Monthly Archives: November 2013

Leaning Against the Leaners

Article in Central Banking 24-2 (November 2013) 27-36.

There is much debate in Sweden and further afield about the use of monetary policy – rather than macro- and micro-prudential tools – to ‘lean against the wind’ as a way of preventing dangerous bubbles building up in economies. This article looks at whether, under a mandate of flexible inflation targeting, household debt should be introduced as an additional target for monetary policy. It also reviews how to conduct policy evaluation, drawing on six years of experience gained as a policymaker at the Sveriges Riksbank.

“Leaning Against the Wind” Leads to a Higher (Not Lower) Household Debt-to-GDP Ratio

New revision, November 2013.
Vox column: “The Riksbank is wrong about the debt: Higher policy rates increase rather than decrease the household-debt ratio,” September 3, 2013.

Abstract

“Leaning against the wind” — a tighter monetary policy than necessary for stabilizing inflation
around the inflation target and unemployment around a long-run sustainable rate — has been
justified as a way of reducing household indebtedness. But, under realistic assumptions, it
actually has the opposite effect; it leads to higher real household debt and a higher household
debt-to-GDP ratio. The reason is that a tighter policy than a baseline induces a relatively slow
fall below the baseline of total nominal (mortgage) debt but a faster fall in the nominal price
level and nominal GDP. There is then first a rise in real debt and the debt-to-GDP ratio relative
to the baseline, a rise that is almost as large and as fast as the fall in the price level and nominal
GDP. Then, real debt and the debt-to-GDP ratio slowly fall back to the baseline during a few
additional years. Therefore, “leaning against the wind” as a way of reducing the household
debt-to-GDP ratio is counterproductive.

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A comparison of monetary policy in Sweden with that in the Eurozone, the UK, and the US

New Ekonomistas post (in Swedish).  Here is an English translation.
Update May 2, 2015: Figures have been updated, and “December 2013” has replaced “now” and “currently” in the text and been inserted in a few places. A quote from an FT editorial May 2, 2015, has been inserted.

Is monetary policy in Sweden expansionary or contractionary? The Riksbank maintains in December 2013 that it is expansionary, since the policy rate, at 1 percent in December 2013, is historically low. But a comparison with history is hardly relevant, since we have had a global trend towards lower interest rates since the 1990s. A comparison with monetary policy in the Eurozone, the UK, and the US is more relevant.
Continue reading →

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. Continue reading →

Summarizing the real-economy consequences of the Riksbank’s monetary policy

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

The Riksbank has systematically neglected the inflation target by keeping inflation significantly lower than the target of 2 percent. This Ekonomistas post summarizes the real-economy consequences of this that I have covered in several previous posts. Since expectations of inflation in the short and longer run have been close to the target, average inflation has fallen significantly below expected inflation. This causes real consequences in the form of higher unemployment, an unexpected and unwelcome increase in the real value of household debt, and an unwelcome transfer of wealth from households to banks. The Riksbank thereby counteracts not only the work of the Government and the Riksdag to achieve the most important objective of economic policy, full employment, it also counteracts Finansinspektionen’s (the Swedish Financial Supervisory Authority) work to maintain financial stability and consumer protection in financial area. Continue reading →