Monetary policy
Stefan Ingves
Monetary policy
implementation with inflation target
The world’s oldest central bank
1668Sveriges Rikes
StändersBank
1661Palmstruch -
first banknotes
1701The Riksbank
issues “transport” notes
1830sCommercial banks
are established
1904Monopoly onissuance of banknotes
1866Sveriges Riksbank
1999New legislation
makes bank independent
An authority under the Riksdag
The Riksdag
The Government Sveriges Riksbank
The Ministry of Finance
The Swedish National Debt Office
Finansinspektionen (theSwedish Financial
Supervisory Authority)
Economic policy
Economic policy
Fiscal policy Monetary policy
The Riksdag and the Government The Riksbank
The Riksbank’s governing
The Riksdag
General Council11 members
Executive Board6 members
The executive board of the Riksbank
Stefan Ingves Karolina Ekholm
Barbro Wickman-Parak
Lars Nyberg Lars E.O. Svensson
Svante Öberg
The Riksbank’s tasks To safeguard the value of money (=price
stability)
- Oversee and analyse monetary stability- Conduct monetary and exchange rate policy measures - Manage the foreign exchange reserve
To promote a safe and efficient payment system - Oversee and analyse stability in the payment system- Responsibility for the RIX system- Ensure the supply of banknotes and coins
CPI-inflation and historical meanAnnual percentage change
Sources: Statistics Sweden and the Riksbank
-2
0
2
4
6
8
10
12
14
16
18
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09-2
0
2
4
6
8
10
12
14
16
18
CPI-inflation
Historical mean
1971-1992Mean 8,3%Standard deviation 3,0%
1993-2009 MarchMean 1,6%Standard deviation 1,4%
Different monetary policy regimes
Source: The Riksbank
0
5
10
15
20
25
30
89 91 93 95 97 99 01 03 05 07 0990
100
110
120
130
140
150
Short term interst rate, 3-monthTreasury Bill (left scale)
SEK measures as TCW (right scale)
Inflation targetFixed exchange rate
Note. The vertical line marks the date for the shift in monetary policy regime, 19 nov 1992.
An independent Riksbank
Up to 1999: Conducted monetary and exchange rate policy.
General Council 4 years
Riksbank Governor 5 years
After 1999: Price stability
General Council 4 years
Executive Board 6 years
The Riksbank’s organisation
Executive Board
Administration Department
IT Department
Internal Audit Department
General Secretariat
Monetary Policy
Department
Market Operations Department
Financial Stability
Department
InternationalSecretariat
Research
Monetary policy theoryWhy a price stability target? Monetary policy can not affect employment in
the long run
Establishing inflation expectations
High and fluctuating inflation increases uncertainty and affects investment
Costly to hold back inflation
High inflation leads to redistribution of income and wealth
One instrument – one target
Inflation expectations by money
market agents Per cent
Sources: Statistics Sweden and Prospera Research AB
-2
-1
0
1
2
3
4
5
94 96 98 00 02 04 06 08 10 12
-2
-1
0
1
2
3
4
5Inflation expectations
CPIJan -95
Nov -05Feb -98
Feb-97
Feb -96
Nov -06
Jan -08
Oct -07
Apr-08
Oct-08Jun-08
Jan-09
Why one to two years ahead?
Uncertainty over the transmission mechanism
Reduce fluctuations in the real economy
Forecasts
6 monetary policy meetings per year (2008)
- 3 Monetary Policy Reports- 3 updated assessments- 2 public hearings before the Riksdag
Committee on Finance
Repo rate with uncertainty bands
Per cent, quarterly averages
Sources: The RiksbankNote. Broken lines represent the Riksbank’s forecast.
0
1
2
3
4
5
6
04 05 06 07 08 09 10 11 12
0
1
2
3
4
5
690%75%50%Repo rate
CPI with uncertainty bandsAnnual percentage change
Source: Statistics Sweden and the RiksbankNote: Broken line is the Riksbank’s forecast
-3
-2
-1
0
1
2
3
4
5
6
04 05 06 07 08 09 10 11 12
-3
-2
-1
0
1
2
3
4
5
690%75%50%CPI
GDP with uncertainty bandsAnnual percentage change, seasonally-
adjusted data
Sources: Statistics Sweden and the RiksbankNote. Broken lines represent the Riksbank’s forecast.
