samchain/econo-pairs-v1 huggingface dataset:
Urban Bäckström: Perspective on the inflation target Speech by Mr Urban Bäckström, Governor of Sveriges Riksbank, to the Swedish Economics Association, Stockholm, 17 April 2002. In the work on this paper I have been greatly assisted by Claes Berg, Anders Borg, Jörgen Eklund, Staffan Viotti and Anders Vredin. I am also grateful for valuable comments from members of the Executive Board and other colleagues at the Riksbank. At the same time, I am solely responsible for any remaining errors and shortcomings, as well as for the opinions expressed here. The references for the speech can be found on the Sveriges Riksbank’s website. *  *  *  First I want to express my thanks for the invitation to attend your Association and discuss various aspects of the Riksbank’s assignment. I truly look forward, in keeping with recent years, to a dialogue on economic policy issues both with my two opponents and with other scholars and students in this Association. The theme for today’s discussion, “Perspective on the Inflation Target”, has led me to take the past year’s increase in the rate of inflation as my starting point. To many forecasters, including those of us at the Riksbank, the increase has come as a surprise. This may raise questions about the intellectual framework, which rests on forecasts, for monetary policy’s formation.

Against this background, most central banks aim for a reasonable compromise between these two extremes. They strive to fulfil the inflation target in the medium run by being forward-looking and accept the occurrence of limited deviations (downwards as well as upwards) in the short term. A monetary policy that acts on current inflation is by definition not forward-looking. Similar arguments apply to a strategy whereby the central bank is guided by nominal GDP outcomes, a question that was discussed last year in this Association. Besides the disadvantages I just mentioned from not looking ahead, a nominal GDP strategy has the drawback that the national accounts frequently have to be revised. Whereas the CPI figures are mostly definitive when they are first published, the GDP outcome data are often changed substantially, sometimes after an interval of several years. The relatively long time lag before monetary policy affects the economy makes it necessary to accept that inflation will sometimes deviate from the target. The alternative would be marked fluctuations in employment and output. This is clear from what happens when one of the Riksbank’s models is run with a monetary policy for correcting inflation quickly. We assume that the rate of inflation suddenly rises from 2 to 3 per cent and the Riksbank immediately tries to counter this by raising the repo rate in a single step of between 4 and 5 percentage points.
On this basis, it can decide to transfer to direct supervision any bank or group of banks that may be considered relevant or the origin of systemic risk. This incorporates the lesson of the crisis that not only big banks can be the source of general financial instability. The SSM’s micro-prudential role will also be complemented by extensive macro-prudential powers. Unifying micro- and macro-prudential powers within the central bank aligns practice in the euro area with that in most other advanced economies. The Bank of England, for instance, will have the Prudential Regulation Authority for micro- and the Financial Policy Committee for macro-prudential issues. And there are in fact additional reasons for doing this in a multi-country monetary union like the euro area, as the level of the main interest rate may not be appropriate for all countries at all times, meaning macro-prudential tools play an important role as a “counter-weight”. A final point to note about the SSM, according to its Regulation, is that its launch will be associated with a comprehensive review of participating banks’ balance sheets. The objective of this review is to identify legacy problems and start with a system that avoids reputational risks for the SSM down the line. This process may have financial implications if impaired assets have to be written down. And this is a further reason why having a Single Resolution Mechanism in place for participating countries is a matter of urgency.

