cecilia skingsley : a new playing field for monetary policy – what can a small, open economy expect? speech by ms cecilia skingsley, deputy governor of the sveriges riksbank, at kammarkollegiet capital market day, stockholm, 19 may 2016. * * * i would like to thank mikael apel for his help in writing this speech, goran katinic for help with the diagrams and claes berg, hans dellmo, gabriela guibourg, ulf soderstrom and anders vredin for useful comments. any remaining errors are strictly my own responsibility. as difficult as it is to believe today, it was only ten years ago that monetary policy was considered to be a relatively straightforward and uncomplicated business. it was assumed that essentially all that the central bank needed to do was to set the policy rate so that inflation ended up close to the target at the same time as production and employment developed in a satisfactory manner. there was a widespread perception that the central banks had finally gotten a grasp of how monetary policy should best be conducted, and this, it was assumed in turn, was an important explanation for the “ great moderation ” – the fairly long period of unusual macroeconomic stability that preceded the financial crisis. how different the situation is today. conducting monetary policy is now rightly seen as anything but easy by both central bank representatives and economic analysts in general. despite heavy monetary policy stimulation, inflation is far below target in many countries and the recovery from the global financial crisis is still going slowly in most places after seven or eight years. a number of central banks have been forced to switch to conducting monetary policy by other means than policy rate adjustments, as this rate has now been cut as far as is deemed possible. monetary policy seems to have lost its magic touch, at least for the time being. today, i intend to describe a few reasons for why it has become more difficult to conduct monetary policy than in the period prior to the global financial crisis. i also intend to describe which further tools monetary policy decision - makers will need to consider if these difficulties persist. in between, i also intend to give my view on how much room for manoeuvre a small country has to deviate from developments in large countries and their monetary policy. low global level of interest rates in recent decades, the level of interest rates has shown a falling trend, both in sweden and internationally ( see figure 1 ). long - term

real interest rates, which is to say nominal interest rates minus inflation, have fallen by about 4. 5 percentage points around the world over the past 30 years. the reasons for the downturn are not fully understood. one example of an explanation is that global saving has increased in recent decades due, for example, to demographic factors, at the same time as investments have decreased due, for example, to a falling relative price for capital and lower public investments. 1 see rachel and smith ( 2015 ). bis central bankers ’ speeches figure 1 low interest rates in sweden, germany and the united states note. yields on 10 - year government bonds. source : macrobond. in that the level of interest rates is lower today than it was previously, central banks ’ room for manoeuvre has decreased. it has become more difficult for them to stimulate the economy when economic activity is weak or inflation is below target. this is partly because when the level of interest rates is low, policy rates are also low, on average. this reduces scope for cutting the policy rate, as this cannot be decreased indefinitely but will reach its lower bound more frequently. 2 a low nominal interest rate situation will also reflect the low level of inflation. all other factors being equal, when average inflation is low, it is more difficult to achieve the really low or even negative real interest rates that are sometimes needed to stimulate the economy. reduced lower boundary for the policy rate and unconventional monetary policy have increased scope for action in principle, the central banks have managed the reduced scope for action in two ways. some central banks, including the riksbank, have cut their policy rates to below zero, which had previously been generally perceived as the lower bound. in the wake of this, a fairly intense international debate has started on the advantages and disadvantages of negative interest rates, in which certain debaters are positive and others almost paint doomsday scenarios. this debate has been somewhat overblown. it seems reasonable to assume that negative interest rates are less problematic to implement and function better in certain countries than in others, depending, for example, on the degree of cash usage. the theory here is that, at a certain interest rate level, probably negative, deposit customers will start to withdraw their money. at this interest rate level, it could thus be said that interest rate stimulation will cease. if the banks are unwilling to cut their deposit rates below zero, their the bank of canada estimates that the real neutral interest rate fell from about