Erik Thedéen: My view of monetary policy
Speech by Mr Erik Thedéen, Governor of the Sveriges Riksbank, at Nordea,
Stockholm, 23 March 2023.
* * *
Accompanying slides of the speech
Good afternoon! Thank you for inviting me.
I have now been Governor of the Riksbank for almost three months. It has been an
intense period in which the most burning issue has of course been the far too high
inflation that has not yet shown any clear sign of falling back. The past two weeks have
also been marked by unease on the financial markets, which has made economic
prospects more uncertain.
The background to the concern is that a couple of US niche banks had problems with
their liquidity and collapsed. This was followed by problems in the Swiss bank Credit
Suisse - a different type of bank, but one that has wrestled with poor profitability and
whose credibility has been eroded. These problems led to the bank being quickly taken
over by its competitor UBS. The authorities in the United States and Switzerland have
been working actively to resolve the problems. This weekend, the major central banks
also launched a joint effort to make it easier for banks to obtain financing in dollars in
general.
Although the situation has become a little calmer, there is underlying concern that the
problems will spread to other banks and further into the financial system. I think it is
necessary to have a sensible but also sensitive attitude towards that risk. At the
moment, the likelihood of an international financial crisis seems slight, and so does the
likelihood of contagion effects to Sweden. There is a major difference between the
banks that have been affected and the Swedish banks, which have high profitability,
good liquidity and relatively large capital buffers. There is thus a high threshold for the
problems to spread to Sweden. However, the financial system is closely interwoven at a
global level, and there is every reason to be vigilant. The Riksbank monitors
developments around the clock and we have a continuous dialogue about the situation
with the other members of the Financial Stability Council.
I shall return to developments on the financial markets later on. What I mainly want to
talk about today is what has been most in focus in my first months on the job, namely
monetary policy and inflation. The monetary policy decision in February was the first
made by the Riksbank under the new Sveriges Riksbank Act. It may therefore be
appropriate to begin with a few words about what the Act means for the Riksbank's
monetary policy framework. After that I would like to give my view on inflation, the
economic situation and monetary policy and also go into more detail on why it is so
important that inflation comes all the way down and stays close to the Riksbank's target
of 2 per cent. This may not be obvious to everyone - after all, it has been thirty years
since we were last in a similar situation.
Same inflation figures as in the early 1990s, but a different situation
When I had just left the Stockholm School of Economics and started working at the
Riksbank in 1990, inflation in Sweden was around 10 per cent. Now when I returned to
the Bank at the start of this year, the inflation figures were at the same level. The
background to, and reasons for, the high inflation now and then differ, of course. But the
important thing is that the conditions for rectifying the situation are much better now.
Looking at economic developments on average over the past thirty years or so, we
have had low inflation combined with good economic growth, Real wages have
increased steadily - with one exception last year - and we have also had, and still
have, stable public finances.
One important reason for this is the reforms of wage formation and the economic policy
frameworks that Sweden implemented in the mid-1990s to address pricewage spirals,
cost crises and an economic policy that was unable to stabilise developments. The
inflation target and the transition to an independent central bank with a strong mandate
to maintain that target were part of this. Since then, the inflation target and a monetary
policy that independently steers towards this target have been a cornerstone of
economic policy in Sweden. This is also reflected in the new Sveriges Riksbank Act,
which applies from the start of this year.
The inflation target is the overriding objective of monetary policy.
As before, the new act states that price stability is the primary objective of the Riksbank.
It is now also stated more clearly that price stability means sustained low and stable
inflation. In concrete terms, the inflation target is the same as before, that is, a target of
2 per cent for inflation measured as the annual change in the CPI with a fixed interest
rate, the CPIF. If the Riksbank wishes to change the specification of the target at some
point in the future, the Riksdag must approve the new specification before it can take
effect.
The Riksbank shall conduct monetary policy in an independent manner to attain the
inflation target - this is a decisive factor for maintaining confidence in the target.
However, this independence does not, of course, prevent us from discussing issues
relevant to monetary policy with the Riksdag and the Government, as well as other
authorities and organisations - as indeed we should, in my opinion.
The Riksbank also takes into account the real economy.
According to the new Sveriges Riksbank Act, the Riksbank shall also take into account
the development of the real economy. Previously, the Riksdag assumed that the
Riksbank would take the real economy into account, but this was not explicitly stated in
the text of the Act. The new Act states that the Riksbank, without neglecting the inflation
target, shall contribute to a balanced development of production and employment.
