In an interview in Bloomberg, Riksbank Deputy Governor Per Jansson again tries to defend the indefensible, the Riksbank’s sharp tightening of monetary policy in the summer of 2010. From the summer of 2010 to the summer of 2011, the Riksbank majority increased the policy rate from 0.25 percent to 2 percent.
The increases “from 0.25 percent in the summer of 2010 up to 2 percent in the middle of 2011 was really mostly about normal things that central banks look at,” given that growth at the time was about 6 percent, inflation was around 2 percent and household credit growth was about 9 percent, [Jansson] said. “There were really, in real time, no comments suggesting that it would be a stupid idea to increase the interest rate.”
But in real time, the Riksbank’s inflation forecast was below the inflation target and unemployment and the unemployment forecast were far above the Riksbank’s estimate of a long-run sustainable rate. In such a situation, easing, not tightening, is the right policy, since it shifts the inflation forecast up and closer to the target and the unemployment forecast down and closer the long-run sustainable rate. It thereby leads to better target achievement. Since tightening instead leads to worse target achievement, it is indefensible. My colleague in the Execeutive Board, Karolina Ekholm, and I indeed dissented from this tightening policy with very clear and logical arguments, namely that easier policy would in this situation lead to better target achievement.
As figure 1 shows, the Riksbank and the Fed FOMC forecasts for inflation and unemployment were very similar at the time. Given these similar forecasts, the Fed obviously did the right thing, keeping the policy rate very low and starting to prepare for QE2, whereas the Riksbank did the wrong thing, tightening. Or is Jansson suggesting that the Fed should have followed the Riksbank example?
Figure 1. Rikbank and FOMC (median) forecasts for inflation and unemployment in June 2010. The horizontal lines in the right panel denote the Riksbank and FOMC estimates at the time of the long-run sustainable unemployment rate. Source: The Riksbank Monetary Policy Report July 2010 and the Fed Summary of Economic Projections June 2010. For details, see Svensson, Lars EO, “Practical Monetary Policy: Examples from Sweden and the United States,” Brookings Papers on Economic Activity, Fall 2011, 289-332.
Jansson refers to high GDP growth as a reason for tightening in the summer of 2010. But as Paul Krugman says in the Bloomberg piece, Jansson seems to make “a fundamental error, confusing levels with rates of change.” Swedish GDP fell a lot during the crises, much more than US GDP. It needed to grow a lot to recover and get back toward the previous trend. Thus, high GDP growth was not a reason to tightening policy. Tightening policy slowed down the recovery and actually caused Swedish GDP to fall below US GDP from the end of 2011. In figure 2, the dashed line shows that Swedish GDP would instead have grown similarly to US GDP if the policy rate had been kept at 0.25 percent.
Figure 2. GDP in Sweden, Germany, US, euro area, and the UK. The dashed line shows Swedish GDP if the policy rate had been kept at 0.25%. Source: Datastream and own calculations.
Thus, Jansson again fails to provide a convincing defense of the Riksbank’s tightening in the summer of 2010. He suggests that Krugman should look at the facts before criticizing the Riksbank. It seems that it is Jansson that should look at the facts.
Janssons previous attempts to defend Riksbank policy, including his strange suggestion that the tightening was not motived by concerns about household debt and housing prices, have been discussed here, here, and here. The cost and benefit of the Riksbank’s leaning against the wind because of concerns about household debt are examined here (with the use of the Riksbank’s own estimates, the cost can be shown to be about 250 times the benefit).