SPEECH
DATE: 20 May 2024
SPEAKER:
Governor Erik Thedéen
PLACE:
Swedish Economic Association, Stockholm
Reflections on the high inflation in
recent years1
Thank you for inviting me to this traditional meeting of the Swedish Economic
Association. In my calendar, this meeting is a sign of spring and an event to look
forward to. Here I have the chance to discuss a topic in a little more depth and
also have the opportunity to highlight new and interesting analyses by staff at the
Riksbank.
The last few years have been tough and turbulent. First came the pandemic,
plunging the whole world into a huge health crisis that also had a major economic
impact. As the world began to recover from the pandemic, Russia invaded
Ukraine, which, in addition to the human suffering, has also had major economic
consequences and led to geopolitical tension. Moreover, since last autumn, a war
between Israel and Hamas has fuelled geopolitical unrest and led to terrible
humanitarian consequences. So there are still many storm clouds and in that
sense this turbulent period is not over. But from an inflation perspective, things
look much brighter now.
When I was here last May, inflation was still too high. The Riksbank had raised the
policy rate by 0.5 percentage points to 3.5 per cent in April, and we emphasised
the importance of inflation quickly coming down to the inflation target. To ensure
this, we then raised the policy rate to 4 per cent, and we have kept it at this level
since September last year, until two weeks ago (see Figure 1). Meanwhile, CPIF
inflation has been trending down towards 2 per cent and we have now started to
cut the policy rate.
1
Thank you to Björn Andersson and Iida Häkkinen Skans for help with the speech. Thanks also to Hanna
Armelius, Aino Bunge, Mattias Erlandsson, Martin Flodén, Marie Hesselman, Peter Kaplan, Mathias Klein,
Stefan Laséen, Mårten Löf, Stefania Mammos, Åsa Olli Segendorf, Marianne Sterner, Pär Stockhammar,
Klara Strömberg and Oskar Tysklind for their input and valuable comments and Elizabeth Nilsson for
translation.
Postal address: SE-103 37 Stockholm, Visitors: Brunkebergstorg 11
Since the introduction of the inflation target in the 1990s, the challenges have
centred on navigating in a low-inflation environment. In fact, the last few years
are the first time that inflation targeting has been seriously tested on the upside
and - as it turns out - has withstood a major upswing in inflation. Now that we
have passed the interest rate hike cycle and have started to cut the interest rate,
it may be appropriate to reflect on the period we have gone through.
Today I intend to start by going through the reasons why inflation rose as it did.
What actually happened? Sometimes one hears confident claims, such as that it
was just a question of large increases in energy prices or an effect of Russia's
invasion of Ukraine. Both of these factors have certainly contributed but they are
not the whole explanation. I intend to go into a little more detail on another
factor that was important and that may also have implications for monetary policy
in the long run, namely firms' pricing behaviour. I would also like to address
developments in the real economy. Looking back over the past few years, it is
striking that the real economy as a whole has performed better than many feared
it would with several percentage points higher interest rates. Finally, I would also
like to look ahead and say a few words about possible future developments.
The upturn in inflation - what actually happened?
But let me start with inflation. In 2021, inflation started to rise from a low level,
both in Sweden and abroad. At the end of 2021, inflation measured as the annual
percentage change in the CPIF was around 4 per cent, which was then the highest
inflation figure we had had in Sweden for thirty years. In February 2022, the
Riksbank assessed that inflation was likely to fall back towards the end of the
year, but as is well known, the opposite was the case. Inflation picked up
significantly and by December 2022, CPIF inflation was in double digits. What
happened?
Rapid recovery from the pandemic combined with global supply shocks
To understand these developments, we first need to go back to the 2020
pandemic. When countries shut down, demand fell dramatically as people
adapted their behaviour to both coercive and self-imposed restrictions. It hit the
Swedish economy via a decline in demand both abroad and in Sweden, with firms
in many service industries, such as hotels and restaurants, being particularly hard
hit. But the pandemic also meant that international supply chains were disrupted
and workers fell ill, making it harder for companies to maintain production. The
pandemic thus affected the economy via both the demand and the supply side.
