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.
One can assess the monetary policy stance according to the outcome for inflation and unemployment. Since the inflation rate is far below the target and the unemployment rate is far above a long-run sustainable rate, and likely to remains so for quite a while, one may with this measuring rod conclude that monetary policy in Sweden is contractionary, even strongly contractionary.
Another way is to compare with the policy rate abroad. Figure 1 shows the policy rate in Sweden, UK, and the US, as well as the so-called Eonia rate in the Eurozone (EZ). In the Eurozone there can be a substantial difference between the official policy rate, the Main Refinancing Rate (MFR), and the interest rate that matters to the economy, the Eonia rate (the overnight rate in the Eurozone). Since the ECB controls the Eonia rate by controlling the floor of the interest-rate corridor around the MFR, one may see the Eonia rate as the actual policy rate in the Eurozone. Therefore the figure shows the Eonia rate instead of the MFR.
We see that the Riksbank’s interest-rate increase starting in June/July 2010 have led to a substantial interest-rate differential between the policy rate in Sweden and the rates abroad. The differential to the rates in the Eurozone and the US is 1 percentage point in December 2013, to the rate in the UK 0.5 percentage points. We see that the differential to the rates in the UK and the US were particularly large during 2011 and 2012.
Update May 2015: In the updated figure below, we see that the Riksbank has recently lowered the policy rate to minus 0.25 percent. As an FT editorial on May 2, 2015, puts it:
Another central bank announcement this week underlines the foolishness of tightening monetary policy too quickly. The Riksbank, the Swedish central bank, said it would expand its quantitative easing programme in amounts that imply it will end up owning about 15 per cent of all Swedish government bonds.
The Riksbank has already lowered its repo rate to minus 0.25 per cent, the world’s lowest, and may be compelled by the threat of deflation to cut it further. Yet the central bank may not have been forced to ease so aggressively had it not prematurely raised interest rates in 2010 and 2011, and then failed to reverse course quickly enough when inflation sank below target.
However, what affects the economy is mainly the real interest rates, not nominal interest rate. If one wants to compare real policy rates in Sweden and abroad, one has to adjust the nominal interest rates for inflation. This can be done in several ways. A simple and robust way to adjust short rates, which the policy rates are, is to subtract the actual inflation rate from the policy rates, where actual inflation is measured in the same for the different economies. Eurostat calculates HICP inflation for the Eurozone and the countries in the European Union, but not for the US. For the US, I therefore use core PCE inflation. Figure 2 shows the inflation rate for the economies in question. We see that HICP inflation in Sweden has fallen steadily since 2010 and by December 2013 become substantially lower than in the other economies. We also see that inflation in the Eurozone and the US has fallen since 2012.
Update May 2015: In the updated figure below, we see that Swedish HICP inflation has stayed not far from zero after December 2013. Recently HICP inflation in the Eurozone and UK has fallen close to zero, whereas US core PCE inflation has stayed above 1 percent.
Figure 3 shows real policy rates in these economies, constructed as the difference between the interest rates in figure 1 and the inflation rates in figure 2. Since Sweden in December 2013 has both a higher policy rate and a lower inflation rate, the real policy rates in recent years become much higher in Sweden than in the other economies. We see that the real policy rates follow each other pretty closely during the crisis years 2008-2009 (although the real rate in the Eurozone is higher). We also see that the Swedish real rate started to rise strongly in 2010, both because the inflation rate fell but also because the Riksbank started to increase the policy rate in the summer of 2010. The real interest-rate differential increased to as much as 2-3 percentage points during 2011-2012, and it remains high in December 2013. Such high real interest-rate differentials normally lead to a very strong currency, and a strong currency is what Sweden has in December 2013.
Update May 2015: In the updated figure below, we see that the real policy rate in Sweden recently has fallen to negative numbers, whereas the real rates in the Eurozone and UK have risen to about zero. The US real interest rate has stayed low and negative.
Measured in this way, monetary policy has been substantially more contractionary in Sweden than in the other economies, especially during 2011 and 2012, but also during 2013. This in spite of the inflation rate in December 2013 being lower in Sweden than in the other economies (as we see in figure 1), and also in spite of the unemployment rate in Sweden according to Eurostat being higher than in the UK and in the US and in most comparable countries in the Eurozone. (Update May 2015: Since the Swedish unemployment rate has stayed high at around 8 percent whereas it has fallen in the UK, US, and most comparable countries, the gap between unemployment rates is even larger in May 2015.) It is difficult to argue, as the Riksbank does, that monetary policy in Sweden is expansionary in December 2013.
Update May 2015: As mentioned above, one can also assess the monetary policy stance according to the outcome for inflation and unemployment. Since in May 2015 the inflation rate remains far below the target and the unemployment rate remains far above a long-run sustainable rate, and they are likely to remain so for quite a while, one may with this measuring rod conclude that monetary policy in Sweden is still contractionary, even strongly contractionary.