Riksbank wanders off the reservation?

Like many, I have some serious problems with Sweden's Central Bank, the Riksbank.  These are the people who pay for and award the "Nobel" prize in economics.  So they have a track record of promoting and rewarding the ideas of some real right-wing loons.  In that role, they are arguably as much to blame for the last 40 years of neoliberalism as any institution on planet earth.  Even the exceptions like Stiglitz and Krugman were serious neoliberals when they got their prizes.  That they have become more enlightened since then is a happy accident.

So when it comes to whether the Riksbank stays "on the reservation" when it comes to monetary policy, such questions are pointlessly amusing because in many ways, the Riksbank IS the "reservation."  Yet here we have Ambrose Evans-Pritchard telling us that the Riksbank just tore up the rulebook when they dropped their interest rates to zero the other day.  As Evans-Pritchard basically speaks for the "City," he assumes that anyone not in London is already off the reservation and so his job is to point out the errors in their thinking from that oh-so-lofty height of British arrogance.

The Swedes are a pragmatic bunch so even their doctrinaire neoliberals are probably still open to facts.  Which leads me to believe that the Riksbank insiders have seen enough data to believe that the looming problems facing the global economy are led by the specter of deflation.  Evans-Pritchard seems to think they should be more worried about fueling an asset bubble but of course, that is absurd.  While asset bubbles tend to pop on their own, there are no serious examples of deflations curing themselves.

My guess is that for once, the Riksbank got it right.  Now if they would just discover a few more enlightened economists for their phony "Nobel" prize, they might actually accomplish some good in the world.

Riksbank cuts rates to zero and mulls currency war to fight deflation

Sweden's central bank is having to pick its poison, choosing between deflation or an asset bubble

By Ambrose Evans-Pritchard, International Business Editor  28 Oct 2014

Sweden’s Riksbank has torn up the rulebook of global central banking, cutting interest rates to zero even though the economy is in the grip of a credit boom.

The extraordinary step is intended to stave off deflation but it comes at a time when the Swedish economy is growing at almost 2pc and property prices are rising briskly. The bank has abandoned earlier efforts to curb asset bubbles by “leaning against the wind”.

The Riksbank cut the deposit rate to -0.75pc in what looks like a preparatory move to drive down the krona. Governor Stefan Ingves said the bank has a toolkit of extreme measures in reserve, including use of the exchange rate. The comment is the first hint that Sweden may follow Switzerland and the Czech Republic in imposing a currency floor through unlimited purchases of foreign bonds.

Lars Svensson, the former deputy governor and a world expert on deflation, said the Riksbank is still behind the curve and may eventually have to launch quantitative easing. The bank has been caught off guard by the precipitous fall in inflation, now expected to average -0.2pc this year. The worry is that Sweden no longer has a safe margin against a 1930s deflation trap if hit by an external shock.

The Riksbank faces an acute dilemma, forced to pick between the competing poisons of deflation or an asset boom. It is a variant of the Morton's Fork faced by a growing number of central banks around the world.

“The fact that the repo rate is now being lowered further will increase the risks associated with high household indebtedness. It is therefore even more urgent now that these risks are managed. Reducing the risks requires measures aimed directly at household demand for credit,” it said.

The ratio of household debt to disposable income has jumped from 120pc to 175pc over the past 12 years. It is expected to reach 185pc by 2017. Stockholm house prices have risen 8pc over the past year. “This trend entails a risk that the economy will develop in a way that is not sustainable in the long run,” it said.

The Riksbank has in effect washed its hands of the credit boom, leaving it to government regulators to control household debt with mortgage curbs, liquidity limits for banks and other "macro-prudential" tools as best they can.

“What the Riksbank is doing is something that a lot of central banks around the world are going to have to do: once interest rates approach zero, they are forced to think about far more radical instruments,” said Lars Christensen, from Danske Bank.

The Riksbank - arguably the world’s oldest central bank, with a tradition of bold monetary experiments – carried out a dramatic volte-face in July when it slashed rates and gave up trying to restrain asset prices. Governor Ingves was outvoted in what amounted to a policy mutiny.

The shift over recent months is a triumph for Mr Svensson, who resigned last year in a stormy dispute. He said the bank made a mistake by tightening before the economy had fully recovered, and then compounding the error by allowing itself to be distracted by the noise of asset bubbles. “Low inflation has actually increased the households’ real debt burden. Riksbank policy has been counterproductive,” he said.

“A lower than expected inflation rate increases the real debt burden. This may in turn contribute to the building up of financial risks and make it more difficult for households, firms, governments and countries to manage their balance sheets. As the experience of Japan since the 1990s has shown, such a spiral may be difficult to break out of,” he added.

Nobel Laureate Paul Krugman has compared the Riksbank’s premature tightening with the error made by the US Federal Reserve in 1937. The ECB made an even more serious mistake by raising rates twice in 2011, setting off the second leg of the EMU debt crisis.

The Riksbank is now fully aligned with the Yellen Fed in Washington, which argues that raising rates to stop asset bubbles merely destroys jobs for little useful purpose. Both are pitted against the Bank for International Settlements. The BIS says radical monetary stimulus may help invidual countries but only by displacing the problem onto others, leading to a “Pareto sub-optimal” for the world as a whole. It warns that speculative excess is reaching pre-Lehman levels, and calls on global central banks to take pre-emptive action before the bubbles becomes unmanageable.

What is far from clear is whether the Riksbank can get away with such policies. It may run into harsh criticism from rest of the world if it is seen to engage in "beggar-thy-neighbour" stealth devaluation at a time when the Swedish economy is expected to grow 2.7pc next year, and has a current account surplus above 7pc of GDP.

The institution enjoys a prestige beyond its size, a legacy of the great Swedish economists of the early 20th century: Knut Wicksell, Gustav Cassel, Bertil Ohlin and Gunnar Myrdal. It is watched closely as a pioneer in central bank theory.

The bank famously began “price targeting” in the early 1930s after breaking free from the Gold Standard. The revolutionary policy was the precursor of today’s inflation targeting. It enabled Sweden to escape deflation early in the Great Depression, suffering far less damage than countries that stuck doggedly to failed orthodoxies. more