Problems with the housing market are no excuse for Ingves to miss the inflation target

New Ekonomistas post (in Swedish), “Problems with the housing market are no excuse for Ingves to miss the inflation target.” Here is an English translation.

In a two-page interview in the Swedish daily Dagens Nyheter on January 3 (in Swedish), the governor of the Riksbank, Stefan Ingves, is as usual worried about household indebtedness and now proposes a broad commission to reform the housing market. For the Riksbank, Stefan Ingves says, a housing market that works better would remove a problem that puts a burden on monetary policy. Then the scope would increases for more clearly focus the interest-rate decisions on achieving the inflation target “in reasonably short time,” he says. But are problems with the housing market an excuse for missing the inflation target?

Stefan Ingves takes as given that risks associated with household indebtedness and the housing market justifies a tight monetary policy with a higher policy rate, “leaning against the wind,” in spite of this leading to an inflation far below the target and unemployment far above a long-run sustainable rate. But this presumes that a higher policy rate would tangibly reduce these risks, and that the reduction of the risks thus achieved would be worth the cost in terms of too low inflation and too high unemployment. This can be questioned, as is well known. In fact, the Riksbank’s “leaning against the wind” seems to be counterproductive as a way to reduce household indebtedness.

Ingves thus seems to mean that household indebtedeness is a reason to undershoot the inflation target. But, at closer scrutiny, household debt is an additional reason for the Riksbank to fulfill the inflation target. This is because households expect inflation approximately equal to the target. If then inflation is allowed to fall below the target, the households suffer an unexpected and unwelcome capital loss on their debt, in the form of a higher real debt, compared if inflation had equaled the target. Currently, this capital loss is considerable, for instance, SEK 40 000 for each SEK million borrowed in the fall of 2011, and SEK 80 000 for each SEK million borrowed in the spring of 2003. The capital loss leads to an unexpected and unwelcome increase in households loan-to-value ratios and a reduction of their net worth, and the households’ resilience to disturbances is reduced, compared to if inflation had been 2 percent.

There are large structural problems with the Swedish housing market, which needs to be dealt with, but these problems are not an excuse for the Riksbank’s tight monetary policy.