The fact that these considerations are now included in the Act and not just mentioned in
the preparatory work emphasises the importance the Government and Riksdag attach
to them. This makes it even more important for the Riksbank to show that these
considerations are included in the monetary policy deliberations and how they are
included. We may thus need to be even clearer about it in our decisions and in the
documentation for the decisions. But this will not entail any revolutionary changes in
monetary policy, nor was the legislator expecting there to be, judging by the preparatory
work for the new act. The Riksbank has already previously conducted what is known as
flexible inflation targeting, which includes taking into account the real economy. In
principle, it is now being legislated that the Riksbank shall conduct monetary policy in
this way.
More focus on motives for decisions and on evaluation
In the new Act, the Riksdag has wanted to clarify the boundaries of the objectives and
powers within the Riksbank's various areas of responsibility in relation to one another.
Among other things, this means that we will need to be clearer in stating the purpose of
various measures, that is, which of the Riksbank's objectives we are trying to achieve
and which tasks we want to resolve with various measures. This is perhaps most
relevant in times of unease on the financial markets, and the Riksbank may have
reason to act both to maintain financial stability and to counteract disturbances on
certain markets as well as to attain the inflation target.
The Act also contains explicit wording to the effect that the Riksbank's measures shall
be fit for purpose and that the intended result shall be in reasonable proportion to the
costs and risks to the Riksbank and to central government finances. It has in fact
always been a general principle that authorities should act proportionately. But the fact
that this is now explicitly stated in the Sveriges Riksbank Act may also require us to
justify our decisions more clearly.
Clear motives make it easier, for instance, to examine and evaluate the Riksbank. With
regard to our independence, particularly concerning monetary policy, it is important that
our principal, the Riksdag, as representative of the Swedish people, follows up and
evaluates the Riksbank's activities in an efficient manner. With the new act, the Finance
Committee will have more resources for this.
Exceptional reasons for the Riksbank to buy private securities
One change in the new act concerns the conditions for the Riksbank to trade in private
securities. The Riksbank can buy and sell Swedish government securities and private, i.
e. non-government, securities. Our monetary policy toolbox in this respect remains the
same as before. But now there is a more restrictive view of when trade in private
securities can be relevant. The Riksbank may buy and sell such securities if there are
exceptional reasons, as stated in the act. In principle, this means that we must make
the assessment that other measures would not have the desired effect on the economy.
The new act now also gives the Riksbank an explicit mandate to trade in securities
within the framework of our task of contributing to the stability and efficiency of the
financial system. For instance, the Riksbank may buy and sell securities to temporarily
support financial markets for the purpose of counteracting a serious disturbance in the
financial system, if there are exceptional reasons.
The Riksbank's mandate remains strong
I will not go through all the details of the new act that have a bearing on monetary
policy. The overall picture is that some things have changed. But the important thing is
that we can do what we need to do to fulfil our tasks, in normal times and in times of
crisis. The Riksbank has a strong and clear mandate to conduct flexible inflation
targeting, where the overriding objective is for inflation to be lastingly low and stable.
This is important now that the inflation target is being seriousl put to the test in a
situation where inflation significantly overshoots the target for the first time since its
introduction in 1995.
Too high inflation and great uncertainty about developments
We have a year behind us in which inflation rose sharply around the world and central
banks raised policy rates at a rapid pace. At the beginning of 2022, inflation was around
4 per cent in Sweden. The Riksbank and most forecasters assessed that inflation would
fall during the year. As we know, it continued to rise instead.
One reason was the rapid economic recovery from the coronavirus crisis, which pushed
up prices on commodities, inputs and transport. Household demand was high, while it
was difficult for businesses to adjust and increase production quickly enough. As a
result, inflation received an unexpected boost when economies opened up.
Another important reason was Russia's invasion of Ukraine, which drove up the prices
of energy and grain, as well as other agricultural products. In addition, the high energy
prices had indirect effects on inflation via, for instance, rising prices for transports and
other input goods for companies. In the context of high demand following the pandemic,
firms found it easier to pass on their increased costs to consumer prices than might
have been expected from previous experience.
One year later, at the beginning of 2023, we thus had both far too high inflation and the
lesson from last year that it is very difficult to know how inflation will develop. There are
many indications that inflation in Sweden, as well as abroad, will fall back in 2023. The
uncertainty instead concerns how much and how quickly it will fall and whether this will
be sufficient. The Swedish economy must not end up in a situation where inflation
becomes entrenched above the target of 2 per cent.
