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Monetary
policy
Stefan Ingves
Monetary
policy
implementation
with inflation
target
The world’s oldest central bank
1668
Sveriges Rikes
Ständers
Bank
1661
Palmstruch first banknotes
1830s
Commercial banks
are established
1701
The Riksbank
issues “transport”
notes
1866
Sveriges
Riksbank
1904
Monopoly on
issuance of
banknotes
1999
New 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 (the
Swedish 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 Council
11 members
Executive Board
6 members
The executive board of the Riksbank
Stefan Ingves
Lars Nyberg
Svante Öberg
Lars E.O. Svensson
Karolina Ekholm
Barbro Wickman-Parak
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 mean
Annual percentage change
18
18
16
16
CPI-inflation
14
14
Historical mean
12
12
10
10
8
8
1993-2009 M arch
M ean 1,6%
Standard deviation 1,4%
6
6
1971-1992
M ean 8,3%
Standard deviation 3,0%
4
4
2
2
0
0
-2
-2
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
Sources: Statistics Sweden and the Riksbank
Different monetary policy regimes
30
150
Fixed
exchange rate
Inflation target
25
140
20
130
15
120
Short term interst rate, 3-month
Treasury Bill (left scale)
SEK measures as TCW (right scale)
10
110
5
100
0
90
89
91
93
95
97
99
01
03
Note. The vertical line marks the date for the shift in monetary policy regime, 19 nov 1992.
05
07
09
Source: The Riksbank
An independent Riksbank

Up to 1999: Conducted
monetary and exchange rate
policy.

After 1999: Price stability
General Council 4 years
General Council 4 years
Riksbank Governor 5 years
Executive Board 6 years
The Riksbank’s organisation
Executive
Board
Internal Audit
Department
Administration
Department
Financial
Stability
Department
General
Secretariat
Market
Operations
Department
International
Secretariat
Monetary
Policy
Department
Research
IT Department
Monetary policy theory
Why 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
5
5
Inflation expectations
Jan -95
CPI
4
Jun-08
Oct-08
4
Apr-08
Jan -08
Feb -96
3
3
Oct -07
Feb-97
2
2
Feb -98
Nov -05
1
1
Nov -06
Jan-09
0
0
-1
-1
-2
-2
94
96
98
00
02
04
06
08
10
12
Sources: Statistics Sweden and Prospera Research AB
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
6
6
90%
75%
50%
Repo rate
5
5
4
4
3
3
2
2
1
1
0
0
04
05
06
07
08
Note. Broken lines represent the Riksbank’s forecast.
09
10
11
12
Sources: The Riksbank
CPI with uncertainty bands
Annual percentage change
6
6
90%
75%
50%
CPI
5
5
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
04
05
06
07
Note: Broken line is the Riksbank’s forecast
08
09
10
11
12
Source: Statistics Sweden and the Riksbank
GDP with uncertainty bands
Annual percentage change, seasonally-adjusted data
6
6
4
4
2
2
0
0
-2
-2
-4
-4
-6
-6
90%
75%
50%
GDP
-8
04
05
-8
06
07
08
Note. Broken lines represent the Riksbank’s forecast.
09
10
11
12
Sources: Statistics Sweden and the Riksbank
Optimal monetary policy

Within a theoretical framework:
Minimize quadratic forecast loss function
Lt
2
(



)


(
y

y
)
=  0 t  ,t
 0 t  ,t t  ,t

* 2

 t  ,t , mean inflation forecast at t for period t  
yt  ,t  yt  ,t mean output gap forecast, 
constant relative weight on output-gap
stabilization
20
Modified Taylor curves (ex-ante) and
optimal monetary policy choice


0
( yt  ,t  yt  ,t )
2
D
A
B
C
0
E
* 2
(



 0 t  ,t )

21
Estimated inflation and GDP gap
Percentage deviation from the target and HP trend
5
5
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
Inflation gap (CPI)
-4
-4
GDP gap
-5
-5
00
01
02
03
04
05
06
Note. Broken lines represent the Riksbank’s forecast.
07
08
09
10
11
12
13
Sources: Statistics Sweden and the Riksbank
Production as a Cobb-Douglas
function