-8
-6
-4
-2
0
2
4
6
04 05 06 07 08 09 10 11 12
-8
-6
-4
-2
0
2
4
6
90%75%50%GDP
20
Optimal monetary policy Within a theoretical framework:
Minimize quadratic forecast loss function
=
, mean inflation forecast at t for period
mean output gap forecast, constant relative weight on output-gap stabilization
* 2 2, , ,0 0
( ) ( )t t t t t ty y
, ,t t t ty y
ttt ,
tL
21
2, ,0
( )t t t ty y
* 2,0
( )t t
B
C
A
0
E
D
Modified Taylor curves (ex-ante) and optimal monetary
policy choice
Estimated inflation and GDP gap
Percentage deviation from the target and HP trend
Sources: Statistics Sweden and the RiksbankNote. Broken lines represent the Riksbank’s forecast.
-5
-4
-3
-2
-1
0
1
2
3
4
5
00 01 02 03 04 05 06 07 08 09 10 11 12 13
-5
-4
-3
-2
-1
0
1
2
3
4
5
Inflation gap (CPI)
GDP gap
23
Production as a Cobb-Douglas function
and
A = Technology, K = Capital , H = Hours worked,
= average hours per worker L = Labour and α = constant
1)(ttttLHKAY
1
ttttHKAY
ttLHH
H
11
ttt
ttLKHAY
Estimated gapsPercentage deviation from the HP trend
Sources: Statistics Sweden and the RiksbankNote. Broken lines represent the Riksbank’s forecast.
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
80 85 90 95 00 05 10
-5
-4
-3
-2
-1
0
1
2
3
4
5
6GDP
Hours worked
Employment
Signalling – influencing expectations Monetary Policy Reports
Policy rates and policy rate forecasts
Minutes of monetary policy meetings
Speeches – clearifying standpoints afterwards, signalling in advance just in exceptional cases
Signalling - Policy rate and 3 month treasury bills
Procent
Source: The Riksbank
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
5,0
97 98 99 00 01 02 03 04 05 06 07 08 090,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
5,0
Repo rate
3 month treasury bill
Summary The Riksbank is an authority under the
Riksdag Reasonably low inflation is beneficial
(target of 2% +-1%) Repo rate change achieves full impact
after 1-2 years Independent from 1999 Openness => a tool that creates
legitimacy
Monetary policy
implementation
Monetary policy repo Repos are implemented weekly
Term of one week Liquidity forecast in the morning Repo announcement on Tuesdays 09.30-
09.45 Allocation at 10.00 Liquidity flow on Wednesday
lending/delivery of collateral Daily fine-tuning operations at 16.20-16.40
Policy rates & deposit ratesPer cent
Source: The Riksbank
0
2
4
6
8
10
96 97 98 99 00 01 02 03 04 05 06 07 08 09
0
2
4
6
8
10Deposit rateLending rateLending overnightRepo rate
The overnight marketIn both examples Bank A and B have two possibilities. 1) They can use the overnight market or2) They can use the standing facilities offered by the Riksbank
Bank A+ 50
Bank B- 50
The Riksbank
1.25
2.75
O/n interest rate
The position of the banking system0
Example 1
Bank A-+100
Bank B- 50
Example 2
The Riksbank
1.25
2.75
O/n interest rate
The position of the banking system0
The overnight market – MPU April-09
In both examples Bank A and B have two possibilities. 1) They can use the overnight market or2) They can use the standing facilities offered by the Riksbank
Bank A+ 50
Bank B- 50
The Riksbank
0.00
0.50
O/n interest rate
The position of the banking system0
Example 1
Bank A-+100
Bank B- 50
Example 2
The Riksbank
0.00
0.50
O/n interest rate
The position of the banking system0
Carrying out the main refinancing operation Calculating the net position of the banking
system Banknotes and coins in circulation +Deposit facility +Other liabilities +Capital ./.Gold and foreign exchange reserve ./.Marginal lending facility ./.Other assets =Net position of the banking system, i.e. the
level of the repooperation or issuing of certificates
Schedule for the main refinancing operation
The Riksbank announces a monetary policy repo or REPOcertificate at 9.30 a.m.