The danger of inflation becoming entrenched at a high level
Let me elaborate on why this is so important, starting with an illustrative example from
when I visited companies last month. One person I spoke to noted that there had been
a clear shift in negotiations with other companies about future prices and deliveries. A
few years ago, inflation was not discussed in these negotiations. But now it is, and this
makes it difficult to enter into long-term business relationships, which in turn has a
negative impact on economic developments. This highlights the problem that high
inflation becomes a factor that makes financial decisions more difficult for companies
and households. And this contributes to the entrenchment of high inflation. We must
return to low and stable inflation because this is a long-term base for good economic
development. In addition, we will then be able to have real wage increases again.
Firms set their prices according to, for instance, the costs they incur, the behaviour of
their competitors and expectations of future price and cost increases. When inflation is
high and cost increases are large, firms are more eager to raise their prices often and to
pass on the increased costs to customers. It is also easier to raise prices, as
competitors do the same. We saw an example of this in the Riksbank's Business
Survey last autumn, where more than two out of three companies responded that they
were now raising their sales prices more often than normal and that this is mainly
because costs are rising all the time.
In turn, the price increases affect other companies' input costs, raising expectations of
future cost increases for which they want to compensate with higher prices - and so on.
Companies' labour costs are also affected if wage increases are pushed up by
demands for compensation for the high inflation.
Another problem is that if inflation is high, it varies more over time than if it remains at a
low level. This makes it more difficult for households and companies to plan and make
financial decisions and it leads to a poorer functioning of the economy as a whole. In
such an environment, it becomes more difficult, for example, to interpret the cause of
price increases on individual goods and services. Is the price increase a sign of a
general price increase in the economy, or has the price of the product actually
increased more than other similar goods? The risk is that consumers become hardened
in the long run and accept all price increases as part of inflation, making it easier for
companies to keep raising prices. It is therefore important to remain active and compare
prices.
A credible 2 per cent inflation target acts as an anchor
Thus, when inflation is high, there are self-reinforcing mechanisms that allow our
expectations to adjust and this contributes to keeping inflation high. But an environment
with low inflation can also become self-reinforcing in a similar way. Firms are then more
likely to let temporary price and cost increases reduce their margins rather than pass
them on to customers. The effects on other firms' prices and costs will then be smaller.
Businesses and households recognise that inflation remains low and adjust their
expectations accordingly. This means people do not need to worry or even think about
inflation in their everyday financial decisions.
An inflation target of 2 per cent creates good conditions for such an environment, as it
acts as an anchor for the expectations of households and companies and also avoids
inflation becoming too low. Households and companies assume that inflation will remain
around the 2 per cent target going forward, even if it happens to be higher or lower at
the moment. But this presupposes that there is confidence that inflation will eventually
return to the target. The longer inflation remains above the target, the greater the risk
that households and companies will be more inclined to focus on what inflation has
been and set their expectations on it continuing to be above the target.
Inflation needs to come down significantly this year
This is one of the main reasons why the Riksbank has a low tolerance for continued
high inflation at present. It is the Riksbank's task to stabilise inflation around 2 per cent
and we have assessed that it is better to act with monetary policy than to wait and see
and risk being surprised by continued high inflation that requires even greater tightening
later on.
Inflation thus needs to fall clearly this year, and it is important that underlying inflation
also falls. We assessed in February that the interest rate needed to be raised and that
we will probably need to raise it in April as well. As usual, it is the outlook for the
economy and inflation that is decisive for monetary policy, and we are well aware that it
takes time for the Riksbank's policy rate increases to have a full impact on the
economy. As it is difficult to know how quickly the impact will be and how great the
effects of the increases will be on the real economy and inflation, it is still important to
follow new outcomes and new indicators to obtain a picture of inflation prospects.
Inflation has already started to decline in some countries, but as we noted in February,
we see few signs that underlying inflation has started to decline in Sweden. Nor has this
picture been changed by the new information on inflation that has come in since our
decision. On the contrary. In February, inflation excluding energy prices rose and the
outcome was significantly above our latest assessment.