Had a single European supervisor existed prior to the crisis, it could have spotted the unsustainable growth in private sector debt and the excessive leveraging of banks’ balance sheets associated with it – and hopefully taken early preventative measures. Mitigating the crisis What about the role of Banking Union in mitigating the crisis? Here I can see two key ways in which it would have been instrumental. First, it would have lessened the so-called “bank-sovereign loop” that drags down the fiscal sustainability of sovereigns. This loop is driven by bank bailouts or just by the expectation that sovereigns will have to bail-out struggling banks, which then increases borrowing costs for sovereigns and further drives up funding costs for banks. A Single Resolution Mechanism would avoid this by resolving banks rather than saving them and by making the private sector rather than the taxpayer pick up the bill. Moreover, any residual fiscal burden on sovereigns would be distributed across the euro area through the common fiscal backstop. Second, a Banking Union would have reduced the fragmentation in financial markets that holds back bank lending and economic growth. At present, market fragmentation is severely disrupting the transmission of the ECB’s monetary policy. In some countries, changes in our main interest rate are being passed on fully by banks; in others, because bank funding is  3  2  Schoenmaker, Dirk (2011): “The Financial Trilemma”, in Economics Letters, 111 pages 57–59. BIS central bankers’ speeches  tight, interest rate changes are being passed on hardly at all.
Intermediaries – safety and market conduct I turn now to the next key component in the capital markets ecosystem – intermediaries. The objective of regulation with respect to capital market intermediaries is twofold: their safety and soundness, and market conduct. Safety and soundness We want intermediaries to be safe and sound, in the interest of preserving systemic stability. Intermediaries connect the various parts of the capital market ecosystem. They stand between buyers and sellers, underwrite risks, act as counterparties in risk transfers, and participate as members of clearing houses. The failure of a major intermediary can transmit risks across the system, causing severe market disruption and undermining confidence. Lest we forget, Lehman Brothers was principally a securities firm, not a bank. MAS regulation cannot rule out the failure of an intermediary. But we can seek to ensure an orderly winding-down process. The segregation of customers’ funds from the intermediary’s own funds is a key feature of our regulatory regime. Unlike banks which can freely deploy the deposits they collect, capital market intermediaries are required to segregate customers’ assets from their own monies. This acts as a safeguard for customers’ funds should the intermediary fail. Fund managers are required to appoint independent custodians and fund valuation firms, and be subject to regular audits. 6  BIS central bankers’ speeches  Market conduct The second regulatory outcome we expect from intermediaries is fair conduct.

MAS is fully engaged in the OTC work of the FSB, the International Organisation of Securities Commissions, and the Committee on Payment Systems and Settlements. We will fully implement the OTC derivatives reform agenda. There must be consistency in implementation across jurisdictions, but there cannot be precise equivalence. The OTC derivatives landscape in Asia and Singapore differs considerably from that in the US and Europe. We have smaller markets and less complex derivative instruments. We have to consider how to implement the G20 reforms effectively while taking into account enforcement issues and the characteristics of our markets. MAS will consult the industry on its proposals for OTC derivatives market reforms by the end of this year. We aim to meet the G20 target to implement the reforms by end-2012. 8  BIS central bankers’ speeches  Conclusion – shared responsibility Let me conclude. In regulating capital markets, we are not dealing with a particular industry or a particular type of institution. We are trying to create the conditions within what is essentially an ecosystem, so that its risks are managed and its economic benefits sustained. But these benefits cannot be achieved by regulation alone. As Winston Churchill puts it, “If you have ten thousand regulations you destroy all respect for the law”. There is a limit to how far regulation can go without undermining compliance, not to mention efficiency and innovation. All components of the capital market ecosystem must play their part. A well-functioning capital market is a shared responsibility.
It should come as no surprise to anyone that the conditional nature of the decisions, which has always been a significant feature of ECB monetary policy practice, should take on particular significance in the current setting of particularly high global uncertainty. Hence in the coming months the main channels through which financial shocks could affect the European economy will have to be monitored very closely. In my opinion, three factors require particular attention. First, it is necessary to gauge the true extent of the US slowdown, its possible spread to the world economy and the possible impact on exchange rates. Second, at the European level, the effect of the turbulence on the cost and availability of financing for the private sector will have to be calibrated. Finally, the possible impact on corporate and consumer confidence will have to be monitored carefully. The signs identified in these latter two channels, i.e. credit and economic sentiment, will be particularly informative for euro area economic growth when they affect countries in which consumption growth is still somewhat hesitant. I also believe that, echoing the words of the ECB President after the Governing Council meeting, this is an appropriate time to reiterate the firm commitment of monetary policy to the objective of price stability, which is the best way to promote the sustained growth of output and employment and thus the welfare of European citizens in general and of Spaniards in particular.

