Erik Thedéen: On risk, uncertainty and geoeconomic fragmentation

Three approaches to risk and uncertainty

Uncertainty in the global economy has increased significantly in recent months, not least as a result of the new US trade policy. In the monetary policy update, the Riksbank assessed that international developments – particularly the elevated uncertainty – are dampening the economic prospects in Sweden. “In turn, this suggests that inflation, beyond the near term, may become lower than in our March forecast. But we also pointed out that there are several risk factors, such as those linked to companies’ global value chains, and that inflation thus could well become unexpectedly high. This illustrates, almost too clearly, that the economic outlook and inflation prospects are always uncertain.”

Fundamentally, there are three approaches for central banks to take towards risk and uncertainty, said Thedéen. You can act cautiously, more forcefully or completely disregard it. Swift and decisive action is justified when the risk of really bad outcomes is high, such as during the 2008 global financial crisis or the 2020 pandemic outbreak.

“I consider that the current situation provides an example of when it is reasonable to apply the conservatism principle. Uncertainty is high and there are several possible scenarios for future inflation developments. It is therefore appropriate to sit tight and wait for more information to get a somewhat clearer view of the inflation and economic outlook.” Thedéen also emphasised that there is always uncertainty about when decision guidance can be said to be adequate. “An important part of monetary policy decision-making is the trade-off between awaiting new information and acting decisively on the information that is available.”

Increased geopolitical divisions pose new risks

A world previously characterised by global cooperation slowly seems to be shifting towards more confrontation and fragmentation. “This is a worrying development that does not just imply security risks but also negative consequences for the economy,” said Thedéen.

“I consider that the strategy for monetary policy that we are already applying, usually called a flexible inflation targeting strategy, also gives us a good framework to manage these challenges.”

Risks related to geopolitics and increasing geoeconomic fragmentation are also similar to supply shocks in which inflation and production move in different directions. “Our experiences in recent years have taught us that disregarding supply shocks is not self-evident, not least because, in real time, it is very difficult to determine whether a shock is temporary or more long-term. Previously, central banks have expended a lot of time on analysing the demand side of the economy, but developments in recent years indicate that we also need to become better at understanding the economy’s supply side.”

Read the whole speech via the link below.