The Riksbank has a target for inflation, not for the krona exchange
rate - but the exchange rate affects inflation
The krona and the role it plays, and will play, for inflation in the future is an issue that
has been in focus in the economic debate. The Riksbank discussed this in connection
with our decision in February. In brief, our assessment was that the weakening of the
krona towards the end of last year is contributing to raising underlying inflation to some
extent now at the beginning of 2023. But given that the krona has weakened over a
long period of time, it is at the same time uncertain how companies take the exchange
rate into account and how great the impact will be on inflation in the period ahead.
Another reason why we talked a lot about the krona in February was to dispel the myth
that the Riksbank is now completely disinterested in the exchange rate. We wanted to
emphasise that the Riksbank actually follows the development of the krona closely. At
the same time, I pointed out that this does not mean that we have an explicit or implicit
target for the exchange rate. The Riksbank has an inflation target and we adjust
monetary policy to stabilise inflation around this target. But there is, as I said, a link
between the development of the krona and inflation. If the exchange rate weakens
substantially, this leads to higher inflation prospects, which requires adjusting monetary
policy. This is true. But this does not mean that the Riksbank will raise the interest rate
or intervene in the foreign exchange market if the exchange rate becomes weaker than
a certain level.
Swedish households more sensitive to interest rates than those in
other countries
Our assessment in February was thus that higher interest rates are needed to stabilise
inflation at the target within a reasonable period of time. At the same time, this entails a
cost for households and for many households with large mortgages this cost is
substantial. The Riksbank and Finansinspektionen have warned for a long time about
exactly the situation we are in right now. Households with high indebtedness combined
with variable-rate loans or loans to be renegotiated may find themselves in a much
tougher financial situation when interest rates rise. Moreover, this is happening at a
time when we risk a stagflation-like scenario, where growth is slowing down while
inflation is high.
Swedish household expenditure is more sensitive to changes in interest rates than
households in many other comparable countries. In some countries, households have
debts that are approximately the same size or larger as a share of GDP than in
Sweden. There are also countries where variable rate mortgages are common.
However, the combination of both high indebtedness and variable interest rates is more
unusual. From this perspective, Swedish and Norwegian households stand out as the
most sensitive to interest rates. In the Netherlands, for example, households have
similar or higher levels of debt, but tend to fix interest rates for more than ten years. In
the euro area as a whole, the share of new variable rate mortgages has been trending
downwards over a twenty-year period and German households appear to be the least
interest rate sensitive.
With regard to Sweden, I believe that the situation we are now experiencing with high
inflation and rising interest rates may to some extent have a self-regulating effect. It
may be the case that households will in the future see greater advantages in fixing their
interest rates for longer periods. There is also a request from Finansinspektionen to the
Ministry of Justice to review the interest rate differential compensation, which may
strengthen the incentives for households to fix their interest rates. In the Swedish
Government Offices the Ministry of Finance is now investigating the matter.
Furthermore, one can ask whether it would be appropriate to regulate to influence
households' choice of interest rate fixation period. But in this case, an indepth study of
the advantages and disadvantages of possible designs is first needed. Regulation
would not necessarily entail imposing binding restrictions, but could rather influence
households' incentives to fix their interest rates to a greater extent.
Higher interest rates cost, but prolonged high inflation costs more
Households' high indebtedness and short interest-rate fixation periods on their loans
mean that higher interest rates have a comparatively large and rapid effect on
households' scope for consumption. It is obvious that many households are heavily
burdened when mortgage rates rise and this is not something the Riksbank takes lightly.
At the same time, it is important to broaden the perspective. Interest rate increases did
indeed reduce households' spending money in 2022, but so did the large price
increases on electricity, food, other goods and services. Of course, the conditions vary
for different households, but looking at an average household, inflation eroded
purchasing power more than interest costs did. Higher interest rates are costly for
households. But it would cost even more if inflation stays at a high level. Partly because
of the high inflation itself, and partly because it would then probably require even larger
interest rate increases to bring inflation down again.
Broadly favourable real economic development in 2022
But doesn't a higher interest rate mean that the Riksbank is "breaking the economy", as
it is sometimes claimed? Our assessment in February was that economic activity is
certainly slowing down and that there will be a cooler development in the labour market
until the economy has cooled down and inflation has fallen. But once we get through
that, the economic situation will improve and activity will gradually increase again.
Statistics published after our decision show that GDP at the end of last year was slightly
higher than we estimated - the Swedish economy was relatively strong in 2022, as in
the previous year. But growth slowed down towards the end of 2022 and during the last
quarter GDP declined.