As households reduced their consumption, their savings increased markedly.2 As
households had needed to restrain their consumption for a long time, the
recovery was then very fast as effective vaccines were put in place and countries
could start opening up in 2021. In some areas, activity rose from almost
nonexistent to very high levels in a short period of time (see Figure 2). Compared with
the 1990s crisis and the 2008 global financial crisis, GDP recovered much faster
after the pandemic (see Figure 3).
In many countries, labour supply had fallen sharply as many people had left the
labour force during the pandemic. In Sweden, the overall labour force
participation rate did not decline significantly, but many people chose to retrain
or change sector. As a result, when demand quickly recovered, many companies
found it difficult to recruit labour with the right skills. The labour shortages caused
wages to rise relatively substantially in several countries.
The recovery was supported by various fiscal policy support packages, which in
some cases were very extensive.3 For households, this included support in the
form of unemployment benefits and sickness benefits. In the United States, large
amounts of direct cash assistance were also paid out. Companies received support
in the form of grants and guarantees to cover revenue losses and to continue
borrowing at a relatively low cost. In Europe, there were also furlough schemes
that saved many workers from being laid off. Fiscal policy support was generally
large, but in comparison with the United States and other European countries,
fiscal policy support measures were relatively smaller in Sweden.4 At the same
time, it is difficult to compare, as the social security systems already in place
provided different protection in different countries. It is also difficult to compare
how effective the measures were in different countries. For example, furlough
schemes can stabilise employment in the short term, but in the longer term they
can reduce the dynamism of the economy and contribute to weaker productivity
growth.
Global supply disruptions lingered longer than expected
The upturn in global demand contributed to a rapid increase in commodity prices
for metals and food in 2021. At the same time, disruptions to global trade
persisted, causing, among other things, a significant increase in freight prices.
Input prices rose to record highs for both manufacturing and services companies.
This had a lagged effect on producer prices, but the impact on Swedish consumer
prices was initially quite small. This was not surprising in itself, as the link between
commodity prices and consumer prices is usually weak. In 2021, energy prices, in
particular electricity prices, also started to increase rapidly. This contributed
greatly to pushing CPIF inflation up and above the inflation target - excluding
energy, CPIF inflation was around 2 per cent at the end of 2021.
Much of the discussion around monetary policy in late 2021 and early 2022
centred on the extent to which these factors would have a temporary or more
permanent effect on inflation.5 How much of their increased costs would
companies pass on through higher prices? Given that producer prices had risen
rapidly, consumer prices would likely increase with some lag. Historical patterns
indicated there would be a limited and temporary upturn, but how much
confidence could be placed in those patterns in the exceptional circumstances
that prevailed? As the rise in CPIF inflation was mainly due to energy prices, and
the Riksbank assessed that their contribution would decline in 2022, the forecast
was that inflation would fall back towards the end of the year.
But the situation worsened in February 2022, when Russia invaded Ukraine. New
disruptions in global value chains emerged. The supply of Russian oil and gas
decreased, as well as the supply of agricultural goods from Ukraine. This caused
the world market prices of some foods to rise and, instead of falling back, energy
prices rose even more. Inflation thus received an extra boost and continued to
rise globally. Following the monetary policy meeting in February 2022, the CPIF
outcomes for the beginning of the year showed that prices for food and other
goods in particular had contributed to a rapid rise in inflation. Clearly, by early
2022, the pace of goods price increases had picked up across the board and
underlying inflation rose faster and was much higher than expected.6 In the
spring, the rate of increase in many services prices also rose, signalling that there
were also more domestically generated inflationary pressures.
During summer and autumn 2022, CPIF inflation continued to rise as price
increases for food and other goods became more pronounced (see Figure 4). In
December, inflation was just over 10 per cent and just under 8.5 per cent
excluding energy prices. In 2023, however, inflation gradually declined. To begin
with, the contribution from energy prices, which had fallen at the end of 2022,
was reduced. However, CPIF inflation excluding energy was still significantly
higher than expected in early 2023. The contributions from prices of food and
other goods declined gradually over the year, but services prices increased
unexpectedly fast. At the end of 2023, inflation excluding energy was just over 5
per cent, with services prices being the main driver of inflation.
The large increase in energy prices had spillover effects
Thus, in addition to the persistent disruptions in global value chains that pushed
up input and freight prices, the rise in energy prices was both larger and more
protracted than expected. This meant that the spillover effects from energy prices
to other prices were also larger than expected. The spillover was via indirect
effects, with the large increases in energy prices driving up firms' production
costs, which were passed on to consumers via larger price increases for goods and
services. In Sweden, however, we experienced very little secondary effects via
large wage increases to compensate for the large price increases.
Energy prices tend to be volatile and affect measured inflation quite substantially.
But while energy prices rose dramatically, they are not the only reason why
inflation rose as fast and as much as it did. Earlier attempts by the Riksbank and
the National Institute of Economic Research (NIER) to estimate the indirect effects
on inflation of a permanent change in the price of oil or electricity showed that
the indirect effects have been about the same size as the direct effect. However,
the indirect effects come with a lag and they are spread over a longer period of
time.7 By the end of 2021, the direct contribution of energy prices to CPIF inflation
was close to 2.5 percentage points and remained at almost the same level until
autumn 2022, with the exception of occasional monthly outcomes. According to
estimates of the indirect effects, one could therefore have expected, as a rule of
thumb, that CPIF inflation would have been pushed up by a further 2.5 percentage
points overall in 2022-2024. As inflation rose significantly more and faster,
indirect effects cannot be the only explanation.
The trend raised questions about companies' pricing behaviour
One should remember, however, that calculations of this type of relationship are
very uncertain, which was also emphasised when the Riksbank and the NIER
published their estimates. The calculations capture the average impact on
inflation of earlier changes in energy prices. But how companies actually set their
prices when energy prices and other production costs rise will be influenced by a
range of factors, depending on the circumstances.
The large and rapid upturn in inflation in 2021-2022 raised questions about this.
How do companies usually set their prices when costs increase and how was this
period different? To what extent were the large price increases indicative of a
change in pricing behaviour, with companies now perhaps raising prices more
than usual in relation to cost increases? New analysis in recent years has provided
interesting insights and some answers to these questions, although data
limitations make it difficult to speak with certainty about this.
The rise in inflation coincided with more frequent price increases
Normally, the Riksbank analyses the development of the CPIF and price increases
in relatively large sub-groups such as goods, services, food and so on. However,
Statistics Sweden's calculations of inflation are based on a very large data set of
prices for individual products. For some years now, researchers at the Riksbank
have been conducting a research project to analyse the development of prices at
this micro level and gain a deeper knowledge of companies' pricing behaviour and
how this is linked to price increases at the aggregate level.8
For example, it turns out that the frequency of price changes, i.e. how often
prices change, seems to play a more important role for inflation than the size of
them. The analysis of prices at the micro level shows that the frequency of price
changes - both raises and cuts - increased in the 2010s up to the pandemic, while
the average size of the changes remained fairly stable.9 There were significant
differences both within and between product groups. In general, food and goods
prices changed on average more frequently than services prices.
In the early part of the 2020 pandemic, price increases were less frequent (see
Figure 5). But from the summer of 2021, there was a dramatic change. The
frequency of price increases then increased noticeably. At the same time, price
cuts were more rare. The difference in the frequency of increases and decreases
thus widened, while inflation rose rapidly.10 Perhaps somewhat surprisingly, the
average size of price changes was only slightly larger during this period, so the rise
in inflation mainly coincided with companies raising their prices more often on
average, rather than raising them more.
These are preliminary results from an ongoing research project. Going forward,
the Riksbank will receive data on prices at the micro level on an ongoing basis and
it is possible that the research project will be able to develop an inflation indicator
from the information on the frequency of price changes. Although it is not
necessarily a leading indicator, it could still complement other indicators and
provide a fuller picture of developments - judging by recent years, it is certainly
worth keeping an eye on inflation as prices start to rise more frequently.
In general, prices increased by about the same amount as companies'
costs
However, to understand the rise in inflation, we also need to look at how price
increases have related to companies' costs. In 2022 and 2023, the NIER conducted
such a study on behalf of the government.11 The main conclusion of the study is
that the CPIF rose by roughly the same amount as business sector costs from
spring 2019 through spring 2023 - costs that were driven up by rising import
prices for commodities and inputs and, to a slightly greater extent, higher labour
costs. However, there are major differences in price adjustments between
different product groups. Smaller price increases than cost increases in some
products, notably services, offset the effect of larger price increases than cost
increases in other products, notably goods.
