Riksbank’s Ingves weighs post-crisis policy legacy

The inadequacy of monetary policy as a macro-prudential tool, difficulties in explaining ultra-loose policies and falling cash usage have shaped Sveriges Riksbank’s post-crisis decade, said governor Stefan Ingves.

On October 15, the governor reflected on these developments in a speech at the Money Macro and Finance Research Group in London.

Ingves first analysed the use of interest rates as a macro-prudential mechanism to prevent the build-up of financial imbalances in Sweden. The governor pointed out the Riksbank was the first central bank to make monetary decisions based on macro-prudential considerations. In fact, in the aftermath of the crisis, it also became the first institution to abandon so-called leaning against the wind due to consistently below-target inflation.

“Most people agree that monetary policy should not have the main responsibility for preventing financial imbalances,” said Ingves. Nonetheless, he did “not believe it is possible to completely ignore financial stability when conducting monetary policy”.

Up until 2014, the Swedish central bank steered the policy rate in order to tame fast growth in household debt and house prices. “To help dampen this development, the repo rate was therefore set slightly higher than would otherwise have been the case,” said Ingves.

However, rate-setters abandoned this policy due to its incompatibility with the inflation target. During the first half of 2013, the average of inflation forecasts placed inflation around 1.5% in 2014. But actual year-on-year price increases were almost one percentage point lower, 1.5 percentage points below the 2% target. Inflation remained below target for an extended period. By mid-2014, annual inflation had been continuously below target since 2010.

“A risk began to build up that the role of the inflation target as benchmark for price-setting and wage formation would begin to weaken,” Ingves said. As a result, in December 2013, the Riksbank started to cut the policy rate, down to a low of –0.50% in February 2016. Additionally, it also began a quantitative easing programme through which it purchased a considerable amount of government bonds in relation to the size of the sovereign debt.

“This, of course, did not mean we ceased to concern ourselves with the problems associated with debt and housing prices,” said Ingves. “Throughout this entire period, we have highlighted this development in our communication as a significant risk in the Swedish economy that needs to be dealt with, but that we do not have the scope to address under the prevailing circumstances.”

Communications challenge

The implementation of these ultra-loose policy measures boosted growth and employment. Inflation also increased, but it has barely reached the target. This mixed result has created a communications challenge for the central bank.

Low inflation has forced the Riksbank to maintain negative rates and a larger balance sheet despite an otherwise solid backdrop of macroeconomic fundamentals. This has stoked criticism from external analysis and journalists, and has been a common source of disagreement among rate-setters.

“Perhaps the debate has been livelier and monetary policy more brought into question than in many other countries with similar frameworks,” acknowledged Ingves.

Other central banks have adopted a similar policy mix, most notably the European Central Bank. In the eurozone, too, these measures have also been met with criticism in some member states, such as Germany and the Netherlands.

However, Ingves pointed out that there is an important difference between both central banks. In the eurozone, “the expansionary policy has been motivated not only by low inflation but also by relatively weak developments in the real economy in the euro area as a whole”.

In order to address the challenges derived from the use of exceptional tools, the governor thought it would be useful, as currently happens in Canada, to periodically review the central bank’s policy remit and its targets. “This would create better understanding and legitimacy for the monetary policy conducted and clarify that the central bank actually only performs the remit it has been given,” Ingves said.

Declining cash usage

Over the last decade, Sweden has recorded a sharp decrease in the use of cash as a means of payment. This could have very meaningful repercussions for monetary policy, warned the governor.

In the Riksbank’s 2018 report on payment patterns, the share of respondents saying they had used cash for their last purchase declined to 13%, down from 40% in 2010. This was one factor that prompted the central bank to start studying the possibility of issuing a central bank digital currency, the e-krona.

One of the main factors behind the study is the fact that if cash were to disappear, “all means of payment available to the general public [would be] issued by private actors, on a payment market that is highly concentrated,” said Ingves. “This could make it more difficult for the Riksbank to perform its remit of promoting a safe and efficient payment system.”

Nonetheless, the introduction of an e-krona would deeply affect monetary policy, regardless of whether this would be interest-bearing or not. In the latter case, the e-krona would be similar to cash. But it would also hamper the central bank’s efforts to reduce the key policy rate deep into negative territory.

In contrast, if it were to bear interest, “the zero bound would then no longer constitute a restriction as the yield of the e-krona itself could be negative”, said the governor. “Furthermore, if physical cash were to be entirely phased out, the policy rate could instead be taken much further into negative territory than today.”

This could potentially increase the effectiveness of monetary policy. However, it would not eliminate communication challenges, as “it would probably be met by significant resistance from economic agents”, concluded Ingves.