the Executive Board. The situation prior to the meetings in both July and
September was marked by a low rate of inflation, for example CPIF inflation has been below
two per cent since 2011, and a level of resource utilisation in the economy that was deemed
to be lower than normal.
The forecasts in July and September were that inflation was expected to rise towards
two per cent in 2015 and that resource utilisation was expected to increase as growth picked
up. The assessment was that the expansionary monetary policy would contribute to this. I
personally voted to keep the repo rate at the historically-low level of one per cent at both the
July and September meetings.
Figure 1
Repo rate remains low
Repo rate, per cent
5 5
July
September
4 4
3 3
2 2
1 1
0 0
What were the trade-offs behind my decisions? On the one hand an even lower repo-rate
path could, according to the Riksbank's calculations, lead to inflation reaching the target
somewhat sooner and to resource utilisation improving somewhat faster, while on the other
hand there were other circumstances to take into account that made the decisions more
complicated. For example, there is always uncertainty about exactly how monetary policy will
affect the economy during the forecast period. When analysing the state of the economy I
have focused on understanding how much can be attributed to cyclical fluctuations and how
much to structural factors. In practice it is of course difficult to precisely distinguish between
structural and cyclical factors, but it is nevertheless important to analyse this as monetary
policy can only affect the latter. I have also asked myself what the relatively strong
development of the Swedish household sector in relation to the weaker situation in the
industrial sector means for monetary policy. All in all, I thought it was reasonable to leave the
repo rate unchanged, for two main reasons. First, I think it would be wrong to lower the repo
rate further in a situation in which the economy is improving. Second, I believe that a lower
repo rate today could increase the risks associated with household indebtedness in the
longer term.
I will now explain my thinking about monetary policy today in more detail and describe how I
see the current situation in the Swedish economy, what I believe monetary policy can
achieve and how I see the situation in the period ahead.
Divided demand - the explanation is to be found abroad
I would like to begin by looking back in order to describe my view of the situation today.
Approximately five years have passed since the financial crisis began in earnest and these
have been turbulent years for the global economy. Sweden is highly affected by what
happens abroad but we have coped much better than many other countries, partly because
we have not been hit by problems resulting from an excessive level of debt in either the
public or the private sectors.
Figure 2
Weak developments abroad have affected Sweden
GDP, quarterly changes in per cent, annual rate, seasonally-adjusted data
12 12
9 9
6 6
3 3
0 0
-3 -3
-6 -6
KIX
-9 -9
USA
EMU
-12 -12
Sweden
-15 -15
After the sharp downturn in 2008-2009, Swedish GDP growth initially recovered quite
quickly. Unfortunately, the improvement in the rate of growth stopped short when the
financial crisis developed into a debt crisis in Europe, and this has restricted Swedish
exports. This has happened directly, as the euro area is Sweden's largest export market, and
indirectly, as the euro area affects industrial activity in other parts of Europe and Asia that in
turn are important growth markets for the Swedish manufacturing industry.
However, while indicators have long shown that the manufacturing industry is in a weaker
than normal state, the financial situation of the households has been relatively strong.
Moreover, if the weak development of exports and investment during, above all, 2012 had
not been counteracted by household consumption, then the latest slowdown in the Swedish
economy would have been more pronounced. Households have become more optimistic
over the last 12 months and this is reflected in higher housing prices, increased lending and
increased consumption. They have been helped by the increase in their disposable incomes
over a period of several years. Low interest rates have of course contributed to this
development in the household sector.
Turning to the labour market, employment has increased but unemployment is nevertheless
higher than it was a year ago as the labour force has increased relatively quickly. This is
partly due to an increase in those of working age in the population, but also to the
government's labour-market reforms, which are both factors of a structural nature. At the
moment unemployment is approximately 8 per cent and with the Riksbank's current forecast
we are approaching the interval of 5 to 7.5 per cent within which the Riksbank believes the
long-run sustainable rate of unemployment lies.1 If we look at the situation in different sectors
we can see that employment has increased in the service sector while the weak demand for
Swedish industrial products is in part responsible for the weak development of employment
in the manufacturing industry.