In this case, the gradualness of the residential investment slowdown was made possible by the support provided by strong housing demand, against a backdrop of high demographic momentum in the Spanish economy in recent years. The lower contribution to growth of these two domestic expenditure components was offset, first, by the continued buoyancy of productive investment of firms, in a situation of high profitability and favourable business expectations due to the continued momentum of domestic demand and, above all, to the surge in the world economy. In particular, capital goods investment in 2006 grew by more than 10% and in recent quarters its rate of expansion has been around 13%. Furthermore, net external demand has helped to mitigate the impact of the slowdown in household spending on growth, thanks to the notable recovery of exports in 2006 and to the moderation in imports in the first half of this year. The most probable scenario for the coming months is the continued gradual moderation of domestic demand and of output growth. In fact, there were signs in 2007 Q2 that might suggest a gradual change to a more subdued growth path, although GDP growth was only 10 bp less than in the first quarter of the year. The information (still very partial and fragmentary) of certain economic indicators relating to 2007 Q3 also points in this direction.
Changes in these prices provide little information about inflationary pressures in the economy. Therefore, some central banks focus on an underlying measure of inflation. This may be the consumer price index excluding prices that fluctuate most, or measures such as the trimmed average or the weighted median. While the purchase and sale of a dwelling is an investment, the advantage we derive from using the dwelling – shelter services – is part of consumption. Therefore, the price of shelter services should be included in the consumer price index. However, this is a price that cannot be observed and is difficult to measure. Consequently, some central banks completely disregard shelter services. New Zealand uses an index for construction costs, while Iceland includes the market value of resale homes. As a rule, the price of shelter services will increase when the interest rate rises. All central banks disregard the direct effect of interest rates on the price of shelter services. This is also the case at Norges Bank. In very open economies, inflation may fluctuate somewhat without prompting fluctuations in domestic output and employment or leading to changes in inflation in the medium term. In such economies, it may be appropriate therefore to accept somewhat wider fluctuations in inflation. Which prices to include in the price index is a topic of discussion.

28-29 March, BIS, Basle. 13 Heikensten, Lars (2005), “Introduction on Monetary Policy” speech to the Committee on Finance, Swedish Parliament, Stockholm, 15 March. 8  BIS Review 43/2005
For example as we move closer to ending too big to fail, and with standardised compensation schemes for retail depositors, one could reasonably ask why we need the same degree of regulation at all? Has the cost of providing credit to the economy been increased? Will the reforms restrict competition and innovation? Have capital markets been rendered dysfunctional? It is possible that there are degrees to which all these questions might have positive answers. But against that, the consequences of the Great Financial Crisis were so large, so negative for millions of people around the globe in terms of unemployment and reduced incomes, that more regulation, in every direction has been a necessary response. Over time one may learn where the reforms can be eased, where they  12  Bank of England/FCA/HMT, June 2015. “Fair and Effective Markets Review”. BIS central bankers’ speeches  11  need to be tightened, or whether other policies need to be introduced to offset any unwanted side effects. Let me re-state what has been said before – the authorities generally, including regulators, do not want the stability of the graveyard. We want successful, profitable, privately owned firms operating in the best interests of the global economy to support sustainable growth. The regulation of the financial services sector has to be aligned with that. But just as we don’t want growth generated by firms causing excess pollution, nor do we want it sustained by financial firms that take excessive risks with other people’s money.

Separately, in November 2014, the FSB announced an international agreement on the minimum amount of Total Loss Absorbing Capital (TLAC) to be held, covering all globally significant banks. The motivation and concept of TLAC are very similar to MREL. As the details of the TLAC proposals are finalised, the two should become consistent, with MREL being the mechanism by which European resolution authorities ensure that their Global Systemically Important Banks (GSIBs) all meet the TLAC standards7. More generally, as the PRA develops its detailed rules to implement regulatory reforms, resolvability is a key consideration at each stage. In many cases the precise formulation of a rule will reflect the effects it has on the ease of resolvability. A particular example of this is the rules on ring-fencing which we will now come on to. Structural reform Structural reform is the general term for the changes being pursued to implement ringfencing as originally proposed by the Independent Commission on Banking in (2011). What structural reform intends to achieve is basically to separate out and “ring-fence” into different legal entities, the activities of retail banking from the activities of investment banking. The distinction is set with some flexibility to reflect different business models: retail deposits and payments must be inside the ring fence, and any active trading units must be outside, whereas corporate lending, for example, could be in either. The rules will only apply to banks with core deposits over £ (broadly those from individuals and small businesses).
The Bank can set only one interest rate – the interest rate on Bank of England money. This interest rate affects every region, every sector, every company and every individual that uses Bank money. In practice, this means pretty much everyone in the UK. In other words, monetary policy affects the fortunes of the whole of the UK economy and it does so equally. The Bank cannot set a different interest rate for the steel and the shipping industries, for Port Talbot and Portstewart, for Wales and West Lothian. If monetary policy is singular, does that imply it should be set in a way which is single-minded? In other words, should monetary policy focus only on the economy-wide picture, taking no account of developments across different sectors or regions, income and age ranges, savers and borrowers? My answer to that, quite different, question is a resounding no. That is for four distinct reasons. First, we know that official data on the economy are noisy and mis-measured. They also often fail to capture fully some areas of economic activity – for example, sectors of the economy that are either rising rapidly (such as the digital economy) or contributions that fall outside of the National Accounts framework (such as volunteering). Forming a picture of the whole economy from official statistics is rather like doing a jigsaw puzzle with half of the pieces missing and the other half slightly water-damaged.

