New demands for amortization, while zero inflation eliminates the automatic amortization

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

In a speech at the meeting of the Swedish Economic Association (Nationalekonomiska föreningen) on May 28, 2014, Riksbank Governor Stefan Ingves suggested a compulsory amortization requirement and showed some calculations for such a requirement that, with a 50-year amortization period, would result in a reduction of a given household loan of 2 percent per year. Strangely enough, he avoided mentioning that the zero inflation Sweden has suffered the last few years, caused by the Riksbank’s leaning against the wind, has eliminated the automatic amortization of 2 percent per year that an inflation rate equal to the target of 2 percent otherwise would have caused. 

In the speech Ingves discussed how a few different policy measures would increase housing expenditures in an example with three typical households. The typical households are thought to represent ordinary indebted households in Luleå, Upplands Väsby, and central Stockholm, with corresponding loans and disposable incomes.

Ingves reported the consequences of a compulsory amortization requirement with a 50 year amortization period, which with linear amortization results in an annual amortization of 2 percent of the loan the first few years. (For later years, with linear amortization and thus a constant nominal amortization, the amortization as a share of the remaining loan is higher.) This means that the three typical households would face a monthly amortization of 2/12 of each household’s loan, corresponding in the example to SEK 1 833, SEK 2 917, and SEK 6 583 for the typical household in Luleå, Upplands Väsby and central Stockholm, respectively.

The other policy measures discussed are a counter-cyclical buffer of 2.5 percent, the elimination of tax relief on mortgage-rate payments, a reduction of the mortgage loan-to-value cap from 85 to 75 percent, and a mortgage-rate increase of 2 percentage points.

Ingves preferred an amortization requirement, since it according to his calculations would imply the largest increase in housing expenditures. (That it also would most likely lead to to falling housing prices and thereby higher LTV ratios, lower net wealth, and lower net wealth to assets for the borrowers was, strangely enough, not mentioned. Neither was it mentionend that amortization is an illiquid form of saving, which not at all need to be the best way of saving for all households.)

Ingves discussed several policy measures, but strangely enough he completely forgot about the Riksbank policy measure of pursuing a monetary policy that has resulted in a CPI inflation rate at zero during the last few years. An inflation rate equal to the inflation target of 2 percent and what borrowers have expected leads to an automatic and expected amortization of 2 percent per year, because the real value of the debt then falls by 2 percent per year. An unexpected low inflation rate of zero percent eliminates this automatic amortization. The real debt of indebted households thus becomes 2 percent higher per year, compared to what it would it had been with the automatic amortization for 2 percent inflation. The corresponding monthly increase in the real debt then amounts to 2/12 of the debt, corresponding to precisely SEK 1 833, SEK 2 917, and SEK 6 583, respectively, for the three typical households.

Ingves’s calculations are summarized in table 1 at the end of the speech. The table is reproduced below. I have marked the monthly increase in expenditures from Ingves’s amortization requirement, in SEK and as a share of disposable income, with red circles for the tree typical households. In addition, I have completed the table, in red, with the monthly increase the real debt that follows from an inflation rate of zero instead of 2 percent.


Thus, first the Riksbank has pursued a monetary policy that has implied that the real debt has become 2 percent larger per year than it would have been with the automatic amortization of 2 percent inflation. Then Ingves suggests an amortization requirement that would imply a reduction of the debt by 2 percent per year. The net result with Ingves’s amortization requirement would be that real debt falls by 2 percent per year, as if the Riksbank would fulfill the inflation target of 2 percent.

One might think that a simpler way to achieve the same result would be for the Riksbank to simply fulfill the inflation target. Then the real debt of the typical households would automatically fall by 2 percent per year, without any amortization requirement.