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Practical Monetary Policy: Examples from Sweden and the U.S.

Lars E.O. Svensson
Sveriges Riksbank, Stockholm University, CEPR, and NBER

First version: July 2011
This version: January 2012

Brookings Papers on Economic Activity, Fall 2011, 289-332.

In the summer of 2010, the Federal Reserve’s and the Swedish Riksbank’s inflation forecasts were below the former’s mandate-consistent rate and the latter’s target, respectively, and their unemployment forecasts were above sustainable rates. Conditions in both countries clearly called for policy easing. The Federal Reserve maintained a minimum policy rate, soon started to communicate possible future easing, and in the fall launched QE2. In contrast, the Riksbank started a period of rapid tightening. I find the arguments against the Federal Reserve’s easing and the arguments for the Riksbank’s tightening unconvincing. Although the Swedish economy subsequently performed better than expected, probably an important reason was that the market implemented much easier financial conditions than were consistent with the Riksbank’s policy rate path. Without the policy tightening, performance would have been even better. The U.S. economy meanwhile performed worse than expected because of factors other than monetary policy. Without the policy easing, performance would have been even worse. In short, the Riksbank did the wrong thing but was lucky, whereas the Federal Reserve did the right thing but was unlucky.

JEL Classification: E52, E58, E42, E43, E47
Keywords: Flexible inflation targeting, forecast targeting, policy evaluation