Chart 15 plots real household disposable income per head across households grouped into five income categories. Because household spending differs materially depending on someone’s income – for example, poorer households spend proportionately more on food and energy – we deflate the income of each group using a price index which reflects their different spending patterns. Chart 15 paints a fairly reassuring picture. In general, lower income groups have fared somewhat better than higher income groups since the crisis: the lowest income quintile has seen disposable incomes rise by around 5% since 2007, while the highest quintile has seen income fall by around 5%. Those in the bottom half of the distribution have seen incomes rise since 2007, while those in the top half have seen them fall. This reflects the impact of the benefits and pensions system in supporting lower income households. As a result, the distribution of incomes across the UK has probably narrowed a little since 2007. Income inequality has, if anything, fallen. That means, when we look at measures of social welfare aggregated across different income groups, we find it has not performed very differently than aggregate real disposable income since the crisis (Chart 16). These patterns of gains and losses are, however, very different when we turn to wealth. Chart 17 plots the distribution of wealth gains since 2010 across income quintiles. It suggests a dramatically uneven pattern. Those in the bottom two-fifths of the income distribution have seen virtually no gains in their wealth since 2010.
To open what I hope will be a day of thoughtful and lively discussion, I would like to share a few thoughts on today’s three topics, in my capacity as both member of the ECB’s Executive Board and Chair of the Committee on Payments and Market Infrastructures (CPMI). Global CCPs require enhanced cooperative oversight across borders Let me begin with the challenges we face in regulating and overseeing global cross-border clearing activities. As the clearing landscape evolved after the crisis, some derivatives markets became highly concentrated. Major markets are now cleared through a few global CCPs, which, as a result, have become systemically important for multiple jurisdictions besides the one in which they are headquartered.2 If not managed appropriately, risks channelled through these CCPs could spread rapidly across borders with potentially destabilising effects for financial markets more widely. For example, for many EU CCPs, including the most important clearing hubs, over two-thirds of the derivatives transactions they clear are submitted by financial institutions incorporated outside the CCP’s home Member State. Credit risks and potential losses are thus borne mainly by financial institutions in other EU or non-EU countries, and –once bank shareholders and creditors have been bailed in – taxpayers in those countries may ultimately have to foot the remaining bill. For this reason, market authorities, prudential supervisors and central banks have a keen interest in other countries complying with the highest financial and operational CCP risk management standards. They rely on home authorities to carry out prudent due diligence.

It means that any potential risks emerging from the introduction of a digital euro should be contained in both normal times and times of financial stress. We have been discussing these aspects in detail over the past few months. We are looking very closely at the risks to monetary policy transmission and financial stability that could be associated with the conversion of large parts of euro area bank deposits into digital euro. Deposits represent the main source of funding for euro area banks today. [14] If not well designed, a digital euro could lead to the substitution of an excessive amount of these deposits. Banks can respond to these outflows, managing the trade-off between funding cost and liquidity risk. [15] The attractiveness of commercial bank deposits will also influence the degree of substitution. But any undesirable consequences that may result from the issuance of digital euro for monetary policy, financial stability and the allocation of credit to the real economy should be minimised in advance by design. And it is indeed possible to design a digital euro with effective tools to prevent it from being used as a form of investment rather than solely as a means of payment. One such tool entails quantitative limits on individual holdings. [16] Another involves discouraging its use as a form of investment by applying disincentivising remuneration above a certain threshold, with larger holdings subject to less attractive rates.