New Ekonomistas post (in Swedish). Here is an English translation:
As is well known, the Riksbank justifies its tight monetary policy and resulting low inflation and high unemployment with the argument that the policy is needed in order to limit household debt and reduce debt growth. But the Riksbank itself, via the inflation rate, strongly affects real debt growth. By keeping inflation below target, the Riksbank actually significantly increases real debt and real debt growth. As we all know, one can debate whether household debt is a problem in Sweden or not. However, if there is debt problem, the Riksbank is making the problem worse by undershooting the inflation target. And regardless of whether or not there is a debt problem, the Riksbank is, with it s current policy, making the situation worse for Swedish borrowers and better for Swedish banks.
In the figure below, the red line shows the annual nominal growth rate for household debt, measured as the lending of monetary and financial institutions (MFI) to Swedish households. The source is the Financial Market Statistics of Statistics Sweden (table 4.3.1, a growth series from 2006 onwards that is adjusted by Statistics Sweden to be consistent over time). We see that the nominal annual growth rate has fallen since 2006 from about 13 percent to currently just under 5 percent.
But real debt (the real value of the nominal debt) is more important than nominal debt. The real growth rate of the debt (the nominal growth rate less the inflation rate) is more important that the nominal growth rate. Everything else equal, lower inflation brings higher real debt and real debt growth.
The blue line in the figure shows the annual real growth rate for household debt. We see that it has varied more than the nominal growth rate, because inflation (the yellow line in the figure) has varied. The grey line shows what the real growth rate would have been if inflation had equaled the inflation target of 2 percent. Then the real growth rate would have been 2 percentages points below the nominal growth rate. Since average inflation has been below 2 percent, the grey line is on average below the blue line. The average real growth rate would have been lower than if the Riksbank had kept average inflation on target. In the last few years, the grey line is substantially below the blue curve. Currently, the real growth rate would have been 2.7 percent if inflation had been on target.
But the actual real growth rate is currently as high as 4,7 percent and as large as the nominal growth rate, since the inflation rate is close to 0 percent. We also see that the real growth rate has increased steadily since the fall of 2011 when it was at only 2.6 percent. This increase is mainly because the inflation rate has fallen during this period, from 3 percent to 0 percent. That the inflation rate has fallen so much is mainly due to the Riksbank starting in the summer of 2010 to tightening policy and increasing the policy rate.
But is it right in this discussion to consider the nominal growth rate of household debt as more or less independent of actual inflation? Yes, for two reasons. First, since long-term decisions such as housing purchases and mortgages should depend on long-term inflation expectations rather than current inflation. And long-term inflation expectations have been close to 2 percent. This in spite of actual inflation on average having substantially undershot the inflation target. Inflation has thus turned out to be lower than anticipated.
Second, because the total stock of household debt is turned over very slowly. The stock of debt is turned over because old mortgages are repaid and new mortgages are taken out, mainly because the housing is sold. According to the housing statistics of Statistics Sweden, during 2000-2012 only 5.6 percent of the housing was sold each year. New mortgages are about 70 percent of the housing value, which for given real housing prices varies inflation and the price level. Changes in total nominal debt therefore depend little on actual inflation, since total nominal debt responds so slowly to changes in the price level. The dynamics of the real debt therefore depends less on the numerator (total nominal debt) and more on the denominator (the price level). (This is sorted out in more detail in this paper, this Vox column, and this English translation of an Ekonomistas post.) The main effect on the real debt is thus from the variation in inflation and the price level.
By neglecting the inflation target, the Riksbank causes a greater increase in real debt than if it would fulfill the inflation target. Over time this adds up to considerable magnitudes. As I have shown this Vox column (and in the English translation of this Ekonomistas post), a mortgage that was taken out in the beginning of 2003 has a real value now that is about 9 percent higher than if the Riksbank had kept average inflation on target.
This also implies a large transfer of wealth from the borrower to the bank that issued the mortgage, compared to if average inflation had equaled the target and inflation expectations had been fulfilled. It also implies a higher loan-to-value ratio, a higher loan-to-income ratio, and lower net worth for this borrower. (The borrower might of course even have become unemployed due to the higher unemployment the Riksbank policy has caused.) Altogether, it implies a worse situation for and a higher vulnerability of this borrower. All this because the Riksbank is neglecting the inflation target, ironically enough with the explicit purpose of limiting household debt and reducing household vulnerability.
The conclusion is that household debt provides an additional reason why the Riksbank shall fulfill its inflation target. As we all know, one can debate whether household debt is a problem in Sweden or not (see for instance here and here; only in Swedish, unfortunately). However, if there is a debt problem, the Riksbank is making it worse, by neglecting the inflation target. And regardless of whether or not there is a debt problem, the Riksbank is, with its current policy, making the situation worse for Swedish borrowers and better for Swedish banks.