The Riksbank buys The banks tender securities and their bids at 9.45 a.m. transfers funds to the The Riksbank sells at the latest banks (the banks securities and
borrow from the receives the funds The Riksbank Riksbank) plus interest (the announces the allot- banks pay back theirment at 10.00 a.m. loans)
Monday Tuesday Wednesday Thursday Friday Saturday Sunday Monday Tuesday Wednesday
CERTIFICATES The certificates The Riksbank issues mature (the Riksbank certificates (the pays back the loan Riksbank borrows plus interest)from the banks)
The Riksbank steering of the O/N Rate
The position of the banking system, i.e the need for the banks to deposit
at or borrow from the Riksbank
Over Night Interest Rate, %
0Liquidity surplus Liquidity deficit
Repo Rate (2.00) and O/N Rate are within the corridor
Deposit Facility (Floor)
Lending Facility (ceiling)(2.75%)
(1.25%)
Fine tuning Operations +/- 10 bp
The Riksbank is carrying out a repo transaction and the liquidity need of the banking system is placed close to zero
The Riksbank steering of the O/N Rate – MPU April-09
The position of the banking system, i.e the need for the banks to deposit
at or borrow from the Riksbank
Over Night Interest Rate, %
0Liquidity surplus Liquidity deficit
Repo Rate (0.50) and O/N Rate are within the corridor
Deposit Facility (Floor)
Lending Facility (ceiling)(0.50%)
(0.00%)
Fine tuning Operations +/- 10 bp
The Riksbank is carrying out a repo transaction and the liquidity need of the banking system is placed close to zero
Changes in the yield curve when the policy rate is
altered
0,5
1,0
1,5
2,0
2,5
3,0
3,5
repo 3 mån 6 mån 12 mån 2 år 3 år 5 år 7 år 9 år 10 år0,5
1,0
1,5
2,0
2,5
3,0
3,5
Before Monetary policy meeting
After Monetary policy meeting
To sum up The banking system has always the
possibility to deposit or borrow over night at predefined interest rates, thus the overnight interest rate will be between these two interest rates.
In order to stabilise the short term interest rate we carry out different monetary policy operations, above all a weekly repo operation and daily fine tuning.
Monetary Policy Repo Weekly Repo transaction
One week maturity Liquidity forecast in the morning Repo announcement / bids
on Tuesdays between 9.30-9.45 Allotment at 10.00 Settlement on Wednesday
Loan/delivery of securities
Example : Repo operation (cont)
Terms and conditions published on Reuters, tuesdays at 09.30
REPO 070214-070221 FIXED REPO RATE 3.00 %.
ON FEBRUARY 14 2007, THE RIKSBANK SHALL PURCHASE GOVERNMENT SECURITIES AND OTHER VALID SECURITIES FOR RESALE ON FEBRUARY 21 2007.
ALL MONETARY POLICY COUNTERPARTIES ARE INVITED TO SUBMIT BIDS TO THE RIKSBANK (08-6966970) BY 9.45 AM ON FEBRUARY 13 2007, AT THE LATEST.
THE LOWEST ACCEPTED VOLUME IS SEK 200 MLN.
THE HIGHEST ACCEPTED VOLUME IS SEK 5 BLN.
Example: Repo operation
Bidding takes place between 09.30-09.45 Bank A bids 3 billion SEK
Bank B bids 2 billion SEKBank C bids 2 billion SEKTotal bids = 7 billion SEK
Riksbank has forecasted the aggregated liquidity deficit of the banking system to 4 billion SEK on average during the repo period.