Figure 3
Weak developments abroad have affected the labour market
Employment by sector, thousands, seasonally-adjusted data
2400 4900
Government sector (left scale)
2200 Services producers (left scale) 4800
Goods producers (left scale)
2000 4700
Total (right scale)
1800 4600
1600 4500
1400 4400
1200 4300
1000 4200
00 02 04 06 08 10 12
Source: Statistics Sweden
The relatively low level of economic activity abroad has also affected inflation in Sweden
more directly. One reason for the low rate of inflation recently is namely that the prices of
goods have increased slowly. The strengthening of the krona in recent years has led to a
further reduction in import prices. On the other hand, service prices in Sweden have helped
to keep up the rate of inflation.
Figure 4
What lies behind the low inflation?
Annual percentage change
5 5
Interest rate costs
Food
4 4
Energy
Good
3 3
Services
2 2
CPI
1 1
0 0
-1 -1
-2 -2
-3 -3
-4 -4
08 09 10 11 12 13
Source: Statistics Sweden
All in all, given the relatively weak development abroad, it is thus not difficult to understand
the division in demand that has marked the Swedish economy in recent years.
What can monetary policy do today?
Swedish monetary policy cannot do anything about the causes of the weak demand from
abroad, but it can mitigate the effects on the Swedish economy. How low the repo rate needs
to be, and how quickly inflation should rise towards the target are ultimately questions of
judgement. I believe that it is appropriate that the Riksbank has let the repo rate remain at
one per cent since the end of last year in order to boost the Swedish economy and to get
inflation to rise to 2 per cent. According to the forecast, the repo rate will remain at this level
until the end of 2014. In the forecast, the real interest rate will remain negative until the
beginning of 2015, which shows that monetary policy is expansionary.
Monetary policy can mitigate the effects of weak development abroad
An even lower repo rate could help inflation to return to the target somewhat more quickly, as
illustrated in a monetary policy scenario in the Monetary Policy Report published in July.
According to the Riksbank's model calculations, a further repo-rate cut would lead to a
further increase in consumption and increased investment. A lower repo rate would also
weaken the exchange rate, which could benefit exports while at the same time making
imports more expensive. All in all, this would lead to higher GDP growth and a higher level of
resource utilisation, which would lead to a higher rate of price increases. According to the
calculations in the Monetary Policy Report, a 0.25 percentage point lower repo rate for one
year would lead CPIF inflation to approach 2 per cent during the first half of 2015, which is
approximately six months earlier than in the Riksbank's main scenario.2 Thereafter, in this
example, CPIF would be marginally above 2 per cent.
Looking at these calculations it appears that a lower repo-rate path would be the better
strategy for stabilising CPIF inflation and resource utilisation. However, this interpretation
does not take into account the fact that there is uncertainty about the effects of monetary
policy on the economy. The quantitative effects in the scenario are estimated using the
Riksbank's macro model for the Swedish economy, but such estimates entail a degree of
uncertainty and other empirical approaches could lead to different results. A common result
in the research literature is that if we take into account the fact that there is uncertainty about
the impact of monetary policy then we should act more gradually over time. However, it may
then take longer for inflation to approach the target and for resource utilisation to normalise
than if we do not take such uncertainty into account.3 This line of reasoning may therefore
mean that a higher repo-rate path is better balanced than the example's lower path, despite
the fact that it will take longer for inflation to reach the target. Put another way, if we are not
absolutely certain about the outcome of monetary policy it is better to proceed gradually.
Moreover, the repo rate is already low at present at the same time as we are seeing more
and more signs that economic activity is picking up and at the same time as there are risks
associated with household indebtedness. I would like to begin by discussing why household
indebtedness has affected my stance on monetary policy.
Risks and rewards must be weighed against each other
Asset managers think in terms of risks and rewards. A strategy is evaluated using a financial
risk calculation that is based on how much an asset portfolio can increase in value in relation
to the risk that it will fall in value. This approach can also be applied to the world of central
banking, although instead of being about an asset portfolio it is then about monitoring risks
relating to the development of the economy and to the central bank's target variables, for
example inflation.4 As in the case of an asset manager, the time horizon on which the
strategy is based is important. Translated to the current situation in the Swedish economy,
this risk-reward approach could be expressed by saying that better target attainment in the
short term must be weighed against increased risks in the longer term.
In other words, using a more expansionary policy to boost a part of the economy that is
already relatively strong, that is the households, to counteract weak demand in the export
sector - which in the main is due to factors beyond the reach of Swedish monetary policy -
risks leading to imbalances in the long term in my opinion. Of course it is true that a more
expansionary monetary policy could weaken the exchange rate, which would benefit the
export sector, but in the monetary policy trade-off I cannot ignore the risks associated with
the high level of household debt.
