stefan ingves : monetary policy and financial stability – some future challenges speech by mr stefan ingves, governor of the sveriges riksbank, to the swedish economics association, stockholm, 17 may 2010. * * * every once in a while, developments take a course that turns old truths on their heads and forces new solutions. this is what happened in sweden in conjunction with the economic crisis at the start of the 1990s, when the policy of a fixed exchange rate reached the end of the road. at that point, we were lucky enough to be able to change track and become one of the very first countries to start to apply an innovation in the field of monetary policy – inflation targeting. in much the same way, the financial crisis, not yet a completely closed chapter, has come to function as a catalyst for reassessment and renewal – not just at home this time, but also on an international level. the spotlight has primarily been focused on the work of maintaining financial stability – but the crisis has also raised the issue of whether there may be lessons to be learned for monetary policy too. today, i plan to discuss some of the challenges that i believe central banks will face in the future. these challenges exist both in the work on financial stability and in the field of monetary policy – and in the borderland between the two. indeed, developments in recent years have demonstrated that monetary policy and financial stability, in many ways, are more intimately connected than we may previously have imagined. one of the challenges i intend to address today deals with the difficulty of assessing the effects on potential output and growth of the financial crisis and the regulations following in its wake. another challenge concerns the impact of these regulations on monetary policy ’ s transmission mechanism. finally, i will also discuss the possibility of preventing a credit - driven property boom. one highly current and significant challenge is that of preventing the central government finance problems primarily facing greece, but also a number of other countries, from leading to new problems on the financial markets. the solution to this must primarily be sought on the international political level. this is a matter both of implementing measures to maintain confidence and of solving the most acute problems. the comprehensive support package for countries with serious budget problems, recently presented by the eu countries and international monetary fund, should be considered one such measure. of course, a more lasting solution will also require the problem to be tackled at its root – for the regulatory framework for central government finances to be reviewed so that similar situations can

explicit supply limits. however, today i have decided to discuss loan - tovalue and amortisation requirements in terms of a “ shadow interest rate ” in order to illustrate the connection between quantitative regulations and monetary policy. rather than regulations, an economist may be more used to thinking in terms of pigovian taxes as regards handling negative external effects. pigovian taxes are common within the area of environmental regulation, where they can, for example, take the form of fuel taxes in order to put a price on the negative environmental effects of traffic. in the same manner as these taxes attempt to put a price on the environment, it is possible to imagine using a pigovian tax, based, for example, on the banks ’ lending, to price – or internalise – negative external effects associated with banking. as the banks would pass at least a portion of such a tax on to their customers, the effect of this tax on the borrowing rate would be equivalent to an increase of the interest rate margin. sweden recently introduced a stability charge to be paid by the banks. this charge is intended to finance a stability fund to act as a central government financial buffer for the costs that may arise in a financial crisis. at present, the stability charge is not riskdifferentiated. a charge that is risk - differentiated in an appropriate manner to provide the banks with the incentive to redistribute their activities depending on risk could be seen as a type of pigovian tax. it could also be imagined that pigovian taxes could be used to attempt to correct the crossborder external effects that may arise in an increasingly integrated european banking market. one example is the swedish banks ’ lending activities in the baltic which have probably entailed a liquidity risk in foreign currency in sweden. the presence of a liquidity risk reduced confidence in the swedish banking system in general and led to a disruption to the swedish financial system. if the banks had internalised this liquidity risk, lending in the baltic would probably have been less extensive. one circumstance that may be worth taking into account here is that the credit market, in practice, is not entirely homogenous. one distinction that can be made is to view the credit market as being divided into a corporate market and a household market. in the recent period in sweden, we have seen ample evidence of the great variance in developments between these two sectors ( figure 9 ). figure 9 lending to companies and households percentage of gdp lending to companies lending