Exports continued to increase at the end of last year. However, household consumption
decreased and business investment also declined in the last quarter of 2022, albeit
from a high level. Residential construction has declined markedly, reflecting the
deterioration in housing market conditions last year. Although house prices have
stabilised in recent months, the overall decline has been large. At the same time, one
needs to put the decline in perspective with the large increase in both construction and
prices in the previous years. I think the effects on the housing market are manageable
so far.
Last year's labour market statistics show that the troubled economic situation is not yet
clearly visible there. Employment rose to a very high level and unemployment fell
across the board. So far this year, the labour market has slowed down somewhat.
There was strong growth in employment in January. But the number of persons
employed fell slightly in February. Unemployment rose slightly in February but, in trend
terms, unemployment has remained roughly unchanged in recent months.
In terms of economic activity, then, things do not look very dramatic so far, but several
forward-looking indicators point to the trend being weaker in the future. The big
question, of course, is how weak. There are forces that can alleviate the coming
downturn. For example, the Swedish economy may be supported by international
economic activity, which has been somewhat stronger than expected. It remains to be
seen to what extent the unease on the financial markets associated with the bank
problems will affect economic activity going forward.
Weak development during 2023, but also resilience
It may also be useful to recall that the Swedish economy has recovered faster from the
pandemic than many other economies. Employment is high in an international
perspective. In addition, Sweden has strong public finances and is well equipped to
target support to groups that are particularly hard hit when the economy is now slowing
down, for example, targeted labour market measures. Such measures need not conflict
with monetary policy when it comes to bringing down inflation. The same applies to
reforms that make the economy function better, for example by strengthening
competition on various markets. In addition to contributing to higher productivity, such
reforms can actually help to dampen inflationary pressures for a while.
The Economic Tendency Survey's confidence indicator clearly shows that households
are very pessimistic about their own finances and the Swedish economy in general. The
fact that households have found it more difficult is also noticeable in the retail sector,
where sales have fallen since last spring. According to the confidence indicator, the
retail trade is the part of the business sector where the mood is most gloomy. But for
February it also shows that confidence in the manufacturing industry rose slightly, after
having fallen for several months in a row. Confidence also increased in the service
sector. Recruitment plans in the business sector point to continued new recruitment,
although there are some differences between sectors.
The difference between different sectors is also shown in the Riksbank's Business
Survey in February. In general, the companies interviewed believe that economic
activity has weakened since last autumn. But several point out that the situation is not
as bad as they had feared. Respondents in the manufacturing industry are much more
satisfied with the situation than in the trade and construction industries. Orders in the
manufacturing industry have increased overall and expectations are that they will
remain at the same levels in the coming months.
We have also received a new outcome for Statistics Sweden's GDP indicator, which
provides an early picture of the development of GDP at the beginning of 2023. It shows
that activity in the Swedish economy rose in January and both exports of goods and
household consumption increased.
Of course, one should not rely too heavily on indicators for individual months. And there
is no doubt that GDP growth and the labour market will be weaker in 2023, partly as a
result of the tighter monetary policy. But I still think it is worth emphasising that so far
the situation in the Swedish economy is not pitch black.
Low inflation a condition for good economic performance
To conclude - we have our next monetary policy meeting in one month's time. By then,
we will have received more information on economic developments, including the
outcome for inflation in March. And as usual, we will weigh up all the information and
make a new overall assessment of inflation prospects, economic developments in
general and the monetary policy that is needed.
The recent concerns linked to the problems in international banks are putting us in a
more uncertain position. The financial unease may dampen international economic
activity, which would also affect economic activity here at home. The unease can also
affect financial conditions, that is, the state of the financial markets and the interest
rates, prices and conditions that households and companies face in those markets. So
far, the signals regarding financial conditions are rather mixed. However, if interest
rates directed to companies begin to rise, conditions for loans tighten, asset prices fall
and credit volumes decline as a result of the bank unease and the risk of contagion
effects, this in itself will have a cooling effect on the economy.
At the same time, there is no doubt that monetary policy needs to be tight. In January
and February inflation was still far too high and in February CPI inflation excluding
energy was significantly above our most recent forecast. The inflation target is the
Riksbank's overriding target and we will do what is necessary to bring inflation back to
low and stable levels. In the short term, this means a more subdued development of
production and employment. But in the longer term, there is no contradiction between
low inflation and expansion of the real economy. On the contrary - low inflation is
necessary for a favourable development of production and employment. Sweden is a
clear example of this.
Thank you!