At the same time, there is also a risk that monetary policy itself can contribute to the build-up
of imbalances in the economy, not only by affecting various players through the well-known
transmission channels, that is the interest rate channel, the exchange rate channel and the
credit channel, but also through the risk-taking channel. The risk-taking channel, which was
analysed in an article in the Riksbank's own journal, "Sveriges Riksbank Economic Review",
last year, is really a collective term for several different mechanisms which mean that
monetary policy, by setting low policy rates, can encourage various players in the economy
to take greater risks.5 The argument is that banks and other financial institutions take greater
risks when the policy rate is low by increasing their level of debt or changing the maturity of
their funding. This may be justified from the individual player's point of view, but poses a risk
to the economy as a whole. In the light of my experience of the financial market before and
after the financial crisis, this theory seems intuitively correct. There is also empirical evidence
to support the hypothesis that low interest rates lead to increased risk taking. It is not certain,
however, that the change in the players' risk taking is solely due to monetary policy, it may
also stem from a generally low level of interest rates that has structural causes. This is a
subject that I am sure we will continue to discuss, not least in terms of what it is reasonable
to expect monetary policy can achieve.
Monetary policy must take financial stability into account
The risk-taking channel has been described as a possible link between monetary policy and
the work to safeguard financial stability. My starting point is that it is reasonable for monetary
policy to take into account factors that relate to financial stability. This is partly because
financial stability is a necessary condition for an effective monetary policy, but also because
financial instability risks leading to major fluctuations in both the real economy and inflation.
We should also take financial stability into account because part of the Riksbank's
assignment is to promote a safe and efficient payment system.
Furthermore, in order to adapt monetary policy to the risk of future crises in the wake of
financial imbalances we do not need to know that a crisis will actually occur, or exactly when,
but we do need to know through what mechanisms or under what circumstances the
probability of a crisis increases. Nor is it a case of a crisis being the most likely outcome but
rather that the risk that something major can happen should make us focus our attention in
that direction.6 If we learned anything from the financial crisis it was that there is every
reason to take even less likely outcomes into account. The financial crisis has also reminded
us that cleaning up after a crisis can entail huge costs and take a long time. Five years after
the financial crisis began, for example, unemployment is still high in many of the countries
that were hit hardest.7
With regard to household indebtedness it is obviously the case that monetary policy cannot
do much about a high level of debt that in turn is due to high housing prices if these have
structural causes, such as insufficient new construction, tax regulations, building regulations
and so on. However, the repo rate nevertheless has an impact on the situation of households
that purchase housing. Experience from other countries shows that a high level of debt can
pose risks to the economy, and the level of household debt in Sweden is now high in both
historical and international terms.
Figure 5
High unemployment following a crisis on the housing market
Unemployed as a percentage of labour force, Index 2007= 100
350 350
Ireland (-47.2 %)
Spain (-30.8 %)
Denmark (-27.6 %)
300 300
USA (-26.7 %)
UK (-12.9 %)
250 Sweden (0.0 %) 250
200 200
150 150
100 100
50 50
00 02 04 06 08 10 12
Note. Figure in brackets refer to the decline in real house prices from the peak to the
trough.
Source: OECD
An article in the Monetary Policy Report published in July analyses the potential
consequences of this.8 One risk in this connection is that the major Swedish banks largely
fund their operations on the international capital markets and the level of confidence in the
banks is decisive for their ability to get funding. A future economic downturn with a fall in
housing prices in Sweden could therefore in the worst case be aggravated if international
investors chose to reduce their exposure to the Swedish banking sector. The IMF recently
repeated its warning about the high level of household debt in Sweden and the relatively
large and concentrated banking sector and called for the quick implementation of the
macroprudential policy instruments.9
Clearer boundaries affect the risk analysis
However, clearer boundaries have been set for the work on preventing future crises since I
became a member of the Executive Board. The government has proposed that
Finansinspektionen should be responsible for macroprudential policy in Sweden and that a
stability council should be formed in which Finansinspektionen, the National Debt Office, the
government and the Riksbank should openly present their assessments and
recommendations concerning financial stability. It is good that there is now a plan for
clarifying the framework for financial stability.
Macroprudential policy should also be able to use special instruments to manage
developments in that part of the economy where there is a risk of imbalances. More specific
instruments, such as amortisation requirements and higher risk weights for mortgages, are
also probably more precise in their effects than the repo rate when the aim is to prevent and
manage the risks associated with household indebtedness. A mortgage cap is already in
place. But we still do not know exactly what form future instruments will take and when it will
be possible to begin using them. Once they are in place, however, I hope that there will be
less need to take household indebtedness into account in the decisions on the repo rate.
