Skingsley: Policy rate will continue to be a desirable monetary policy tool

The coronavirus pandemic has dramatically changed the economic playing field and caused central banks and governments around the world to implement measures to counteract a recession. It has also meant that the international debate regarding central banks’ monetary policy framework and strategy has been brought to a head. “How can we ensure that monetary policy continues to have scope to counteract recessions and increased unemployment?” This question was put by First Deputy Governor Cecilia Skingsley when she took part at Nordea’s webinar on central banks in transformation on Wednesday.

Date: 07/10/2020 14:00

Speaker: First Deputy Governor Cecilia Skingsley

Place: Nordea

We haven't given up the inflation target

“We need to ensure that we can continue to use the policy rate as a monetary policy tool to stabilise the economy, counteract unemployment and keep inflation low and stable. And it is easier to do this if there is some level of average inflation in the economy,” said Ms Skingsley.

The fact that the Riksbank is forecasting that inflation will undershoot the target has caused some people to believe we have given up the inflation target. But of course this is not the case. Others feel that the inflation target has now become obsolete. Ms Skingsley pointed out that she sees this as worrying. “The point of an inflation target is not just to prevent high inflation, but also to ensure that inflation does not become too low. Both of these are important to ensure monetary policy can contribute to economic development in a positive way.”

Fiscal policy contribution

Monetary policy should remain expansionary. But it is also clear that fiscal policy needs to play a larger stabilisation policy role than has been the case in recent decades. “One interesting idea is if fiscal policy were to contribute to maintaining confidence in the inflation target,” said Ms Skingsley. The inflation target is, after all, not merely the Riksbank’s target but a target for society with a political majority behind it. Fiscal policy will also function better if the inflation target can continue to be the anchor in price-setting and wage formation.

Communication can supplement monetary policy measures

Communication of monetary policy could also reinforce the measures. “The Executive Board of the Riksbank has in recent years, and most recently in the Monetary Policy Report published in September, expressed it is open to inflation being allowed to overshoot the 2 per cent target before it is time to make monetary policy less expansionary. One possibility could be to condition monetary policy in a more formal manner,” added Ms Skingsley.  This could be a way of reducing the risk that monetary policy applies the brakes too soon in an economic upturn.

One problem for the Riksbank and many other central banks over the past decade has been that inflation has tended to undershoot the target. This appears to have been one factor the US Federal Reserve had in mind when it recently announced its strategy changes. “I think these changes are interesting and thought-provoking, and the Riksbank will analyse them thoroughly,” concluded Cecilia Skingsley.

Updated 07/10/2020