Food prices have been of particular interest and the NIER's overall assessment is
that consumer food prices increased more than was justified by production costs.
However, it is difficult to assess whether any particular part of the food supply
chain accounted for the bulk of the price increase. An interesting finding of the
study is that changes in, among other things, energy prices and the exchange rate
appear to have affected food prices significantly more since 2022 - not only
because the changes were larger than before, but also because pricing appears to
have reacted more to the changes than it did before. Companies in general may
also have been somewhat faster in passing on their cost increases to consumers in
recent years.
Stronger link between producer prices and consumer prices
The pass-through from cost increases to price increases thus appears to have
been greater than before. Another sign of this is that the link between producer
prices and consumer prices seems to have become stronger. Consumer prices are
the prices of goods and services consumed by households, while producer prices
are the prices at the first sales stage, i.e. the selling prices of goods and services
produced by Swedish companies and purchased by Swedish importers. Comparing
the evolution of producer prices and overall consumer prices for food and other
goods in the 2000s, the relationship was relatively weak until recent years,
although somewhat more pronounced for food. The fact that the pass-through is
normally different in different product groups is confirmed by a study of more
disaggregated data.12
An important explanation for the fact that changes in producer prices tend not to
have a full impact on consumer prices is that the purchase of goods represents
only part of companies' total costs. Consumer prices will therefore not fluctuate
as much as producer prices, even if companies allow changes in costs to directly
affect prices. Companies may also choose to pass on variations in purchasing costs
to profit margins instead of passing them on directly to customers, for example if
there are costs or competitive disadvantages associated with frequent price
changes. However, in recent years, the pass-through from producer prices to
consumer prices seems to have been greater and faster than before.13
Greater impact of a weaker krona on consumer prices
Signs that this has been the case are also visible in the pass-through from the
exchange rate to inflation. With some variations, the krona has been depreciating
against a trade-weighted basket of currencies for a long time, but the trend was
particularly evident from the beginning of 2022 until the end of 2023. Compared
to the dollar and the euro, the krona weakened a lot in a short period of time and
I discussed possible reasons for this at an SNS seminar last year.14 As a weaker
exchange rate raises the prices of imported products in krona terms, the exchange
rate was another reason for Swedish companies' cost increases in 2022-2023.
Based on previous calculations, one would expect variations in the exchange rate
to have moderate effects on inflation - a rule of thumb based on various empirical
estimates has been that if the exchange rate were to depreciate lastingly by 10
per cent against a trade-weighted basket of currencies, this would lead to around
0.5 percentage points higher inflation after one year.15 Given that inflation
increased by several percentage points in 2022, there were suspicions that the
12
In general, pass-through appears to be faster for goods, such as food, where prices are updated
frequently, see E. Ahlander, M. Carlsson and M. Klein (2023), "Price Pass-Through Along the Supply Chain:
Evidence from PPI and CPI Microdata", Sveriges Riksbank Working Paper Series 426. As the study points
out, there are significant differences in the goods covered by the producer price and consumer price indices
and how they are weighted together. This makes it more difficult to study the relationship between the
indices. One way to reduce this problem is to match similar products at the producer and consumer levels
using price microdata.
13
See the analysis entitled "Relationship between producer and consumer prices", Monetary Policy Report,
March 2024.
14
See "The krona will strengthen in the long run", speech on 22 September 2023, and the article with a
similar title in Monetary Policy Report, September 2023. A discussion of the krona in a longer perspective
and the role of monetary policy in the development of the exchange rate can be found in C.-J. Belfrage, J.
Hansson and A. Vredin (2023), "How should we view the development of the krona?", Economic
Commentary no. 3, Sveriges Riksbank.
15
See the article "The impact of the exchange rate on inflation" in Monetary Policy Report, December 2016.
pass-through of the krona depreciation was much larger and faster than before.16
For example, goods prices increased faster in Sweden than in the euro area and,
compared with neighbouring countries, goods prices increased faster in Sweden
and Norway, both of whose currencies depreciated against the euro, than in
Denmark, whose krona is pegged to the euro.
