samchain/econo-pairs-v1 huggingface dataset:
SPEECH DATE:  08/12/2021  SPEAKER:  Deputy Governor Per Jansson  VENUE:  Sveriges Riksbank  SVERIGES RIKSBANK SE-103 37 Stockholm (Brunkebergstorg 11) Tel +46 8 787 00 00 Fax +46 8 21 05 31 registratorn@riksbank.se www.riksbank.se  Is it time to review the division of roles in macroeconomic policy? * Sometimes, developments can make you start pondering somewhat larger and more fundamental issues than you might usually do. This is how it has been for me recently. The question I would like to address today is whether it might be time for us to modify our view of the appropriate division of roles in macroeconomic policy, by which I mean our overall fiscal and monetary policy. I am not entirely sure of the answer myself, although I am inclined to believe that it is something we should probably do. In this talk, I will try to explain my preliminary and probably rather unfinished thoughts. What I am quite sure of, however, is that we have reached a point where it is time for us to start discussing what an appropriate division of macroeconomic roles would be. I am glad to say that the number of articles touching upon the subject has increased recently, and I hope that this speech will contribute further to this discussion. But let me take a step back and start from scratch. The devaluation policy reached the end of the road in the early 1990s Thirty years ago, the Swedish economy was in a dire situation.

On the one hand, the recovery of developed economies goes on, but only moderately and insufficiently to reduce the high rates of unemployment (figure 1). Risks are substantial. In fact, the intensity and velocity of the events we saw in Europe in early November are proof of the fragility of the world economy. On the other hand, growth prospects in emerging markets are still positive; commodity prices are still high, with copper standing out recently at record highs, and external financing conditions are good. The sustainability of this imbalanced scenario for the global economy is one of the primary risk factors for next year. Some of the questions we must try to answer and monitor closely are: How fast can emerging economies grow if the advanced economies are further weakened? How can advanced economies grow without incurring in unsustainable current-account deficits? How will the financial tensions in Europe be resolved? Is it possible for expenditure in Chile to grow excessively while ignoring the risks coming from abroad? In this context, the Board has continued to gradually normalize the monetary policy interest rate (MPR), setting it at 3.25% in its December meeting. In the most likely scenario, it will continue to gradually withdraw the monetary stimulus, which will depend on the unfolding of internal and external macroeconomic conditions. Let me now take a closer look at the scenario we believe is the most likely for the next two years and its implications for inflation and monetary policy. Macroeconomic scenario I will begin with the world economy.
When the Bank was founded in 1968, Malta formed part of the sterling area, reflecting its past as a British colony and its strong ties with the United Kingdom. When the Bretton Woods system collapsed in 1972, the Maltese monetary authorities decided to break the exclusive link with the pound sterling and to peg the lira to a trade-weighted basket of currencies. During the 1980s the composition of the basket was revised on several occasions until, in 1989, the number of component currencies was reduced to three, the ECU - which had replaced several European currencies - the pound sterling and the US dollar. In 2002, the weight of the euro was raised to 70%, while those of the dollar and the pound were set at 20% and 10%, respectively. Following Malta’s accession to the European Union, in May 2004, the authorities resolved to move swiftly to adopt the euro. A year later, the Maltese lira entered Exchange Rate Mechanism Mark II (ERM II) with a unilateral commitment by the Maltese authorities to maintain its value unchanged at the central parity rate. This central parity rate then became the conversion rate between the Maltese lira and the euro when Malta adopted the single currency at the beginning of 2008. In effect, Malta has moved from a currency union with the pound sterling to membership of the euro area, with a period characterised by a basically fixed exchange rate in between.