Yt  At K t H t
1
and

H t  H Lt
A = Technology, K = Capital , H = Hours worked,

H = average hours per worker
L = Labour and α = constant


Yt  At Kt ( H Lt )1

Yt  At H t
1

Kt Lt
1
23
Estimated gaps
Percentage deviation from the HP trend
6
6
GDP
Hours worked
Employment
5
4
5
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
-4
-4
-5
-5
80
85
90
95
Note. Broken lines represent the Riksbank’s forecast.
00
05
10
Sources: Statistics Sweden and the Riksbank
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
5,0
5,0
4,5
4,5
4,0
4,0
3,5
3,5
3,0
3,0
2,5
2,5
2,0
2,0
1,5
Repo rate
1,5
1,0
3 month treasury bill
1,0
0,5
0,5
0,0
0,0
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: The Riksbank
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 rates
Per cent
10
10
Deposit rate
Lending rate
Lending overnight
Repo rate
8
8
6
6
4
4
2
2
0
0
96
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: The Riksbank
The overnight market
In both examples Bank A and B have two possibilities.
1) They can use the overnight market or
2) They can use the standing facilities offered by the
Riksbank
The Riksbank
O/n interest rate
Example 1
Bank A
+ 50
2.75
Bank B
- 50
1.25
The position of
the banking
system
0
The Riksbank
O/n interest rate
Example 2
2.75
Bank A
-+100
Bank B
- 50
1.25
0
The position of
the banking
system
The overnight market – MPU April-09
In both examples Bank A and B have two possibilities.
1) They can use the overnight market or
2) They can use the standing facilities offered by the
Riksbank
The Riksbank
O/n interest rate
Example 1
Bank A
+ 50
0.50
Bank B
- 50
0.00
The position of
the banking
system
0
The Riksbank
O/n interest rate
Example 2
0.50
Bank A
-+100
Bank B
- 50
0.00
0
The position of
the banking
system
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
certificate at 9.30 a.m.
REPO
The Riksbank buys
securities and
transfers funds to the
banks (the banks
borrow from the
Riksbank)
The banks tender
their bids at 9.45 a.m.
at the latest
The Riksbank
announces the allotment at 10.00 a.m.
Monday
Tuesday Wednesday Thursday
Friday
CERTIFICATES
The Riksbank issues
certificates (the
Riksbank borrows
from the banks)
Saturday
Sunday
The Riksbank sells
securities and
receives the funds
plus interest (the
banks pay back their
loans)
Monday
Tuesday Wednesday
The certificates
mature (the Riksbank
pays back the loan
plus interest)
The Riksbank steering of the
O/N Rate
Over Night Interest Rate, %
Lending Facility (ceiling)
Fine tuning Operations
+/- 10 bp
(2.75%)
Repo Rate (2.00) and O/N
Rate are within the corridor
(1.25%)
Deposit Facility (Floor)
Liquidity surplus
0
Liquidity deficit
The position of the banking system,
i.e the need for the banks to deposit at
or borrow from the Riksbank
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
Over Night Interest Rate, %
Lending Facility (ceiling)
Fine tuning Operations
+/- 10 bp
(0.50%)
Repo Rate (0.50) and O/N
Rate are within the corridor
(0.00%)
Deposit Facility (Floor)
Liquidity surplus
0
Liquidity deficit
The position of the banking system,
i.e the need for the banks to deposit at
or borrow from the Riksbank
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
3,5
3,5
Before M onetary policy meeting
3,0
After M onetary policy meeting
3,0
2,5
2,5
2,0
2,0
1,5
1,5
1,0
1,0
0,5
0,5
repo
3 mån
6 mån 12 mån
2 år
3 år
5 år
7 år
9 år
10 år
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 SEK
Bank C bids 2 billion SEK
Total 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 GDP
Per cent
12
12
China
10
10
Sweden
8
8
USA
6
6
4
4
2
2
0
0
-2
-2
-4
-4
-6
-6
-8
-8
-10
-10
95
98
01
04
07
Source: The IMF
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 USA
basis points
2200
2000
1800
Aaa
Baa
High-yield
1600
1400
1200
1000
800
600
400
200
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
*)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
etc.
rate
”Moral
suasion”
Inject liquidity
etc.
Monetary policy and financial
stability are interlinked:
i
lending
t
 it  mct ,...
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 policy
A stylised balance sheet for a central bank
Assets
Liabilities
Foreign assets
Banknotes and coins
Domestic assets
Bank deposits
Lending
Equity
Central banks’ balance sheets
Percentage of GDP
25
25
ECB
BOE
20
20
Federal Reserve
The Riksbank
15
15
10
10
5
5
0
jan-07
0
apr-07
jul-07
okt-07
jan-08
apr-08
jul-08
okt-08
jan-09
Sources: Bureau of Economic Analysis, Eurostat, Office for National Statistics, Statistics Sweden and the
respective central banks
The Riksbank’s balance sheet on 30 June
2008 (prior to Lehman Brothers crash)
Assets
Gold
Foreign currency
reserve
Lending USD
Liabilities
26 Banknotes & coins
158 Fine-tuning
108
0
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
Gold
Foreign currency
reserve
Lending USD
Lending SEK
Other
TOTAL
Liabilities
30 Banknotes & coins
200 Fine-tuning
196 Riksbank
Certificates
262 Liabilities to Fed
112
207
49
189
7 Equity
59
Other
84
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 base
SEK billion
400 000
400 000
The banks' holdings of Riksbank certificates
350 000
350 000
The banks' deposit at the Riksbank
Banknotes and coins in circulations
300 000
300 000
250 000
250 000
200 000
200 000
150 000
150 000
100 000
100 000
50 000
50 000
0
0
jan-08
apr-08
jul-08
okt-08
jan-09
Source: The Riksbank
Credit easing
Federal 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 easing
Bank 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:
M V  P  Y
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

 
it   t  r    t    Y Yt  Y
*
t
*

A ”Taylor rule” for capital
adequacy



ct  c   L Lt  L   Y Yt  Y
*

The link between monetary
policy and financial stability
i
lending
t
 it  mct ,...
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!