Monetary policy with an inflation target

The world’s oldest central bank 1668 Sveriges Rikes Ständers Bank 1661 Palmstruch - first banknotes 1701 The Riksbank issues “transport” notes 1830s Commercial banks are established 1904 Monopoly on issuance of banknotes 1866 Sveriges Riksbank 1999 New legislation makes bank independent

An authority under the Riksdag The Riksdag The Government The Ministry of Finance The Swedish National Debt Office Finansinspektionen (the Swedish Financial Supervisory Authority) Sveriges Riksbank

Economic policy

The Riksbank’s governing The Riksdag General Council 11 members Executive Board 6 members

The executive board of the Riksbank Eva Srejber Lars HeikenstenIrma Rosenberg Kristina PerssonLars Nyberg Svante Öberg Stefan Ingves

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

UND1X inflation and historical mean Annual percentage change Sources: Statistics Sweden and the Riksbank

Different monetary policy regimes Source: The Riksbank

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 International Secretariat 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 transmisson mechanism Reduce fluctuations in the real economy

CPI or UND1X? …..the change in the consumer price index as from 1995 shall be limited to 2 per cent, with a tolerance for deviations of 1 percentage point. General Council of the Riksbank however excl. transitory effects (interest expenditure and indirect taxes) supply shocks – longer time horizon Executive Board of the Riksbank

UND1X forecast, October 2006 Annual percentage change Sources: Statistics Sweden and the Riksbank Within 2 years

Inflation forecasts 8 monetary policy meetings per year - 4 (3) Inflation Reports - 4 updated assessments - 2 public hearings before the Riksdag Committee on Finance

Repo rate and implicit forward rate Per cent Source: The RiksbankNote. 15-day average.

UND1X with uncertainty bands Annual percentage change Sources: Statistics Sweden and the Riksbank

Monetary policy repo Repos are implemented weekly Term of one week Liquidity forecast in the morning Repo announcement on Tuesdays Allocation at Liquidity flow on Wednesday lending/delivery of collateral Daily fine-tuning operations at

Policy rates & deposit rates Per cent Source: The Riksbank

Signalling – influencing expectations Inflation reports Speeches Minutes of monetary policy meetings Policy rates

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 implementatio n

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 Bank A + 50 Bank B - 50 The Riksbank 1,25 2,75 O/n interest rate The position of the banking system 0 Example 1 Bank A Bank B - 50 Example 2 The Riksbank 1,25 2,75 O/n interest rate The position of the banking system 0

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 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, % 0 Liquidity surplusLiquidity 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

Changes in the yield curve when the policy rate is altered Maturity Interest rate (%) O/n3 months2 years10 years ,50 Before lowering After lowering B A

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.

Simplified balance sheets The Central bank The rest of the world Assets Liabilities Assets Liabilities

RB:s balance sheet (Apr 06) Assets Liabilities

RB:s balance sheet with reserve requirement Assets Liabilities