The Riksbank’s Catch-22
The Riksbank continue their brave fight against employment, inflation and debt. The July Monetary Policy Report has a lengthy discussion (pages 42-48) of the trade-off they are making; here’s a quote:
Two monetary policy alternatives have been illustrated in this article: a higher and a lower repo-rate path. During the usual three-year forecast period, the lower repo-rate path provides better expected target attainment in terms of inflation and resource utilisation. However, as a lower repo-rate path can contribute to increased indebtedness, it also increases the risk of an unfavourable scenario beyond the forecast horizon, for example in the form of a fall in housing prices in connection
with a high level of household indebtedness. This scenario entails major losses, for example in terms of higher unemployment, which in itself can also be aggravated by a high level of indebtedness at the outset.
A monetary policy that takes into account financial imbalances therefore means that the choice between the two repo-rate paths in this case becomes a trade-off between attaining the target in the short and long term: inflation’s deviation from 2 per cent and unemployment’s deviation from a normal level during the normal three-year period are weighed against the expected course of development beyond the forecast horizon (see Figure A5).
I think Yossarian would appreciate all this. The Riksbank are deliberately missing their targets – keeping inflation below target for longer, and unemployment higher for longer. Why? Because if they tried to hit their targets then the bogeyman named “household debt” might jump out from underneath the bed. So what, you might ask? Well, if the debt bogeyman strikes, the Riksbank might miss their targets.
What is most depressing to read is that they are clearly trying to avoid the perceived mistakes of other central banks:
One way of estimating the consequences that a fall in housing prices could have for the Swedish economy is to produce a scenario based on international experience. The scenario is based on the average macroeconomic effects of a number of episodes in OECD countries where house prices have fallen and indebtedness has been high. As additional comparisons, the average course of development in Denmark, the Netherlands and the United Kingdom during the latest financial crisis is also illustrated, as well as the course of development during the Swedish crisis of the 1990s.
Failure begets failure; the lesson learnt from the UK’s failed inflation targeting regime is apparently that tight money is a good way to avoid recessions.
The Riksbank have “successfully” driven nominal GDP growth down to below 2% and headline inflation to around 0% with a well-timed series of repo rate rises: