Inflation targeting — the Swedish experience

2 Sep, 2013 at 12:15 | Posted in Economics | 2 Comments

inflationtargeting

Lars E. O. Svensson – former deputy governor of the Riksbank – has written a blog post in which he lambasts the Swedish Riksbank for having pursued a policy during the last fifteen years that has increased unemployment in Sweden:

The conclusion from the analysis is thus that the actual monetary policy has led to substantially lower inflation than the target and substantially higher unemployment than a policy that would have kept the policy rate unchanged at 0.25 percent.

The Riksbank has more recently justified the tight policy by maintaining that a lower policy rate would have increased the household debt ratio (debt relative to disposable income) and would have increased any risks connected with the debt. But, as I have shown … this is not true. A lower policy rate would have led to a lower debt ratio, not a higher one. This is because a lower policy rate increases the denominator (nominal disposable income) faster than the numerator (nominal debt). Then the debt ratio falls …

In summary, the Riksbank has conducted a monetary policy that has led to far too low inflation, far too high unemployment, and a somewhat higher debt ratio compared to if the policy rate had been left at 0.25 percent from the summer of 2010 until now. This is not a good result.

By the way, the latest report The Swedish Economy by the National Institute of Economic Research includes a very interesting special study, ”The Riksbank has systematically overestimated inflation,” which may be important in this context. In an analysis of the Riksbank’s inflation forecasts, the NIER shows that Riksbank forecasts have systematically overestimated inflation. The NIER concludes that “[t]he Riksbank’s overestimation of inflation has contributed to overly tight monetary policy with higher unemployment and lower inflation than would have been the case if, on average, its inflation forecasts had been on the mark.”

Why the majority of the Executive Board so systematically has exaggerated inflation risks so systematically is a question that may be worth returning to.

The Swedish Riksbank has according to Lars E. O. Svensson been pursuing a policy during the last fifteen years that in reality has made inflation on average more than half a percentage units lower than the goal set by the Riksbank. The Phillips Curve he estimates shows that unemployment as a result of this overly “austere” inflation level has been almost 1% higher than if one had stuck to the set inflation goal of 2%.

What Svensson is saying, without so many words, is that the Swedish Fed for no reason at all has made people unemployed. As a consequence of a faulty monetary policy the unemployment is considerably higher than it would have been if the Swedish Fed had done its job adequately.

From a more methodological point of view it is of course also interesting to consider the use made of the rational expectations hypothesis in these model-based calculations (and models of the same ilk that abounds in “modern” macroeconomics). When data tells us that “average inflation expectations exceeded average inflation for 15 years” – wouldn’t it be high time to put the REH where it belongs – in the dustbin of history!

To me Svensson’s calculations basically confirms what I wrote a couple of months ago:

Models based on REH impute beliefs to the agents that is not based on any real informational considerations, but simply stipulated to make the models mathematically-statistically tractable.

Of course you can make assumptions based on tractability, but then you do also have to take into account the necessary trade-off in terms of the ability to make relevant and valid statements on the intended target system.

Mathematical tractability cannot be the ultimate arbiter in science when it comes to modeling real world target systems. Of course, one could perhaps accept REH if it had produced lots of verified predictions and good explanations. But it has done nothing of the kind. Therefore the burden of proof is on those who still want to use models built on ridiculously unreal assumptions – models devoid of all empirical interest.

In reality, REH is a rather harmful modeling assumption, since it contributes to perpetuating the ongoing transformation of economics into a kind of science-fiction-economics. If economics is to guide us, help us make forecasts, explain or better understand real world phenomena, it is in fact next to worthless.

2 Comments

  1. Facit för penningpolitiken: För låg inflation, för hög arbetslöshet och något högre (inte lägre) skuldkvot
    http://ekonomistas.se/2013/09/02/facit-for-penningpolitiken-for-lag-inflation-for-hog-arbetsloshet-och-nagot-hogre-inte-lagre-skuldkvot/

    2013-09-02 AV LARS E.O SVENSSON
    Sammantaget har Riksbanken fört en politik som lett till alldeles för låg inflation, alldeles för hög arbetslöshet och något högre skuldkvot jämfört med om räntan fått ligga kvar på 0,25 procent från sommaren 2010. Det är inget bra facit. Inflationen i Sverige är sedan mer än ett år långt under målet och arbetslösheten ligger högt över en rimlig långsiktigt hållbar nivå. Måluppfyllelsen för penningpolitiken är således dålig.

    Riksbanken har på senare tid motiverat den strama penningpolitiken med att en lägre ränta skulle ha lett till högre skuldkvot för hushållen (skuld i förhållande till disponibel inkomst) och skulle ha ökat risker förenade med hushållens skulder. Men som jag visat i ett tidigare Ekonomistas-inlägg och i en uppsats stämmer inte det. En lägre ränta hade lett till lägre skuldkvot, inte högre. Det beror på att en lägre ränta ökar nämnaren (nominell disponibel inkomst) snabbare än täljaren (nominella skulder).

  2. Riksbanken behöver sysselsättningsmålRiksbanken meddelar idag att reporäntan hålls oförändrad på 1 procent. Det senaste beslutet att ändra räntan var i samband med sänkningen i december 2012.
    – För varje månad och för varje räntebeslut blir det alltmer klart att Riksbankens mål måste ses över, kommenterar Ulla Andersson, Vänsterpartiets ekonomiskpolitiska talesperson.
    Riksbanken har underskridit målet fem gånger oftare än vad man överskridit det, konstaterar Ulla Andersson.

    – Det har kostat massor av arbetstillfällen. Vi har inte råd med de självpåtagna mål som Riksbanken låter sig styras av.
    – För att skapa ny dynamik på arbetsmarknaden behövs ett sysselsättningsmål vid sidan av inflationsmålet. Det har också efterfrågats länge av både fack och arbetsgivare, säger Ulla Andersson.

    Ulla Andersson, ekonomiskpolitisk talesperson (V)

    http://www.vansterpartiet.se/riksbanken-behover-sysselsattningsmal/


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