The rapid rise in inflation in the rest of the world has also led researchers to focus
on the question of whether the pass-through varies depending on the state of the
economy.17 A recent Riksbank study has examined whether this has been the case
in terms of the krona's impact on various measures of inflation from 2000 until
autumn 2023.18 The study finds that the impact on CPIF inflation is on average in
line with the Riksbank's earlier calculations. These, in turn, are close to the
performance of other developed economies. However, there appears to be a
nonlinear relationship whereby a weakening exchange rate has a much greater
impact on inflation in times of geopolitical uncertainty or when domestic inflation
is above the inflation target.
Why was the pass-through from costs to prices higher this time?
There are thus many indications that companies have allowed cost increases to be
reflected in price increases to a greater extent in recent years than they did earlier
in the 2000s. The natural follow-up question is why. What was the difference from
previous episodes when production costs increased?
One obvious difference is the particular circumstances and magnitude of the
disruption that affected companies this time. Costs rose rapidly and significantly
via higher prices for energy, commodities, inputs, freight and so on in a context
where many companies were already under pressure since the pandemic. For
some companies, it was simply not possible to offset the increased costs in the
normal way through their margins, and so they passed on the costs to consumer
prices to a greater extent than before. Others could then follow suit and raise
their prices.
Households also had a pent-up need to consume after the pandemic, so demand
in the economy was high. Households were willing to pay more for certain goods
and services that they had not been able to consume for a long time. This made it
easier for companies to raise prices, as they ran less risk of losing customers. It is
also possible that households were, at least to some extent, more accepting of
price increases, as they could see and understand that companies were struggling
with large cost increases.19 However, as the debate on high food prices in spring
2023, for example, showed, this is likely to have been a factor that may have
played a greater role for some goods and services than for others.
The rise in inflation was due to a combination of high demand and supply
shocks
So what can we learn from this turbulent period of high inflation? I discussed this
in a speech last winter and I think that developments since then and new analysis
support the conclusions I drew then.20 A first conclusion is that the rise in inflation
was driven by a combination of both supply-side and demand-side factors. There
has been a strong focus on this issue in the monetary policy debate, where the
argument has been that the rise in inflation was, in principle, purely an effect of
supply shocks that monetary policy could not influence.
One of the Riksbank's analysis projects has used various models to study the
drivers of inflation broken down into supply and demand factors during the period
of high inflation.21 The results show that both have affected inflation. Overall, the
results suggest that slightly more than half of the inflation in recent years can be
attributed to supply factors and the rest to demand factors (see Figure 6).
However, the results vary, for example, depending on the model used.
Tighter monetary policy was necessary to bring inflation back to target
These breakdowns help us understand what drives economic developments. But
as I discussed in my December speech, monetary policy cannot simply react when
inflation is fuelled by demand factors and completely ignore increases due to
supply factors. Inflationary impulses from the supply side can also propagate - for
example, through changes in pricing behaviour, as I have discussed today, and
through expectations of future inflation. Expectations are not formed in a vacuum
- if the Riksbank does not act to ensure that inflation is on target in the long term,
the credibility of the target may decline.
Monetary policy is very much about expectations and credibility. Thus, while the
rise in inflation was to a fairly large extent caused by various supply shocks related
to the pandemic and war - which central banks cannot directly influence - it was
important to tighten monetary policy. The purpose of the Riksbank's interest rate
increases has been to bring inflation back to the target within a reasonable time,
without slowing economic activity unnecessarily. The fact that inflation has now
come down and is close to the inflation target is due to the fading of global shocks
and the dampening effect of tight monetary policy on demand.
What would have happened if we had not raised interest rates? When people
criticise the interest rate increases, they rarely comment on this counterfactual
development. It is inherently difficult to give precise figures, but based on the
impact of monetary policy in the past, inflation would have been significantly
higher. Model estimates show that it would likely have peaked somewhere
around 14 per cent instead of around 10 per cent if we had only raised interest
rates very little or not at all in 2022.22
In addition, these models do not take into account the risk that prolonged
deviations from the inflation target could lead to households and companies
losing confidence in the inflation target. If they start to expect high inflation to
persist for a longer period of time, this can become self-fulfilling and so-called
wage-price spirals can arise. In such cases, bringing down inflation becomes even
more difficult and costly for the real economy, as the experiences of the 1970s
and 1980s show. I therefore judge that the Riksbank's interest rate increases were
necessary, both to prevent inflation from becoming even higher and to keep
longterm inflation expectations anchored to the target. We have succeeded in doing
so (see Figure 7).