The EC forecast shows that both for 2017 and 2018, Malta’s unemployment rate will be 4.9%, which is extremely low when compared to the both the euro area and the EU. During 2017, it is expected that unemployment in the euro area and the EU will be 9.6% and 8.1% respectively. For 2018,  4  unemployment in the euro area is expected to go down to 9.1% whilst that in the EU will also decline to 7.8%. Malta’s general government deficit as a percentage of GDP is also expected to continue on the positive trajectory it has embarked on the in the previous years. It is expected to narrow further to 0.6% in 2017 and remain at this level in 2018. This figure is also compares favourably to the average deficit ratios projected in the euro area19 (2017 and 2018: -1.4%) and the EU (2017:= -1.7% and 2018= -1.6%). For the first time in many years, Malta’s gross government debt to GDP is expected to fall below the 60% threshold. In fact, for 2017 the debt ratio is expected to be 58.0% and to decline even further in 2018 (55.6%). In my view, the main lesson to be learnt from this half a century of experience is that while a flexible exchange rate policy may afford some leeway in the short term, allowing the economy to withstand economic shocks, it is no substitute for structural reforms that achieve greater flexibility in product and labour markets. This is especially the case for small open economies.
Accordingly, the yield curve plays a dual role for monetary policymakers: on the one hand, as a transmitter of monetary policy; on the other hand, as a source of information about the expectations and risk assessments of investors about the future macroeconomic environment and the future path for monetary policy. Response of the yield curve to monetary policy in normal times Let me first revisit the benchmark case of how the yield curve reacts to the standard policy tool of variations in short-term interest rates. To this end, I will focus on a rate cut, in order to facilitate the comparison with a subsequent discussion of our unconventional monetary easing policies. When measuring the effect of monetary policy on the yield curve, macroeconomists typically focus on monetary policy shocks: that is, surprise changes in the policy rate that occur independently of other structural shocks, such as innovations in aggregate demand or cost-push shocks. Since monetary policy decisions respond to these other shocks, naive calculations of the co-variation between monetary policy  and the yield curve cannot distinguish the contribution of monetary policy from the impact of the underlying structural shocks. Accordingly, the independent role of monetary policy is revealed by focusing on the surprise element in monetary policy decisions, and there is a buoyant literature trying to identify these shocks and measure their impact on the yield curve and the economy.

Notes: Surprise impact normalised to 10 basis points for the six-month maturity. Why do we see a stronger effect on longer maturities when the rate cut takes place in negative territory? One factor here is that cuts in negative territory were often accompanied by communication or at least market perceptions that the ECB was willing to lower the negative rate even further, if warranted by subsequent economic conditions. As a case in point, for the final two of the last five rate cuts, the introductory statement at the press conference clarified that the ECB’s Governing Council “expects the key ECB interest rates to remain at present or lower levels”. This type of communication about the scope of negative rates can provide accommodation even in the absence of actual rate cuts. This mechanism adds another dimension to the standard channels of rate forward guidance. Let me elaborate on this point. Consider the situation in which the central bank is perceived to be constrained by the zero lower bound. Guided by an understanding of the central bank’s reaction function and a depressed macroeconomic outlook, markets may think that in one year’s time, the central bank would like to set negative rates with positive probability but that, if constrained by the zero lower bound, the best the central bank can do in those states of the world is to keep rates at zero. In technical terms: the presence of the lower bound induces a censored distribution for future short rates.
The strategy to be employed has not been fully decided,  6  BIS Review 39/2010  but recent speeches by FOMC members and the recent FOMC minutes have begun to convey some of the possibilities. Many of the potential steps described seem to guard against the risks involved. For example, reducing the size of the Fed’s balance sheet through redemptions for now will produce a gradual adjustment that will be easier for the markets to digest. In addition, steps taken to drain reserves ahead of policy tightening may best ensure the success of interest on reserves at influencing other short-term interest rates. Overall, an approach along these lines should help to ensure a smooth exit from the current accommodative stance of monetary policy. Moreover, if the Fed’s intentions are well communicated to the financial market participants, they too should be fully prepared and in the best possible shape for navigating this exit. BIS Review 39/2010  7

Therefore, the Central Bank must be attentive to steer monetary policy to avoid secondround effects on other prices, wages, or private sector inflation expectations due to supply shocks, that could end up driving inflation persistently away from the 3% target. Of course it also has to foresee the consequences of the business cycle over inflation. It also The efficacy of this monetary policy over the 2000s is evident (Figure 3). BIS Review 97/2007  3  Figure 3: Deviation of inflation from its target  Source: Central Bank of Chile. The international financial turmoil Regarding recent developments in world financial markets, the first thing to do is recognize that the adjustment they are undergoing is part of an overdue normalization process in credit risk spreads for a large variety of securities, and volatility levels of the riskier assets prices (Figure 4). In fact, for some time our Financial Stability and Monetary Policy reports have stated that a correction in risk premiums and an increase in market volatility were to be expected, because the good conditions would not last indefinitely, in particular given the monetary policy normalization period in the main economies that was already prolonging for some years. It is very likely that today we are witnessing precisely that correction in risk valuation and volatility. Figure 4: Sovereign risk premiums and volatility (basis points)  (1) Risk premium on developed market corporate bonds with less than investment grade risk ratings (CCC to BB), according to Standard and Poor’s.
By design, Basel II served as an incentive device for banks to upgrade their risk management technology. As a by-product, there was a step change in the granularity of the Basel framework. Risk exposures were no longer captured at a broad asset class level. And risk weights on these exposures were no longer confined to five buckets. That meant greater detail and complexity. Reflecting these changes, Basel II came in at 347 pages – an order of magnitude longer than its predecessor. 10 The ink was barely dry on Basel II when the financial crisis struck. This exposed gaping holes in the agreement. In the period since, the response has been to fill the largest of these gaps, with large upwards revisions to the calibration of the Basel framework. Agreement on this revised framework, Basel III, was reached in 2010. In line with historical trends the documents making up Basel III added up to 616 pages, almost double Basel II. 11 The length of the Basel rulebook, if anything, understates its complexity. The move to internal models, and from broad asset classes to individual loan exposures, has resulted in a ballooning in the number of estimated risk weights. For a large, complex bank, this has meant a rise in the number of calculations required from single figures a generation ago to several million today (Haldane (2011)). That increases opacity. It also raises questions about regulatory robustness since it places reliance on a large number of estimated parameters.