The allotment will therefore be 4 billion/7 billion = 0,5714 = 57,14 per cent
Example : Repo operation (cont)
Bank A receives 57,14 % of bidding volume.0,5714 x 3 billion = 1 714 billion SEK
Bank B receives 57,14 % of bidding volume.0,5714 x 2 billion = 1 143 billion SEK
Bank C receives 57,14 % of bidding volume.0,5714 x 2 billion = 1 143 billion SEK
Total amount allocated: 1 714 + 1 143 + 1 143 = 4 000 SEK billion
Example : Repo operation (cont)
Result of repo operation published on Reuters at 10.00
RESULT OF FIXED REPO 070207-070214
FIXED REPO RATE 3.00 %
ACCEPTED VOLUME 4.0 billion
PERCENTAGE ALLOTTED 57.1400 %
DEPOSIT RATE 2.25 %
LENDING RATE 3.75 %
The monetary policy
landscape in a financial crisis
The macroeconomic landscape The financial landscape Regulatory landscape
The inflation target Stability in the payment system
Background to the crisis:The macroeconomic landscape
Global imbalances built up over a longer period of time
Large current account surplus in the east
Large current account deficit in the west Large capital flows and expansionary
monetary policy pushed down interest rates
Current account as share of GDPPer cent
Source: The IMF
-10
-8
-6
-4
-2
0
2
4
6
8
10
12
95 98 01 04 07
-10
-8
-6
-4
-2
0
2
4
6
8
10
12China
Sweden
USA
Background to the crisis:The financial landscape Low interest rates led to hunt for
investment with higher return Increased indebtedness Sharp increase in asset prices Extremely low risk premiums
Securitisation and many new instruments Special companies off the banks’ balance
sheets Implicit and explicit guarantees led risks back
into the banks
Credit spreads* for corporate bonds in the USAbasis points
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2200
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
AaaBaaHigh-yield
*)Difference between corporate bond rate and government bond rate, source Reuters EcoWin
Background to the crisis:The financial landscape (cont.) A complicated structure that was
difficult to gain insight into Much uncertainty over where risks lay Fears caused trade to fade away on
many markets Many banks experienced difficulty
refinancing themselves When Lehman Brothers fell Swedish
banks were also indirectly drawn into the crisis
Background to the crisis:The financial landscape (cont.) Fundamental failures in risk management
The banks’ incentives to monitor credit risks partly disappeared
The credit rating agencies’ models were inadequate and credit ratings were used wrongly.
Correlations were underestimated Liquidity risks were underestimated Risks were priced incorrectly
Fundamental flaws in corporate governance
Background to the crisis:the Regulatory landscape Gaps in the regulatory framework enabled
regulation arbitrage Investment banks OTC derivatives Banks could expand off balance sheet
Too little focus on liquidity risks Insufficient links between supervision and
macro factors and systemic risk factors respectively
Too strong national focus in financial supervision
Massive and unusual measures by authorities Large increase in lending by central banks
Longer maturities, different collateral Special liquidity assistance to individual
institutions Agreements on currency loans between
countries Extended deposit guarantee Programme for guarantees and capital
injections Large policy rate cuts
How monetary policy normally functions The transmission mechanism
The transmission mechanism Interest rate channel Credit channel Exchange rate channel Inflation expectations
Financial markets are not functioning normally => transmission mechanism becomes less effectives
Monetary policy and financial stability The Riksbank has two
main tasks: Monetary policy and financial stability
Normally separate tools are used for these tasks
During the crisis it has become increasingly clear how closely interwoven the two tasks are.
Monetary policy
Financial stability
Policy rate etc.
”Moral suasion”Inject liquidityetc.
