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					Monetary
 policy


  Stefan Ingves
  Monetary
     policy
implementation
 with inflation
    target
The world’s oldest central bank
              1668
                                      1830s                1904
          Sveriges Rikes
            Ständers            Commercial banks       Monopoly on
                                 are established       issuance of
               Bank
                                                        banknotes




                                                                1999
      1661                 1701               1866
                                                           New legislation
  Palmstruch -         The Riksbank         Sveriges
                                                            makes bank
first banknotes     issues “transport”      Riksbank
                                                            independent
                           notes
 An authority under the Riksdag

                        The Riksdag


                The Government            Sveriges Riksbank


             The Ministry of Finance


                           Finansinspektionen (the
The Swedish National
                              Swedish Financial
     Debt Office
                            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    Svante Öberg           Karolina Ekholm




Lars Nyberg       Lars E.O. Svensson   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




                     Sources: Statistics Sweden and the Riksbank
       Different monetary policy regimes




Note. The vertical line marks the date for the shift in monetary policy regime, 19 nov 1992.
                                                                                               Source: The Riksbank
    An independent Riksbank
   Up to 1999: Conducted           After 1999: Price stability
    monetary and exchange rate
    policy.




                                         General Council 4 years
     General Council 4 years




    Riksbank Governor 5 years             Executive Board 6 years
      The Riksbank’s organisation
                                 Executive
                                   Board



                      Internal Audit      General      International
                       Department        Secretariat    Secretariat



                  Financial        Market       Monetary
Administration
                  Stability      Operations      Policy        IT Department
 Department
                 Department      Department    Department

                                                  Research
        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




                    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




Note. Broken lines represent the Riksbank’s forecast.   Sources: The Riksbank
                  CPI with uncertainty bands
                         Annual percentage change




Note: Broken line is the Riksbank’s forecast   Source: Statistics Sweden and the Riksbank
                GDP with uncertainty bands
 Annual percentage change, seasonally-adjusted data




Note. Broken lines represent the Riksbank’s forecast.   Sources: Statistics Sweden and the Riksbank
      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

                                                   20
Modified Taylor curves (ex-ante) and
  optimal monetary policy choice


        D
       A

            B
                     E
                C

   0
                                       21
          Estimated inflation and GDP gap
    Percentage deviation from the target and HP trend




Note. Broken lines represent the Riksbank’s forecast.   Sources: Statistics Sweden and the Riksbank
Production as a Cobb-Douglas
           function
                                 and


A = Technology, K = Capital , H = Hours worked,
    = average hours per worker
L = Labour and α = constant




                                                  23
                                Estimated gaps
              Percentage deviation from the HP trend




Note. Broken lines represent the Riksbank’s forecast.   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




                                             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




                               Source: The Riksbank
The overnight market
  In both examples Bank A and B have two possibilities.
  1) They can use the overnight market or                                The Riksbank
  2) They can use the standing facilities offered by the
  Riksbank                                                        O/n interest rate


  Example 1                                                                           2.75

      Bank A                             Bank B            1.25
                                                                                             The position of
       + 50                               - 50                                               the banking
                                                                           0                 system



                                                                        The Riksbank
                                                              O/n interest rate

  Example 2
                                                                                      2.75
      Bank A                             Bank B            1.25
       -+100                              - 50                                           The position of
                                                                                         the banking
                                                                          0              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                                The Riksbank
   2) They can use the standing facilities offered by the
   Riksbank                                                        O/n interest rate


   Example 1                                                                            0.50


       Bank A                             Bank B            0.00
                                                                                              The position of
        + 50                               - 50                                               the banking
                                                                            0                 system



                                                                         The Riksbank
                                                               O/n interest rate

   Example 2
                                                                                       0.50
       Bank A                             Bank B            0.00
        -+100                              - 50                                           The position of
                                                                                          the banking
                                                                           0              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 steering of the
    O/N Rate
                         Over Night Interest Rate, %




                                         Lending Facility (ceiling)
                                                                       (2.75%)

Fine tuning Operations
       +/- 10 bp                                    Repo Rate (2.00) and O/N
                                                    Rate are within the corridor

(1.25%)
          Deposit Facility (Floor)

                                                                        The position of the banking system,
                 Liquidity surplus   0      Liquidity deficit         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)
                                                                       (0.50%)

Fine tuning Operations
       +/- 10 bp                                    Repo Rate (0.50) and O/N
                                                    Rate are within the corridor

(0.00%)
          Deposit Facility (Floor)

                                                                        The position of the banking system,
                 Liquidity surplus   0      Liquidity deficit         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
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




                          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




*)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        Monetary policy Financial stability
    main tasks: Monetary        Policy rate     ”Moral suasion”
    policy and financial        etc.            Inject liquidity
    stability
                                                 etc.


   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 and financial
stability are interlinked:
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




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                       Liabilities
Gold                26 Banknotes & coins       108
Foreign currency   158 Fine-tuning               0
reserve
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   200 Fine-tuning            207
reserve
Lending USD        196 Riksbank                49
                       Certificates
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 base
SEK billion




                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:
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):
The Taylor rule for monetary
policy
A ”Taylor rule” for capital
adequacy
The link between monetary
policy and financial stability
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!

				
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