Krugman still thinking about Sweden — and still only gets it partly right

21 Apr, 2014 at 11:33 | Posted in Economics | 23 Comments

As I reported last week, Sweden is according to Statistics Sweden in a state of deflation. The inflation rate was -0.6 percent in March.

To a large extent the deflation is caused by tight monetary and fiscal policies  pursued by Sweden’s  Central Bank and the government. With a very defensive fiscal policy and a targeted inflation rate set at a very low level, real inflation has during the last 2-3 years been very close to zero, and now even negative. Another consequence of the austere fiscal and monetary policies is that overall unemployment is still at almost 9 % and youth unemployment close to 26 %.

This is deeply worrying. On this Krugman and yours truly seem to agree:

I’m still thinking about Sweden’s slide into deflation, which actually offers several lessons relevant to the rest of us.

First, it’s an object lesson in the power of sadomonetarism, the desire of many monetary officials to raise interest rates … In 2010 Sweden had high unemployment and low inflation; Econ 101 level macro should have said that this was no time to raise rates. Yet the Riksbank went ahead and did so anyway. Why?

It now says that it was all about financial stability, about fears of excessive house prices and borrowing. But that’s not what it was saying at the time! The bank’s governor did a chat in December 2010 in which he declared that it was about inflation:

“If the interest rate isn’t raised now, we’ll run the risk of too much inflation further ahead. This wouldn’t be good for the economy. Our most important task is to ensure that we meet our inflation target of 2%.”

Strange to say, however, when inflation started coming in well below the target, the Riksbank just kept raising rates, and switched to the financial stability justification.

Krugman’s argumentation, however, gives a somewhat too simplistic view of the problems facing the Swedish economy today. And just pooh-poohing deeply felt concerns and fears of a housing bubble with conspiracy theories (“excuses”) is debating economic policies analogous to playing tennis with the nets down.

So let’s try to get the full — and somewhat more complicated — picture right.

Lars E. O. Svensson — former deputy governor of the Riksbank — has repeatedly during the last year lambasted 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.

So far, so good — I have no problem with Svensson’s — or Krugman’s — argument about the inadequacy of the Swedish inflation targeting policies.

However, what makes the picture more complicated than Krugman — and Svensson — wants to admit, is that we do have a housing bubble in Sweden — it’s not just a figment of imagination the “bad guys” use to intimidate us with. [That said, I, of course, in no way want to imply that central bank interest rate targeting (and/or accommodations) is the best way to counteract housing bubbles. Far from it.]

The increase in house loans – and house prices – in Sweden has for many years been among the steepest in the world.

Sweden’s house price boom started in mid-1990s, and looking at the development of real house prices since 1986, there are obvious reasons to be deeply worried:

Source: Statistics Sweden

The indebtedness of the Swedish household sector has also risen to alarmingly high levels, as indicated by the figure below (based on new data published earlier this year by Statistics Sweden, showing the development of household debts/disposable income 1990 – 2012):

Source: Statistics Sweden

As a result yours truly has been trying to argue with “very serious people” that it’s really high time to “take away the punch bowl.”

The Swedish housing market — with a high level of prices and household indebtedness — has become increasingly fragile during the last two decades. A ‘Minsky moment’ actually doesn’t seem to be that far away, and we may sooner than we think face a deflationary house price spiral driving the economy to a classic Fisher-Keynes-Minsky debt deflation crisis.

And this is the part of the story that Krugman doesn’t want to admit gives some credence to the arguments put forward recently by the Riksbank.

“Simple” models may sometimes help you think clearly about matters. But sometimes it’s also absolutely imperative to get the full picture. As H. L. Mencken once famously had it:

There is always an easy solution to every problem – neat, plausible and wrong.

Added 22 & 23 April: There’s more on the rather heated Swedish debate herehere, and here.


  1. If Sweden is in deflation now, what happens when they actually start amortizising their mortgages?

  2. Lars,

    Jag tror inte du följt vad Krugman sagt om Sverige och vår eventuella bostadsbubbla. Krugman tror vi har en bostadsbubbla men vill inte använda räntan som vapen mot skuldsättningen. Frågan gäller väl egentligen om Riksbanken ska använda räntevapnet trots att FI har mandatet och bättre förutsättningar att bekämpa skuldsättningen.

      • “However, what makes the picture more complicated than Krugman — and Svensson — wants to admit, is that we do have a housing bubble in Sweden”

        Då måste jag fråga vad är det Krugman inte vill erkänna?

        • Ja, du, om det nu inte helt enkelt är så att PK så gärna vill driva en viss ek-pol linje och då blundar för fakta som inte passar in i den argumentationen …

          • Fast jag tycker inte han gör det. Han säger att även om vi har en bostadsbubbla så ska man inte använda räntan. PK har som du skrivit om sagt att han tror vi har en bubbla. Det märkligaste är att Riksbanken inte tycker vi har en bostadsbubbla men använder räntan för att bekämpa skuldsättningen.

            Att PK driver en ek-pol linje är väl inget konstigt. Det vore nästan förvånande om det han skrev på opinion pages i NY-times vore helt opolitiskt.