Monetary policy and financial stability are interlinked:
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Monetary policy in a financial crisis Interest rates close to zero in many
countries When the traditional monetary policy
tools are no longer effective it is necessary to find new ways
”Unconventional methods” Different ways of making the financial
markets function better Improve the supply of credit
Unconventional monetary policyA stylised balance sheet for a central bank
Assets Liabilities
Foreign assets Banknotes and coins
Domestic assets Bank deposits
Lending Equity
Central banks’ balance sheetsPercentage of GDP
Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics, Statistics Sweden and the respective central banks
0
5
10
15
20
25
jan-07 apr-07 jul-07 okt-07 jan-08 apr-08 jul-08 okt-08 jan-09
0
5
10
15
20
25ECB
BOE
Federal Reserve
The Riksbank
The Riksbank’s balance sheet on 30 June 2008 (prior to Lehman Brothers crash)
Assets Liabilities
Gold 26 Banknotes & coins
108
Foreign currency reserve
158
Fine-tuning 0
Lending USD 0 Riksbank Certificates
0
Lending SEK 4 Liabilities to Fed 0
Other 4 Equity 59
Other 25
TOTAL 192
TOTAL 192
The Riksbank’s balance sheet on 31 Dec 2008 (after Lehman Brothers crash)
Assets Liabilities
Gold 30 Banknotes & coins
112
Foreign currency reserve
200 Fine-tuning 207
Lending USD 196 Riksbank Certificates
49
Lending SEK 262 Liabilities to Fed 189
Other 7 Equity 59
Other 84
TOTAL 700 TOTAL 700
Monetary policy measures The banks’ access to means of
payment is increasing The monetary base (the banks’
reserves + banknotes and coins in circulation) is increasing
The Federal Reserve and the Bank of England have gone a step further than the RB and bought different types of domestic financial assets
Monetary baseSEK billion
Source: The Riksbank
0
50 000
100 000
150 000
200 000
250 000
300 000
350 000
400 000
jan-08 apr-08 jul-08 okt-08 jan-09
0
50 000
100 000
150 000
200 000
250 000
300 000
350 000
400 000The banks' holdings of Riksbank certificates
The banks' deposit at the Riksbank
Banknotes and coins in circulations
Credit easingFederal Reserve: Purchase of certain private financial
assets Aimed at
reducing risk spreads making it easier for companies and
households to gain access to credit Focus on the asset side of the balance
sheet
Quantitative easingBank of England: Purchase of government securities Focus on the liabilities side of the
balance sheet Instead of the price, i.e. the policy
rate, the quantity of the banks’ borrowing, the monetary base, is affected directly
Quantity equation:
YPVM
Unconventional measures Both Quantitative Easing and Credit
Easing are only used under special circumstances
The situation is new for most central banks
It may be wise to exercise a good portion of humility with regard to what these measures entail
Are similar measures needed in Sweden? We do not know yet Inflation expectations and the
credibility of the inflation target are crucial
The Riksbank’s established monetary policy framework is a strength
The Riksbank does what is necessary, when it is necessary
How do we prevent crises in the future?By bursting bubbles with interest rate
policy? Difficult and important question, but
not easy to reach a general conclusion In one way or another, substantial
increases in asset prices will affect monetary policy in the future
However, probably more important to have suitable rules and supervisory functions for financial companies
How do we prevent crises in the future?Financial supervision functions?National level: Important to have coordination between the
Riksbank and Finansinspektionen (Swedish financial supervisory authority)
International level – de Larosiére group: European Systemic Risk Council (27 central
banks + ECB) monitoring systemic risks Supervisory committees in Europe
strengthened A step in the right direction – and not a day
too soon!
How do we prevent crises in the future?
A Taylor rule for capital adequacy?
Knut Wicksell (1898):
i
The Taylor rule for monetary policy
YYri tYtttt **
A ”Taylor rule” for capital adequacy
YYLLcc tYtLt *
The link between monetary policy and financial stability
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Concluding reflections Financial crises are nothing new The scope and complexity of this
crisis makes it more serious than previous crises
Deglobalisation in the wake of the crisis is worrying
We must find tools to attain a more balanced development in the future
How do we ensure that confidence is restored? The international banking system
requires a purge All problems must be brought to light Only when we see the scope of the
losses can confidence be restored This is a more difficult process than
during the Swedish bank crisis of the 1990s
Meanwhile the Riksbank is prepared to do whatever is necessary!