The current discussion on the division of responsibility for macroprudential policy also calls to
mind the relationship between monetary policy and fiscal policy. Through the medium of
monetary policy, the Riksbank can influence the development of the real economy and
thereby the loan losses of the financial institutions, the profitability of the companies and
assets prices on the financial markets. All this in turn affects financial stability. And a
macroprudential policy that aims to promote financial stability and comprises risk weights,
capital requirements and amortisation requirements will affect interest-rate margins and
interest-rate differentials which in turn will have an impact on the transmission mechanism of
monetary policy. When the new framework for macroprudential policy is eventually in place
and in use, the Riksbank will need to consider how it believes macroprudential policy
measures will affect the development of the economy and financial stability in its forecasting
work. The Riksbank should be able to take into account the effects of the macroprudential
policy instruments in roughly the same way as it now takes into account how the
government's future budget plans will affect the economy.
Gradual improvement in economic activity, but uncertainty remains
I began this speech by looking back at the economic situation over the last few years. I would
now like to spend the rest of my time looking forward. My second argument for leaving the
repo rate unchanged at 1 per cent in July and September was namely that the economy
seems to be taking a turn for the better. A gradual improvement in economic activity was
indeed in line with the Riksbank's earlier forecast, but ahead of the September meeting we
had received additional statistics and other information that supported this assessment. For
example, confidence indicators for Sweden and abroad had improved. Share indexes on the
financial markets had risen thanks to positive signals about the recovery of the global
economy. The outlook for a continued recovery in the United States was good and there
were signs that an improvement had begun in the euro area.
Economic activity improving
When it comes to the prospects for higher demand from the euro countries following the debt
crisis and all the structural problems, I have become gradually less pessimistic over the last
12 months. This is for example because several highly-indebted countries have made
progress in reducing their budget deficits. The Swedish crisis of the 1990s made a great
impression on me as an economist and my experience from that period tells me that when
households and companies see that the worst problems are over and that the situation is
being managed then there is potential for increased confidence about the future, which we
have also seen in recent months. This is despite the fact that unemployment is still high and
that the recovery of economic activity in these countries is starting from a low level. Of
course a lot remains to be done and here the responsibility primarily lies with the politicians
in the respective countries.
The euro area's common monetary policy is an important tool for easing the readjustment,
but it cannot correct all the causes of the crisis. This requires decisions at the national level
in order to come to terms with weak public finances and to change economic and political
structures so that competitiveness is improved. It has long been the Riksbank's assessment
that the crisis can be resolved in an orderly way and that economic growth will gradually
improve. This assessment still applies, and it is gratifying that recent events have confirmed
an improvement, although forecasts of the future of course remain uncertain.
Figure 6
Positive signs
Purchasing Managers' Index PMI, manufacturing industry,
seasonally-adjusted data
70 70
65 65
60 60
55 55
50 50
45 45
Sweden
40 40
USA
EMU
35 35
30 30
06 07 08 09 10 11 12 13
Source: Markit Economics
Uncertainty remains
However, apart from uncertainty regarding developments in the euro area there are, to
paraphrase Donald Rumsfeld, the former Secretary of Defence of the United States, also
other "known unknowns" that may affect the short-term prospects. One example of this is if
there is a tangible change in market expectations regarding monetary policy in the United
States. Ahead of yesterday's meeting of the US central bank, the Federal Reserve, long-term
interest rates had risen in the United States and Europe, partly due to expectations that the
Federal Reserve would reduce its asset purchases and partly due to the more positive
signals about the performance of the economy. Share prices have risen in parallel with the
rise in interest rates. However, a side effect of the better growth prospects and the
expectations of a less expansionary monetary policy in the United States has been that
several emerging economies have been hit by capital outflows.
In the slightly longer term, questions also remain about the outlook for global trade at large, a
factor that has a substantial impact on an export-dependent country such as Sweden.
