Translation of analysis of DN Debatt 5 November 2014

This is a translation of my analysis of DN Debatt 5 November 2014 (see here for a translation of the original article). See here for a description of the project as a whole.

DN Debatt 5 November graded 4/10

In today’s DN Debatt Governor Stefan Ingves defends the Riksbank’s (the Swedish Central Bank) monetary policy, against criticism, from amongst other former Deputy Governor Lars E. O. Svensson and Nobel laureate Paul Krugman, saying that it has been too tight. The article is not very well-argued and is not characterized by the intellectual honesty you would expect from a high-ranking government official. My grade is 4/10. Detailed comments follow below.

Ingves starts off by arguing that GDP and employment have developed better in Sweden than in other Western countries since the financial crisis. He then draws the following conclusion:

It is hard to believe that such a development would have come about without the help of a reasonably well-balanced monetary policy.

The Riksbank’s main task is, however, not to stimulate GDP and jobs growth, but rather to “maintain price stability and financial stability”. The price stability objective is that “inflation as measured by the annual change in the consumer price index, CPI, should be 2 per cent.” As you can see from the graphs below, the Swedish inflation has, however, not only been well below this target, but also far below the US rate of inflation and average inflation in the EU.* This is a sign that monetary policy has been less balanced in Sweden than in other countries.

The Riksbank certainly still considers employment and GDP growth to some extent when making monetary policy decisions. However, it is difficult to see that the relatively good Swedish development on these points is due to the Riksbank’s policies. Those who defend the Riksbank and those who think that they should have pursued more expansionary monetary policy agree that a lower interest rate, and so-called QE, quantitative easing (which means that the central bank buys financial assets to boost the money supply), both increase employment and GDP on the one hand, and inflation, on the other. The Riksbank has, however, as the graph below shows, conducted a distinctly less expansionary monetary policy than the US, which has had zero interest for six years and also has pursued extensive QE programs.

The conclusion must be that the relatively strong Swedish GDP and employment growth occurred despite rather than because of the Riksbank’s monetary policy. The even in international comparison exceptionally low inflation gave considerable room for a more expansionary monetary policy, which, according to the view of the effects of monetary policy the Riksbank themselves accept, would have led to increased employment and growth. That Sweden’s GDP and employment growth has been relatively good compared to other countries therefore definitely does not show that the Riksbank has conducted a reasonable policy.

Further down Ingves writes:

Low inflation is a global challenge. What we struggle with is too low inflation, but that challenge we share with many countries.

Yes, but Sweden is, as we have seen, worse off in this regard than most comparable countries, as the  graphs show.

Further down Ingves writes:

Swedish monetary policy is expansive and effective. Critics have argued that we have kept interest rates too high and that we should have cut them more quickly to stimulate demand more and to increase inflation. But then you forget the fact that the Executive Board has reduced the interest rate from 2 percent to zero since 2011.

My emphasis. This is hardly something the critics “forget” – as I have said they have argued that we should have cut the rates faster.

Ingves describes the disagreements within the Executive Board as follows.

Anyone who immerses himself in the protocols can easily see that the differences in the Executive Board concerned the appropriate time to raise the rates, and that everyone agreed that interest rates would have to rise. Even the members of the Executive Board who wanted a comparatively more dovish interest rate policy advocated, for example, in July 2011 that the policy rate should be raised gradually to 3.8 percent in mid-2014, which was only marginally below the majority’s preferred interest rate path.

Lars E.O. Svensson, the member of the Executive Board who most vociferously argued for a more expansionary monetary policy, eventually resigned in anger over the Riksbank failing to conduct such an expansionary monetary policy. Subsequently, Svensson wrote a long series of articles (not the least on the blog Ekonomistas) in which he attacked the Riksbank’s policy. I assume that he will also comment on this article of Ingves’s. It would be interesting to see what he has to say about Ingves’s description of the discussion the Riksbank. Without going into details of the picture that Ingves paints, it seems to me that it is somewhat misleading. Svensson had hardly made so much noise if there had been such extensive agreement as Ingves suggests there was. [Edit Nov. 6: Lars EO Svensson tweets about this.]

Further down Ingves writes:

In addition, the market rates in Sweden have followed the repo rate very well. Both Swedish households and companies have faced low interest rates – lower than in the euro area last year, even though the ECB’s policy rate has been lower. This shows that Swedish monetary policy works effectively, and is also a reason why we have weathered the crisis in relatively well.

My emphasis. Here one gets the impression that the fact that the Swedish market rates follow the repo rate shows that the Riksbank’s monetary policy has been effective. In my understanding, this fact is, however, rather due to the the Swedish banking system being in better health than its European counterparts. The fact that the Swedish market rates follow the repo rate is not an effect of monetary policy being effective, but rather a prerequisite for it to be so. If changes in the repo rate would not lead to changes in market rates, it would be difficult for the Riksbank to control the economy.

It is, by all means, possible to interpret this paragraph as saying that a strong correlation between the repo rate and the market rates is a prerequisite for an effective monetary policy, but I think that most readers will rather interpret Ingves as saying that this strong correlation shows that monetary policy has been effective. It almost seems like Ingves is being deliberately ambiguous here. (With the reservation that I may have misunderstood this not too clear paragraph.)

Furthermore Ingves defends the tight monetary policy as follows:

In addition, Sweden had [in 2009] no framework for prudential supervision in place to curb households’ credit growth. The measures have been introduced since then have not been sufficient.

This to some extent inconsistent with what he says higher up:

 It is true that we have communicated actively on debt to get the issue on the agenda, but the rate increases primarily had conventional monetary policy purposes.

Ingves writes further down:

Inflation will rise. There are those who argue that the interest rate cuts are not enough. Some facts that tell against this are that the Riksbank has cut interest rates sharply, has postponed the time of the first increase and that monetary policy so far has had a good impact on the rates that households and companies get.

The critics are of course aware of the facts that the Riksbank has cut the interest rates sharply and postponed the time of the first increase. The gist of their criticism is that this is not enough. These two statements can therefore hardly count as arguments. That monetary policy has had a good impact in the final rates that households and firms is nothing new either. This argumentations is thus very weak.

Ingves writes further down:

Household mortgages are currently increasing by 6 per cent year – which is more than twice as fast as GDP and almost twice as fast as household disposable income.

In this context it should be noted that this is not something new. This is the growth of household debt (of which mortgages account for more than 80%) from 1999 to 2012:

Finally, Ingves writes:

We need several measures to deal with this situation, but a good initial step is to introduce amortization requirements. Here it is obviously important to apply an appropriate dosage so that credit and house price growth slow but a sharp fall in house prices is avoided.

First, the notion that household debt is a problem not uncontroversial (Lars E.O. Svensson argues against this notion in an interesting post). Furthermore, Ingves gives no justification of why amortization requirements would be an appropriate measure. Already today the banks recommend loans worth more than 70% of the property value should be repaid. Smaller loans are probably seen as relatively safe even by the Riksbank. Therefore, Ingves should have given a proper explanation of why he wants to reduce the debt levels by increased repayments, rather than, for example, reduced interest-rate tax deductions or increased property taxes.

* The CPI is Sweden’s official inflation measure. CPIF is a measure of underlying inflation, which disregards the direct effects of the Riksbank’s interest rate changes. The HICP is, in turn, the EU’s harmonized measure of inflation.

The US inflation measure is, again, slightly different, but this study suggests that the US economy would exhibit roughly the same inflation if it was measured in the European way.

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