Posted by: Doug Henwood | July 19, 2011

Sweden: no paradise of monetary ease

Several people have commented that my characterization of the Swedish central bank—Sveriges Riksbank—as a pretty tough customer is wrong. They point to a rapid response to the 2008 financial crisis, more dramatic than that of the U.S. Federal Reserve.

Yes, the Bank moved quickly to counteract the implosion. It flooded the system with liquidity—and briefly resorted to negative interest rates (though this was a largely symbolic gesture, since Swedish banks rarely borrow from the Riksbank). This is exactly what a central bank should do in the midst of a crisis. It also began withdrawing stimulus in early 2009 (see p. 11 of this IMF document) and has already begun tightening to fight inflation (Minutes of the Executive Board’s monetary policy meeting on 4 July 2011.)

Sweden is in a very different situation from the U.S. It got caught up in the financial crisis mainly by a hit to exports—it’s a very trade-dependent economy. It doesn’t have all the deep structural problems of the U.S. So its recovery was relatively quick and strong. Not so the U.S. But the Fed remains indulgent, and is likely to stay that way for months to come.

Sweden had a major financial crisis and deep recession in the 1990s—but its government moved to nationalize the banking system and clean it up. It was a model of how to approach a banking disaster, but it was done mainly through fiscal mechanisms and not magic monetary interventions.

But reactions to crises weren’t what was at issue. It was whether a long-term policy of easy money is either desirable or effective. And here is what the Riksbank has to say on that topic:

It was also noted in the preparatory work on the Sveriges Riksbank Act that monetary policy cannot be used to influence real economic quantities such as growth and employment other than in the short term. A central bank thus cannot lastingly increase growth and employment by conducting systematically expansionary policy. A systematically expansionary monetary policy would lead to high inflation and probably ultimately entail a poorer development of the real economy. It is therefore neither useful nor appropriate to set lastingly high growth or high employment as targets for monetary policy. Growth and employment are determined in the long term by other factors, such as technological advances, the supply of labour and the functioning of the economy. However, monetary policy can affect the average development of the price level and thus the average inflation rate. Accordingly, the statutory and thereby overriding objective for monetary policy is to maintain price stability.

In other words, the Riksbank believes that there’s not much that monetary policy can do to affect the long-term path of an economy. It can do a lot to prevent crises from getting out of hand, but outside crisis moments, its stated responsibility under Swedish law is price stability. (By contrast, the Fed has what is usually called a dual mandate —price stability and “maximum employment.”) I’ll stick with my characterization of the Riksbank as a tough customer.

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Responses

  1. That’s edifying.

  2. 1. “It also began withdrawing stimulus in early 2009”

    The document shows that Sweden kept the primary tool of monetary stimulus active in 2009 (the repo rate cuts). P. 10 shows that they doubled liquidity in 2009. P. 11 shows that they ended some “bailout” fiscal programs that provided loans directly to companies. Some programs ended, but liquidity shot up dramatically in the second half of 2009.

    2. “But reactions to crises weren’t what was at issue. It was whether a long-term policy of easy money is either desirable or effective.”

    No. No one is arguing that monetary policy can increase employment in the long run (in economic jargon, no one is challenging the “neutrality of money” principle). The increase in unemployment happened in a very short period of time, and monetary policy can effectively reverse sharp short-run drops in output.

    3. “its stated responsibility under Swedish law is price stability”

    Yes, but through the mechanism of a “flexible inflation target.” This is a sort of backdoor dual-mandate that allows the central bank to stimulate in order to reverse sharp drops in output and employment in the short run. Indeed, it is only by doing this that they can restore average inflation to the explicit 2% target (the financial crisis caused sharp deflation which must be counteracted with inflation if the latter is to average out to 2% over the medium term).

    4. “I’ll stick with my characterization of the Riksbank as a tough customer.”

    It’s precisely their toughness that allowed them to be stimulative. No one doubted that they would return average inflation to 2%. This meant that no one doubted that the central bank would allow inflation above 2% temporarily in the service of restoring full employment. The Fed’s weakness is precisely what is rendering it ineffective, as no one believes that it will attempt to counterbalance deflation with above-average inflation, even temporarily.

  3. The Fed’s “weakness”? Huh?

  4. If the Riksbank is “tough,” then it’s opposite would be “weak.” It’s your metaphor, dude.


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