eva srejber : the divorce between macro financial stability and micro supervisory responsibility - are we now in for a more stable life? speech by ms eva srejber, first deputy governor of the sveriges riksbank, at the 33rd economics conference of the oesterreichische nationalbank ( austrian national bank ), vienna, 13 may 2005. * * * introduction i hope i won ’ t disappoint our kind hosts who asked me to deliver this address but i have a confession to make – in sweden, macro financial stability and supervision are not divorced. they have never been married. indeed, it is only quite recently that the riksbank and the fsa ( financial supervisory authority ) have started to acknowledge – operationally in their respective policy frameworks – the link between macro financial stability and micro supervisory issues. whether we just got divorced or are soon to get married, the relationship between financial stability and supervision is highly relevant. i will structure this address in the following way. first, i will give a brief description of how the relationship between supervision and financial stability has developed in sweden. then, i will move on to the financial sector developments that now challenge the ways supervisors and central banks have been working. the process of internationalisation, in general, and cross - border integration, in the eu, will force both supervisors and national central banks to focus on their core tasks and to a certain degree invent new ways to perform those tasks. finally, i will comment more specifically on some of these challenges, and in connection to that also discuss some of the proposed alternative ways of responding to these challenges. the swedish case before the banking crisis in the early 1990s, the cooperation between the riksbank and the swedish fsa ( then the banking inspection ) was limited to high - level contacts. in their day - to - day activities, however, the two authorities worked in different silos – the riksbank with monetary and exchange rate policy and the fsa with regulating and supervising financial institutions. the crisis made it very clear to the swedish authorities that there is a strong link between soundness of financial institutions and macro financial stability, and hence a need for close cooperation between the fsa and the central bank. this economic link is mirrored by a parallel link spanning at least three aspects of regulatory involvement in the financial sector – crisis prevention, crisis management and crisis resolution. in sweden, these aspects of regulatory involvement are shared between the supervisor, the central bank and the ministry of

the issue at some length. in a speech to the economics association in february 1995, for instance, i noted that there are shocks, such as altered indirect taxes and subsidies, which may affect the price level at short notice and cause inflation to deviate from the target. while such effects are usually absorbed inside the tolerance interval, they may sometimes be so pronounced that inflation fluctuates more widely. in such situations it is up to monetary policy to ensure that the deviations from the target do not have permanent consequences for the rate of inflation and inflation expectations. while drastic countermeasures might produce quick results, they would destabilise the economy, which is not desirable. in various contexts i made it clear that monetary policy would be conducted so that price effects from the consolidation of government finances would be left to materialise in the price level. at the same time, it was important to ensure that the transitory effects were, in fact, temporary and did not colour inflation expectations. at that time, however, survey data indicated that the level of inflation expectations was already around 4 per cent. the overall assessment of inflation, based on an unchanged instrumental rate, accordingly pointed to a risk of the inflation target being exceeded as economic activity became stronger. moreover, the high inflation expectations contributed to excessively high wage settlements in the spring of 1995. it was partly this — not the price effects from budget consolidation — that warranted the upward adjustments of the instrumental rate from august 1994 to july 1995. transitory effects again conditioned the rate of inflation during 1996 and 1997 but now in a downward direction via falling house mortgage interest costs. the krona ’ s appreciation, in connection with the rapid enhancement of confidence in budget policy, also tended to lower the cpi. had the riksbank continued to reduce the instrumental rate — after the earlier cuts had had a transitory downward effect on inflation ’ s current rate — it would have tended to destabilise the economy. the riksbank would, as it were, have been chasing its own tail, with interest rate cuts that became increasingly large and frequent. inflation expectations and actual inflation would ultimately have risen, obliging the riksbank to swing to a markedly restrictive stance. as interest rate increases also have transitory effects on inflation, the riksbank would again start to chase its own tail but now in an upward spiral. this illustrates how absurd it would be to raise or lower the instrumental rate as a response to the direct, but