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The long-anticipated independent review of the Riksbank that was published on 19 January offered a number of harsh criticisms of the bank and suggestions on monetary policy. The Riksbank was heavily criticised for its repo rate adjustments in recent years and the review recommended that the Riksbank’s inflation target should no longer focus on the headline inflation rate, but on core inflation. Furthermore, the Riksbank’s responsibilities should be more clearly defined, and the inflation target itself should no longer be set by the central bank but by the Riksdag. And finally, the Riksbank should have the ability to miss its inflation target, if it deems that stabilising the economy is more important.
Since the global financial crisis in 2007-09, the performance of the Riksbank, the world’s oldest central bank, has been attracting significant interest among central banks and economists worldwide due to its policy responses and a brush with deflation. Following the crisis, the Swedish economy had started to recover quickly and interest rates, having been cut sharply during the crisis, were raised in 2010 – 2011, mainly due to worries over high levels of household debt. Subsequently, this tightening of monetary policy proved highly controversial and was criticised by the by the likes of Nobel Laureate Paul Krugman, the United States Federal Reserve chair, Janet Yellen. as well as members of the Riksbank board. The board was deeply divided over the policy and – uncharacteristically – aired their grievances in media.
The Riksbank’s 2 per cent inflation target has served as its established goal since 1994. However, the primary measure for total inflation, Sweden’s CPI (Consumer Price Index), has been stuck at zero for many years now. To change this, the Riksbank has taken to increasingly desperate measures. In 2015 the repo rate was reduced below zero and the Riksbank bought government bonds to provide the government with more spendable cash. At the beginning of 2016, the Riksbank also announced that it was prepared to intervene on the foreign exchange market, signalling that it was prepared to weaken the krona by the direct purchase of foreign currency. In spite of these unprecedented attempts, the lacklustre inflation rate has proven unmovable. Furthermore, the effects of this strategy are gradually creating significant risks for the Swedish economy: with household debt and housing prices striking new record highs on a more or less monthly basis. In other words, the Riksbank has not come close to achieving its stated goal in the last 5 years, despite the fact that the Swedish economy has a forecast growth rate of almost 4 per cent for 2016. The patient has been put on the strongest of medicines but is not responding to treatment!
Bringing in the experts
The Riksdag Committee on Finance commissions an external and independent review of Swedish monetary policy every four years. As a result of the Riksbank’s problems in getting the Swedish economy going, the Committee on Finance decided to commission a review of the monetary policy for the period of 2010–2014. External experts were brought in to review the Riksbank’s performance: Mervyn King, the former Governor of the Bank of England (2003–2013) and US economist Professor Marvin Goodfriend of Carnegie Mellon University. The choice of Lord King was interesting because he has been critical of many central banks’ apparent obsession with inflation. Considering the state of the Swedish housing market, which is often characterised as a bubble by both local and international experts this became an even more controversial choice once it is recognised that Lord King served as Governor in 2008, when the United Kingdom experienced its worst housing bubble in history. Had he recommended that the Riksbank abandon its established goal, then the Riksbank might decide to flag for repo rate hikes much earlier than planned.
A more flexible monetary policy
The review did not advise the Riksbank to abandon its 2 per cent inflation target. However, it did state that the Riksbank should be allowed to miss a core inflation target of 2 per cent for up to 4 or 5 years if the project of stabilising the Swedish economy proves to be more important. The review’s main monetary policy proposal was that the Riksbank ought to focus not on headline inflation, but instead on core inflation (i.e. the CPI minus certain products with volatile prices). Swedish core inflation currently stands at 0.9 per cent whereas its headline rate is no more than 0.1 per cent.
The review joined in with critics regarding financial stability, especially with respect to household debt and housing prices. This is a sensitive topic for the Riksbank, which has been in a bureaucratic bind with the Financial Supervisory Authority (Finansinspektionen or FSA) concerning which institution ought to be responsible for macro prudential policy. Stefan Ingves, the Governor of the Riksbank, has repeatedly stated that the main responsibility of the Riksbank is inflation, and that others, i.e. the government and the FSA, should take care of the other variables of the equation. As a result, it is undeniable that the Riksbank’s negative repo rate of -0.35 per cent, the lowest of its kind in the world, has contributed significantly to soaring housing prices and rampant Swedish indebtedness. The review is critical of this attitude, suggesting instead that the Riksbank and the FSA ought to come together to found a joint Prudential Policy Committee, the purpose of which will be to adjust the instruments determining Sweden’s macro prudential policy.