Currently there are some 9,000 HLIs with assets under management of about USD 1,600 billion. 4 Despite these impressive figures, the HLI industry remains modest in relative terms. HLIs have a market share which is smaller than the trading books of the five largest international banks and they represent only a fragment of the total debt securities (USD 65,000 billion) and credit default swaps outstanding (USD 25,000 billion). However, more important is the activity of HLIs in some market segments, especially in the more complex ones. In the markets for credit default swaps, distressed debt and emerging market bonds, for instance, roughly half of the trading volume can be attributed to HLIs. In the more traditional markets for interest rate derivatives and mortgagebacked securities, their share drops to only 10% again. 5  2. The benefits of HLIs  HLIs have undoubtedly been a source of innovation in the global asset management industry, especially with regard to traded credit products. Moreover, through their flexible and largely unconstrained investment approaches as well as through their extensive use of innovative financial instruments, they have contributed to improving the efficiency of price discovery in financial markets. By buying assets that are perceived to be undervalued and by selling assets that are perceived to be overvalued, HLIs help to move mispriced assets toward their fundamental values. HLIs play an important role in trading and distributing risk. Thus, they enhance market liquidity, perhaps even in periods of stress, when nobody else is willing to take risks.
– The new capital requirements require balance sheet rebalancing of internationally active banks, i.e., increase of the capital or reduction in risk weighted assets. Given the still slow recovery process that would be an obstacle for faster increase of capital (through reinvested earnings or new capital injections) this may have implications for the availability of finance. One related issue is the exclusion of minority stakes from consolidated group capital and its implications for the process of deleverage as well as for the development and liquidity of local equity markets (change in the nature of acquisitions). – “Retrenchment in specialty finance due to higher risk weights for certain finance instruments would be particularly harmful to the growth outlook of the region. Some of the sectors most exposed to the retrenchment process are specialty finance lines, particularly infrastructure finance and trade finance. Infrastructure finance is characterized by long maturities, heavy use of syndication, and dependence on long-term dollar funding that makes it particularly exposed to deleveraging” – Cost of finance – “The cost of finance in the region could increase due to inherent inconsistencies in the treatment of sovereign exposures at the solo and consolidated levels. Host supervisors typically apply low risk-weighting for exposures to the host sovereign. However under the forthcoming set of EU regulations, higher risk weights on these exposures could result in a higher cost of finance in the host jurisdiction”. The second channel of transmission is related to the Basel III liquidity framework.