            • Nej det är inget konstigt att PK driver en ek-pol linje, men att han inte problematiserar bobubblans inflytande på den är.

  3. Hey Lars, I fully agree that there is rarely if ever a simple solution. But if you do manage to twist any ears in Sweden maybe you should look into Palley’s Asset-Based Reserve Requirement (ABRR) proposal. I laid it out in a recent Guardian piece. See here:

    I am hopefully going to get to propose this to some key figures in the Bank of England soon.

    What you can do under this policy is keep the interest rate low but raise interest rates on particular loans — like, say, mortgage loans. Then, when the housing bubble pops have the government step in with deficit spending that will have very low interest rates because the central bank will be holding the rates down.

    • Sounds interesting. I’ll have a look 🙂

    • I may be wrong, but I think it will not work. The system is too complex to be regulated successfully by humans. The only viable soluton is the absolute minimization or elimination of regulation; the free market reflects the will and wishes of the participants. Anything else is not freedom; it is one group of people deciding for others.

      • Oh right, Toebs. So the free market sets interest rates at the right level? Like, of I don’t know, the interest rates on Mortgage-Backed Securities (MBS) between 2003 and 2008? Get out of your libertarian fantasy land and get real. In the markets interest rates are set by speculation and, often, by outright fraud ala the NINJA loans.

        • Phil, is there a recap somewhere of the possible alternatives to the overnight rate (including now of course Palley’s ABRR) as a means for central banks to handle asset bubbles? If not, could I suggest it as a topic for your own blog at some point?

          • There’s a few options. All of them have the same result. I think Palley’s is the neatest option which is why I promote it. It’s a great idea. And I think that central banks might actually see the wisdom on this one. I’ve been working all my life to provide a theoretical justification for such actions.

  4. Krugman and his buddy Lars EO Svensson support the orthodox ‘Loanable Funds Theory’ – they do not believe that private sector credit affects economies. They don’t believe that private debt can cause problems in economies. How can you have watched the financial crisis and still believe that? By hanging out in Princeton looking at equilibrium models of an economy – ha! Every housing market that went up has either gone done or is about to go down. Sweden included, despite the Riiksbank’s valiant efforts.
    Read Steve Keen’s recent debate about why Krugman was wrong about the financial crisis:

  5. When I read Krugman’s column today in the NYT, I thought about what might be motivating the Swedish Riksbank to increase interest rates, and I thought that perhaps they had decided that structural employment would not change with a decrease in interest rates, that is, that increasing employment with cheap labor might create unfavorable competition with firms or sectors that the Swedish Riksbank opposes. So, are there any political reasons for this decision?

  6. Meantime in London we have a boom/rash of high -end speculative “residential” developments (esp along River Thames) fuelled by “hot”/”funny” money largely ex :
    1) Gulf (arabian) states
    2)Ukraine/Russian/former Soviet oligarchs.
    Our “estimable”! Foreign Secretary ruled out any sanctions which might target any of above @ 2).

    • So what though? *more* building isn’t going to reduce the building done for others. If someone has the money to pay for it, what is wrong with them having their house built? what business is it of ours to regulate someone else’s life?

  7. I lived in Stockholm for one year. Swedish labour market practises are a major part of the unemployment problem. Companies must by law dismiss employees in reverse order of hiring. This naturally strongly encourages unemployment amongst those without an existing track record, e.g. those new to the labour market, such as freshly graduated students.

    The rental market in Sweden is utterly dsyfunctional, due to law; it is in fact illegal for a private individual to rent from another private individual, without permission from the State. To obtain permission, one enters the queue and accumulates points over time. After twenty or so years, enough points are accumulated to rent in central Stockholm. Rents are set by the State and at levels far below the market rate, so supply into the rental market is massively discouraged. There is a secondary market, tenants subletting, but it’s a nightmare to be in.

    As a result, the rental market is wholly unable to remove pressure from the housing market. People buy, because renting is impossible.

    All in all, there is so far as I have seen no major problematic economic situation *not* caused by the actions of State.

    • It has nothing to do with what you’re saying.
      There simply hasn’t been enough building for a very long time to keep up with the increase in population, especially rental apartments.

      Thanks to our neoliberal government, which we had for the last 8 ears, lots of rental apartments have been transformed to tenant-ownership, making it even worse. They also removed the state incentive aimed for construction companies to build rental apartments, resulting in a halt building the very same.

  8. Svensson: “This is because a lower policy rate increases the denominator (nominal disposable income) faster than the numerator (nominal debt).”

    Is this true? It would be interesting to see some empirical data on this.

    Also, I’m not sure if it’s of relevance to Sweden, but in some countries, e.g. Iceland, mortgages and other long-term debt are usually indexed to the CPI, so inflation doesn’t really erode nominal debt.

  9. you should also consider that housing affordability has never been better and that the price of old real estate is way below the price of newly constructed real estate, meaning that prices might even be too low actually.

  10. Skriv detta i en kommentar till Svenssons inlägg istället. Vore intressant med en debatt.

  11. Couple of years ago Krugman proposed creation of housing bubble in the US. Rent-seeking is really the biggest tabu there is among economists. They will never accept that it’s an increasing cost, not wealth creation.

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