The Riksbank’s inflation rate adjustments receive several criticisms. The review states that the central bank was too optimistic in its macroeconomic analysis in 2013, anticipating an unreasonably high level of growth in 2013 in the Eurozone. Furthermore, its assumptions about the interest rates of the surrounding world have proven to differ significantly from those of the financial markets. The review argues that it is because of disparate perspectives on matters like these that the Riksbank’s inflation prognoses have come to estimate a much higher inflation rate than that actually achieved, which is cause for concern. This is all the more worrying considering the fact that the Riksbank’s prognoses were intended to have a determining effect on market rates, which they never did. At a press conference at the Riksdag, Lord King referred to the Riksbank’s detailed interest rate prognoses as ‘surreal’ given that the markets obviously did not have any confidence in their accuracy. The review also hands out criticism because the leadership of the Riksbank has relied extensively on economic models for forecasting, noting that the models did not have very much to say about rising housing prices and household indebtedness, and omitting to take into account the economics of falling real interest rates across the world.
The review did offer some praise for the Riksbank’s actions. For instance, it defended the bank’s decision to raise the repo rate from 0.25 per cent to 2 per cent between June 2010 and July 2011. Nonetheless, the review argues that the string of hikes in this period were reasonable considering the information that was available to the Riksbank at the time.
The review recommended that the Riksbank develop new tools by which to construct prognoses for the world economy and the world interest rates. Furthermore, to the extent that the Riksbank’s forecasted repo rate trajectory deviates from that anticipated by surrounding markets, it should routinely present a written analysis explaining why there is such a deviation, as well as how it thinks that this deviation will affect monetary policy.
The review also provided advice for the Riksdag too. Among this advice was the recommendation that the Riksdag clearly define and express in numbers the exact nature of the inflation target, and to provide the Riksbank with the mandate to achieve this goal.
Swedish politicians received their fair share of criticism in the Riksbank review. It is particularly clear that the Riksbank must be given more power to adjust the imbalances that plague the Swedish political economy. Specifically, politicians must change their approach to housing and the housing market.
The Minister for Finance, Magdalena Andersson (S), says that the reviewers have carried out their assigned task in a laudable manner. She describes the calls for clarity regarding responsibilities as ‘interesting’. But she was careful about commenting on specific suggestions, such as that of handing the Riksdag and the Ministry for Finance the task of defining the inflation target, arguing that “our central bank legislation is based on a broad agreement that Sweden ought to have an independent central bank. However, given that this legislation is quite old, the time to revise it may have arrived.” Regarding the review’s demand that the Riksbank ought to be given more power, she was unwilling to comment.
Annika Winsth, Chief Economist at Nordea Bank, said that the review would result in political changes with regard to taxation connected to moving houses, as well as interest rate deductions on mortgages. Changes to the first of these would encourage more people to sell their house, increasing supply on the housing market, bringing down housing prices and so contributing to the stifling of household debt through smaller mortgages. Changes made to the second alternative would make it more expensive to hold mortgages generally, because a smaller percentage of the interest would be tax deductible. This would bring down the size of mortgages and household debt. Of course, Mr Ingves has been calling for at least the latter of these for some time now. However, as is emphasised in the review, his institution has not had enough influence to address these kinds of issues. Johan Schück of Dagens Nyheter writes that the criticism directed towards the Riksbank by the review is justified, especially given its erroneous prognoses and consistent failures to achieve its inflation target. He argues that a majority of the Riksbank’s Executive Board bears responsibility unemployment being higher than necessary. He also thinks that many of the suggestions made by the review appear sound, especially the proposal that the inflation target should be set by the Riksdag and not the Riksbank.
The First Deputy Governor of the Riksbank, Kerstin af Jochnick, thinks that many of the suggestions made by the review are worth considering. In particular, she expresses positivity regarding the demand for clarification regarding task-distribution among institutions. She says that, “we have called for an improved picture concerning institutional responsibilities in the context of macro prudential policy for a long time”. She also believes that the criticisms raised about the Riksbank’s work on producing rate prognoses are fair. However, she maintains that the Riksbank’s main task will continue to be the attainment of its inflation target, emphasising that this is absolutely essential to the growth of the Swedish economy. As such, she asserts that the Riksbank’s Executive Board stands ready to act in order to ensure that the inflation target is reached.
Still, it remains to be seen how the review will affect the Riksbank’s policy in future. An analysis by Nordea states that the bank still believes that the Riksbank will lower the repo rate further in February. The reason for this is primarily because it came really close to doing so in December already, due to the fact that the inflation rate had turned out lower than forecasted. The National Institute of Economic Research (Konjunkturinstitutet, NIER) has also speculated that the Riksbank will commit itself to an even more expansionary monetary policy in February, following lower oil prices and the fact that international monetary policy is also becoming increasingly expansionary. As a result, it might be that the Riksbank’s monetary policy will continue largely as it has up until now.
The review will now be sent out to referral bodies and then debated in the Riksdag on 12 May with the Riksbank Governor participating. Thus, any changes in the Riksbank law will happen this summer at the earliest.
 Fokus, 15 – 21 January 2016, issue 1 – 2, p. 19.