Two weeks ago, the oldest central bank in the world, Sweden's Riksbank stunned the world when it unveiled 40% more QE than consensus had been expecting. Specifically, the Riksbank announced that it was expanding its quantitative easing program to 700 billion kronor ($82 billion), which was 200 billion kronor more than its earlier target. To be sure, with the Riksbank having locked itself in after Governor Stefan Ingves said just a few years prior that its "experiment" with negative rates was officially over, expanding QE was the only available option unless the central bank was willing to gamble with its credibility (and until there is a far greater crisis when negative rates will be unavoidable, damn the soaring house prices).
And while most Swedish central bankers were on board with the decision, there was at least one who hopefully sees the writing on the wall: that central banks will be able to superglue the falling house of cards for only a few more years (effectively echoing the BIS' latest warning).
In a jarring break with the central bank consensus, Riksbank Deputy Governor Martin Floden presented a "long list of objections to the proposed decision" to expand QE through to the end of 2021, he said in minutes from the Nov 25 policy discussion, and noting that "it is the list as a whole that leads me to enter a reservation."
Below we summarize his six objections (the full text is below):
- First, it’s unlikely that further purchases will be able to push down already low bond yields to noticeably lower levels, and that
- " a promise today for larger asset purchases will not make monetary policy more expansionary in the near term."
- Second, it’s "uncertain whether asset purchases in the autumn of 2021 will make monetary policy more expansionary then."
- Third, "communication concerning a comprehensive purchasing program until the end of 2021 may generate more uncertainty than clarity"
- Fourth, "the actors and markets" that the Riksbank can directly affect are still not in such an acute crisis situation as they were in the spring
- Fifth, "the most important mechanism is that central banks, via asset purchases, are able to remove risk from the markets." And since this mechanism hardly works if the Riksbank purchases government securities with short maturities, Floden doesn’t consider purchases of treasury bills to be an effective measure
- Sixth, uncertainty over developments in the near term is high, bank needs “to take a new monetary policy decision to purchase more in the near term”
He concluded that "instead of expanding the programme, I advocate that we communicate clearly that we will ensure that the level of interest rates remains low for a long time to come." He was overruled.
Floden's Minutes excerpt is below:
The Riksbank’s measures throughout the pandemic have been important and have resulted in a low level of interest rates and continued access to credit for companies and households. The consequences of the pandemic will impede the Swedish economy for a long time to come. The Riksbank therefore needs to ensure that the level of interest rates remains low for many years. In this way, monetary policy will facilitate an economic recovery, which will contribute to inflation ultimately rising towards the target of 2 per cent.
So far, I agree with the reasoning behind the proposed monetary policy decision in the draft Monetary Policy Report. Nevertheless, my objections to the proposed decision are many.
I will now present a long list of objections to the proposed decision. But the length of the list is not a good indication of how far from the proposed decision I stand. No point on my list would alone justify a reservation to the proposed decision. It is the list as a whole that leads me to enter a reservation. In addition, my opinion is that I have the same view of the need for a continued expansionary policy as the rest of the Executive Board. My reservation thus concerns how we can best design monetary policy to achieve this.
First, the Riksbank has already decided on a comprehensive purchase programme, running until mid-2021. The programme has had a positive impact on interest rates and lending. Yields on safe assets, such as government bonds, are low at all maturities. For example, the yield on all government bonds with maturities up to 10 years is negative and thus lower than our policy rate. The yield curve is thus low and flat. Additionally, yields on riskier and less liquid assets are also low. For example, yields on mortgage and corporate bonds are lower than before the pandemic. This is contributing to low lending rates to both households and companies. My assessment is that the repo rate sets a boundary for how low all of these rates can fall. In my opinion, it is unlikely that further purchases will be able to push the rates down to noticeably lower levels. I therefore deem that a promise today for larger asset purchases will not make monetary policy more expansionary in the near term.