But, of course, this was not only due to the Riksbank. In the work to bring down
inflation, Sweden has also benefited from well-functioning wage formation and a
restrained fiscal policy. Wage increases have been somewhat higher than in the
past, but relatively moderate given the high inflation, and lower than in many
other countries. However, wage formation based on the inflation target
presupposes that the Riksbank also does its job and brings inflation back down to
the target within a reasonable time. If we hadn't done that, the conditions for the
autumn wage bargaining rounds would have been different.
Where do we stand now?
That was all about the years of high inflation. Where do we stand now? Inflation
has thus come down and is expected to stabilise around 2 per cent. Moreover,
inflation expectations are firmly anchored and wage increases are moderate. The
Riksbank has now begun to cut the policy rate. The adjustment of monetary policy
going forward will be characterised by caution, with gradual cuts to the policy
rate. I have made it sound as though the inflationary upswing is over, and most
indications are that this is the case. But it is best not to be too confident in the
forecasting business, and there is still a risk of setbacks. The geopolitical unease
could increase, for instance, and lead to renewed supply shocks. Future
developments in the exchange rate and companies' pricing also remain uncertain.
Inflation has come down but this does not necessarily mean that old
relationships apply again
So, as I have described, there are clear signs that something happened to
companies' pricing behaviour when inflation was high. For example, the
correlations between producer prices and consumer prices, between energy
prices and consumer prices, and between exchange rates and inflation have not
followed historical patterns. Inflation has now come down and a relevant question
is whether this also means that we are back in the old relationship again. There
are certainly signs that pricing is normalising and that price increases at the
producer level have decreased.23 The frequency of consumer price increases has
declined steadily since the beginning of 2023 and, at the beginning of 2024, was
at about the same level as before the pandemic (see Figure 5). According to the
Economic Tendency Survey and the Riksbank's Business Survey, companies' plans
for price increases are now more modest, although there are differences between
different sectors. As I mentioned, there is also evidence to suggest that the
passthrough from the exchange rate should become more normal once inflation is
close to the target again. Normalisation thus seems to be underway.
However, one conclusion from recent years is that old relationships cannot always
be relied upon to remain valid - even those that have been stable over longer
periods. As a policymaker, you need to be prepared for this because it is easy to
get caught up in the prevailing zeitgeist. This may sound simple and obvious but in
practice is not that easy. With the benefit of hindsight, it may seem obvious that
relationships have changed. But decisions are made in real time, mostly based on
data that is lagging behind.
We now know that inflation is by no means "dead", as it was sometimes labelled
when inflation was below the central banks' inflation targets for a long period.
The threshold for raising prices may be lower now than it was in the past, allowing
inflation to accelerate in earnest under certain circumstances. We should
therefore not take it for granted that pricing behaviour and cost-price
relationships will return to those that prevailed before the upsurge in inflation in
recent years. For monetary policy, it will be important to monitor indicators that
can quickly reflect changes in price-setting behaviour. The Riksbank has also
started to make greater use of different scenarios, which clearly focus on the
possible consequences for inflation, and thus for the interest rate, if
developments do not follow old relationships.24
Overall, the Swedish economy has been more resilient to the rise in
interest rates than expected
In December, I noted that conclusions remained to be drawn about the impact on
the real economy of the years of high inflation and interest rate hikes. The
purpose of monetary policy during the interest rate hikes was to bring inflation
back to the target within a reasonable time, without slowing economic activity
unnecessarily. We now know more about how it has worked, although it is still
too early to say how successful it has been. It is possible that we have not yet
seen the full impact of the rate hikes on the labour market. Redundancy notices
are at relatively high levels and unemployment has risen slightly. In addition, the
number of job vacancies has decreased. There is therefore a risk that
developments in the real economy will be worse than expected and also that
inflation will undershoot the target.
But so far, it can at least be noted that the real economy in Sweden, as is the case
internationally, has not been affected by the rise in interest rates as much as
many were expecting. This is perhaps more notable in Sweden's case, given that
we entered the period of interest rate hikes with more interest rate-sens