Zero inflation leads to higher debt, substantially higher debt

New Ekonomistas post (in Swedish). Here is an English translation.

The most recent observation of CPI inflation from Statistics Sweden is negative, minus 0.1 percent. The inflation rate has been around zero since November 2012. This means that the CPI index, the general price level, is now at the same level as two years ago, November 2011. If the inflation rate had been 2 percent, the price level would now have been 4 percent higher than it was in November 2011.

That the inflation rate is so low has substantial consequences for household indebtedness. The real value of household debt has become 4 percent higher than if the inflation rate had been 2 percent the last two years. For every borrowed SEK million, the borrower has made a capital loss of SEK 40 000. Furthermore, with low inflation, the nominal value of housing has become lower, in contrast to the nominal debt. Therefore the loan-to-value (LTV) ratio has become higher. A new mortgage in November 2011 has now an LTV ratio that is 4 percent higher than if inflation had been 2 percent.

PR0101_2013M10_DI_PI_SV_PRESS5

CPI (green), CPIF (yellow), and HICP inflation (black) for Sweden, and HICP inflation (blue) for the European Union. (Statistics Sweden: Data incl. October 2013)

The reason why the inflation rate is so low is that the Riksbank does not want to lower the policy rate because it is worried that the household debt would then become too high. The Riksbank is “leaning against the wind,” conducting a tighter monetary policy than is justified by the objective of stabilizing inflation around the inflation target of 2 percent and unemployment around a long-run sustainable rate.

But this policy is counter-productive. Because the policy leads to an inflation rate substantially below the target, it actually increases the real debt, the debt-to-income ratio, and the LTV ratio, compared to if the inflation rate had been on target. The policy then also reduces household net wealth and the net wealth-to-total assets ratio. The borrowers suffer a capital loss, and the lenders, the banks, make a capital gain.

Household mortgages are now according to the Financial Market Statistics of Statistics Sweden about SEK 2 300 billion. 4 percent of this is about SEK 90 billion. The Riksbank’s monetary policy has thus led to the borrowers losing SEK 90 billion and the banks gaining the same amount. This amount can be compared to the profits of the four major Swedish banks: During the third quarter this year, they were around SEK 4 to 5 billion for each of Handelsbanken, SEB, and Swedbank, about double that for Nordea. [Addition: It is true that the banks make a capital gain on their mortgages, but the also make a capital loss on their nominal financing of the mortgages. Therefore, only a small part of the SEK 90 billion stay with the banks.]

When is the Riksbank going to understand how monetary policy actually affects household indebtedness and act accordingly? And should Finansinspektionen (the Swedish financial supervisory authority), with responsibility for both financial stability and consumer protection in the financial sector,  silently watch the borrowers being hurt and the household balance sheets being weakened? And what is the Finance Committee of the Riksdag doing, the committee that supervises the Riksbank and assesses its performance and target achievement?

Here and here there is more to read about how monetary policy and inflation actually affect household debt.

 

Share Tweet about this on TwitterShare on FacebookEmail this to someoneShare on Google+Print this page