Second, I consider it uncertain whether asset purchases in the autumn of 2021 will make monetary policy more expansionary then. When our previously-announced purchase programme expires in mid-2021, the Riksbank will own a large proportion of Swedish nominal government bonds and have a large holding of mortgage bonds. The Riksbank will also be a significant actor in the fairly illiquid secondary markets for municipal and corporate bonds, as well as real government bonds. I therefore consider it likely that the Riksbank will be able to hold yields on these assets at low levels by only buying assets to compensate for redemptions, or at least by purchasing new assets to a lesser extent than is now proposed in the draft decision. I do not rule out the possibility that substantial asset purchases may be justified but I do not see it as a main scenario.
Third, I consider that communication concerning a comprehensive purchasing programme until the end of 2021 may generate more uncertainty than clarity. It is good that central banks are transparent and provide guidance on their policy rules and future plans. But the Riksbank is now a major actor on the bond markets. At present, it is not possible to predict how purchases next autumn will affect these markets. Instead of promising purchases of a certain magnitude, I think that our communication should focus on what we wish to achieve. Consequently, I would rather see us communicating that, for a long time to come, we will keep the repo rate low, ensure that the level of interest rates otherwise remains low, and make sure that lending continues to function. The tools we need to use to achieve this and the possible purchase sums that will be relevant can be assessed on an ongoing basis. Increased asset purchases may hold the level of interest rates down if risk, liquidity or term premia start to rise. But if the level of interest rates as a whole needs to be pushed down from the current level, it would probably be better to cut the repo rate instead.
Fourth, there are situations in which we can inspire confidence by demonstrating strong initiative and preferring to do too much rather than too little. It was important that the Riksbank acted rapidly and forcefully with major support programmes at the outbreak of the pandemic in the spring. The pandemic is now getting worse again and some sectors are being very badly impacted, but the actors and markets that the Riksbank can directly affect are still not in such an acute crisis situation as they were in the spring. Our asset purchases must be balanced both against the undesirability of a central bank dominating the markets and excessively affecting price mechanisms – for example by generating abnormally low risk premia – and against large purchases leading to increased credit and, above all, interest rate risk on the Riksbank’s balance sheet.
Fifth, I do not consider purchases of treasury bills to be an effective measure. There are various hypotheses around how and why quantitative easing works. Easing presumably acts via several different mechanisms and in different ways depending on the economic situation and institutional conditions. But perhaps the most important mechanism is that central banks, via asset purchases, are able to remove risk from the markets. This mechanism hardly works if the Riksbank purchases government securities with short maturities. These securities are liquid and secure, and lack term premia. Among other things, this can be seen by the way they are already being traded at rates that are lower than the Riksbank’s repo rate. If our ambition is to bring short-term market rates for safe assets down, this can best be achieved by cutting the repo rate.
Sixth, uncertainty over developments in the near term is high. The spread of infection has increased substantially in recent weeks and new restrictions have been introduced. I therefore consider it positive that we are laying down a plan for asset purchases in the first quarter of next year that remains extensive. I advocate the same purchase plan for the first quarter of next year as in the proposed decision, with the exception of the SEK 10 billion intended for the purchases of treasury bills. However, conditions on the financial markets can change rapidly, in which case new measures may be needed from the Riksbank. The Riksbank therefore also needs to be prepared to adjust monetary policy before the next ordinary monetary policy meeting. But the expanded programme does not make us better equipped to react if conditions change in the near term. We are now making decisions on the rate of purchases for the first quarter in 2021. Consequently, we need to take a new monetary policy decision to purchase more in the near term, regardless of whether or not we expand the programme today.
Instead of expanding the programme, I advocate that we communicate clearly that we will ensure that the level of interest rates remains low for a long time to come. In more concrete terms, this would involve us keeping to the previously announced programme of asset purchases for SEK 500 billion until the middle of next year and communicating our preparedness, even in the near term, either to extend the purchase programme, cut the repo rate or otherwise react to developments that otherwise would jeopardise the expansionary impact of monetary policy