According to some analysts, the development of global trade is now weaker than implied by
historical links with global growth.10 If this is the case, is it because companies have less
access to trade credits in the wake of the financial crisis or because there has been a
structural shift in the growth curve for global trade? It is perhaps not reasonable to expect the
high rates of growth that we saw in the early 2000s - and which were boosted by
globalisation in the wake of technological development, lower transports costs, increased
specialisation, China joining the WTO and so on - to continue. It is also important to monitor
how Swedish exports develop in relation to global trade. These are complex questions that it
is probably too soon to answer. However, there is every reason to return to these questions
too, particularly with regard to the potential consequences for Sweden. All in all, the
Riksbank's assessment from the September Monetary Policy Update is nevertheless that
economic activity abroad will, if only gradually, make a positive contribution to Swedish
growth.
Figure 7
What can we expect of world trade?
Word trade index, volume, Index 2005 = 100, seasonally-adjusted data
150 150
World trade index
Forecast IMF (WEO April 2013)
140 140
Forecast IMF (WEO July 2013)
130 130
120 120
110 110
100 100
90 90
05 07 09 11 13 15
Sources: CPB Netherlands Bureau of Economic Policy Analysis
Manufacturing industry catching up
It is probable that we will be able to continue to describe the Swedish economy as divided for
a while longer, even though confidence indicators suggest that the situation in the
manufacturing industry is returning to normal. However, given the prospects for higher global
demand we should also expect Swedish exports to increase in the years ahead. In
combination with a more expansionary fiscal policy in Sweden and a low repo rate, GDP
growth can thus be expected to pick up and the current low rate of CPIF inflation can be
expected to gradually increase.
Some new statistics have been published since the monetary policy meeting in September
that shed light on the current situation in the Swedish economy. CPIF inflation was
1.2 per cent in August, which was somewhat higher than expected. A revised version of the
National Accounts has also been published which shows that GDP fell slightly more in the
second quarter than indicated by the figures published earlier. The growth figures have also
been revised down somewhat for 2011 and up somewhat for 2012. In addition, new labour
market statistics show that seasonally-adjusted unemployment amounted to 8 per cent in
August. The next Monetary Policy Report will not be published for a while yet, but at the
Riksbank we are already working with new analyses and forecasts. Ahead of the monetary
policy meeting on 23 October I will weigh these factors against each other, but also take
account of any additional information that becomes available before then in order to arrive at
a new assessment.
Figure 8
Low but gradually increasing inflation
CPI and CPIF, annual percentage change
5 5
CPIF
4 4
CPI
3 3
2 2
1 1
0 0
-1 -1
-2 -2
07 09 11 13 15
Note. The CPIF is the CPI with a fixed mortgage rate
Sources: Statistics Sweden and the Riksbank
Good development in the short term, sustainable in the long term
I hope that in my speech today I have been able to convey my thinking on monetary policy at
the two latest monetary policy meetings and how I view the current situation.
The repo rate is low at present. The Riksbank's forecasts show that inflation will reach
2 per cent within the forecast period at the same time as resource utilisation will improve.
Although the global economy is weak at the moment, the preconditions for a recovery are in
place. Sweden is in a better position than many other countries, but there is work to be done
to put an effective structure for macroprudential policy in place. Once this structure is in
place, we will be more able to manage the risks associated with the high level of household
debt. Monetary policy could of course be somewhat more expansionary in the short term but
we must remember that monetary policy is not perfectly precise and we must have realistic
expectations of what it can achieve in relation to the risks that exist. As I see it we are
already at full stretch as far as household indebtedness is concerned. A continued low repo
rate offers the possibility of good economic development in the short term and sustainable
development in the long term.
References
Apel, M. and C.A. Claussen (2012), "Monetary policy, interest rates and risk taking"
Economic Review,
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Blanchard, O., G. Dell'Ariccia and P. Mauro (2013), "Rethinking Macro Policy II: Getting
Granular" IMF Staff Discussion Note 13/03, International Monetary Fund.
Brainard, W.C. (1967), "Uncertainty and the Effectiveness of Policy" American Economic
Review 57:2, 1967, pp. 411-425.
IMF (2013), "Sweden Staff Report for the 2013 Article IV Consultation" Country Report
No.
13/276, September 2013, International Monetary Fund.
Kilian, L. and S. Manganelli (2003), "The Central Bank as a Risk Manager: Quantifying and
Forecasting Inflation Risks" ECB Working Paper no. 226, April 2003, European Central Bank.
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Monetary Policy Report, July 2012.
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in July 2013.
The World Trade Organization (2013) "World Trade 2012, Prospects for 2013" Press release
April 10, 2013.
Working Paper
Williams, J.C. (2013), "A Defense of Moderation in Monetary Policy" 2013:15,
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