I will talk about where we are in this process and some of the priorities for policy frameworks as well as for the management of risks by financial institutions as we move forward. This, I hope, will provide useful inputs for your deliberation and discussion in this conference. The case for greater financial integration ASEAN is home to more than 600 million people and if considered as a single entity, would represent the sixth largest economy in the world with a combined GDP of USD2.5 trillion. According to the OECD, the region is projected to sustain an average annual growth of 5.6%  BIS central bankers’ speeches  1  over the next four years and is expected to be the fourth largest trading bloc by 2050. Concurrently, the standards of living among the general populace will continue to improve. Household purchasing power has risen significantly over the last decade, transforming the region into a thriving hub of consumer demand. The size of ASEAN’s consuming class is expected to double from 81 million to 163 million by 2030. By 2020, Asia is estimated to account for more than half of the total global middle class population, with ASEAN representing more than USD2 trillion of additional consumption within the region. Also, as the sources of economic growth become increasingly domestic-based, this enables many economies to diversify their sources of growth. An important development is the significant increase in intra-regional trade.
Slower growth, tighter liquidity, and heightened risk aversion in mature markets generally mean lower commodity prices, less capital flows, and higher interest rates for EM borrowers - conditions that helped produce some spectacular financial crises in the past dozen years. Not a pretty picture, and one that begs the question of what lies around the corner“. However, if asset shortages story is correct, then upcoming US slowdown (or brief recession according to some non-consensual forecasts) would likely further increase excess saving (as fading growth prospects will discourage investment projects and encourage more private saving amid rising uncertainty, only partly offset by higher public dissaving due to automatic stabilizers), and lower valuation of US equities will make the world supply of assets even more scarce. In such situation US economy having hard times may not necessarily lead to higher risk premia for emerging markets (as it was the case in the past) rather any increase in risk premia would be used by investors to enhance returns, spread compression will continue, and yield curve inversion may even deepen on major markets, and knock the door in some emerging markets 20 . PIMCO seems to subscribe to this possibility, although they do not use asset shortage argument, but they do say: “Local markets investments may provide the greatest divergence of returns within the EM universe, with those “developing” economies furthest along the road to “developed” market status able to enact traditional policy prescriptions in a slowing global economy and therefore providing enhanced return potential to local fixed-income instruments“.

It depends on the importance of imported goods in the consumer price index and on whether lower import prices are passed on to consumers. 5 In the UK in the ten years from 1994 to 2004, the price of imported goods fell on average by one per cent per annum, so the direct effect of this on the consumer price index was quite marked. This shows up in the striking contrast between goods and services consumer price inflation (Chart 3). But the impact of greater competition does not stop with prices. Business tells us that greater competition between companies is encouraging them to protect their profits by cutting costs. This involves control of wage growth and the search for productivity improvements. This has been complemented by greater contestability in the labour market due to both greater migration and the potential for out-sourcing and relocation of production should wage demands become excessive. My view therefore is that the disinflationary pressure from globalisation may well have been more substantial than the direct estimates suggest, and this helps to explain why inflation has fallen throughout the world over the last 15 years from 30% in the early 1990s to about 4% in 2003. 6 This  4  The weight of manufacturing in UK gross value added was 14.7% in 2003. (United Kingdom Economic Accounts, 2006q1).
5  Source: St.meld. 39 (1993-94). 6  Source: For Sweden: Jennergren and Näslund (1998). For Norway: Norges Bank, Moen (2003). 7  See Hoggarth, Reis and Saporta (2002). 8  Peek and Rosengren (2000) look at the loan supply shock facing U.S. firms borrowing from Japanese banks during the banking crisis in Japan. They identify a substantial impact on U.S. real estate activity from this supply shock. 9  See Ongena, Smith and Michalsen (2003) and Vale (2002). 4  BIS Review 58/2003  good advice, but there is a delicate balance between restoring private ownership quickly and trying to recover as much as possible of the government’s fiscal costs. The Norwegian banking crisis was handled swiftly and transparently and at relatively low cost to the taxpayers. Furthermore, the banks that came out of the crisis had trimmed their operating costs and established much better systems to evaluate credit risks. In one respect, we were rather lucky compared to others. The crisis built up gradually, so there was time to assess the situation and strengthen the defences of the financial system before the crisis became systemic. The banks’ equity capital provided the first line of defence and the banks’ collective guarantee funds the second when bank losses started to soar. The third line of defence - the Government Bank Insurance Fund - was only established when it was evident that the first and second lines of defence did not hold, but it was nevertheless established in time.

First, we did our routine work in the money markets of lending to the banking system against high quality collateral, such as government debt, and at Bank Rate set each month by the Monetary Policy Committee. After some initial volatility, we achieved our primary objective in the money markets of bringing interest rates on overnight borrowing into line with Bank Rate. And over the past two months as a whole, overnight interest rates have, on average, been as close to Bank Rate in the UK as in the euro area and closer than in the US. We were, however, pressed to do more than our routine job and to lend in exchange for other collateral, including the financial assets for which the markets had virtually closed. Banks, in particular, said they wanted us to help them turn illiquid assets into cash. As I told the House of Commons Treasury Committee on 20 September, we were cautious about doing this. The case for caution is, in the jargon, moral hazard. Put simply, such action by us encourages the very risk-taking that caused the present problems. It is crucial that, in making their lending and borrowing decisions, banks face the right incentives. That is why we did offer to lend in exchange for illiquid assets but only at a penalty rate of interest. Support on the scale required by Northern Rock would have been difficult to undertake without it becoming “stigmatised” – regardless of the method adopted.