Svensson: For a better monetary policy: Focus on inflation and unemployment
On 8 March, Lars E.O. Svensson spoke at Luleå University about his view that the monetary policy framework can be improved, why it is important that the Riksbank’s decisions and communication do not give the impression that monetary policy has targets other than stabilising inflation and resource utilisation and why he entered a reservation at the latest monetary policy meeting.
Mr Svensson took as his starting point the Riksbank’s document Monetary policy in Sweden, which stipulates that the Riksbank should pursue a flexible inflation targeting policy in which monetary policy focuses on stabilising inflation around the target and resource utilisation around a normal level. He said that the existing framework for monetary policy can be improved by making the operational measures of inflation, resource utilisation and their stability more precise. He also said that there are several reasons why only one operational measure of inflation and only one operational measure of resource utilisation should be used. The inflation target is formulated in terms of the CPI, but he believed that the most appropriate operational measure of inflation is the CPIF, which excludes the direct effects of the Riksbank’s repo-rate changes on the CPI. This would also entail the stabilisation of the CPI in the slightly longer term. He explained why he believed that the unemployment gap between the actual rate of unemployment and the sustainable rate of unemployment is the most appropriate measure of resource utilisation. He also asserted that the mean squared gap is the most appropriate measure of the stability of inflation and resource utilisation.
Making the monetary policy framework more precise in this way would, he said, make monetary policy, simpler, clearer and more robust. The preparations before each policy meeting could focus on calculating forecasts of CPIF inflation and unemployment for a few alternative repo-rate paths. These forecasts, together with an assessment of the sustainable rate of unemployment, would summarise all the information the members of the Executive Board would need to make their decisions and choose between the alternative repo-rate paths. The decisions would be easy to explain and the explanations would be clear. This would also make it easy to evaluate monetary policy. The monetary policy framework would become more robust because all the information and all the assessments that affect the forecasts and the sustainable rate of unemployment could be incorporated into the decision-making process in a systematic way.
In order to avoid monetary policy being unclear in the future, he said that the Riksbank’s decisions and communication should not give the impression that monetary policy has more targets than inflation and resource utilisation. There has been an intensive discussion in the media and in market newsletters about a new focus for monetary policy, for example on stabilizing house prices and limiting household indebtedness. If, in the choice between two repo-rate paths, the Riksbank chooses a path that provides poorer target attainment for both inflation and resource utilisation, this may undeniably give the impression that monetary policy has more targets than those relating to inflation and resource utilisation. Furthermore, if repo-rate increases are justified with reference to factors such as high growth, house prices, household indebtedness, the low level of interest rates, possible financial imbalances in the future and so on, there is a risk that this impression will be strengthened. If this happens, monetary policy will become unclear.
On this basis, Mr Svensson entered a reservation at the latest monetary policy meeting and advocated leaving the repo rate unchanged and then a lower repo-rate path than the path in the main scenario, as such a lower path would better stabilise inflation measured in terms of the CPIF and resource utilisation measured in terms of the unemployment gap.
Read the whole speech in the PDF file below.
