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Sweden has long been a leader in the field of monetary policy. The homeland of Wicksell and Cassel pioneered the first price level targeting regime, in 1931. In 2008 they depreciated the krona, which is why Sweden did better than the rest of the Eurozone. Unfortunately they are now pioneers in a rather unfortunate direction. But first a bit of context.

A few months ago I pointed out that the view of policymakers tend to be shaped by the key events of their youth. Thus the 55 year-old policymakers of the 1960s had their views shaped by the Depression, and erred on the side of too much inflation. Today’s policymakers were shaped by the Great Inflation, and you can see the results all around us. I speculated that the next generation would be obsessed with stamping out bubbles, because the consensus (wrongly) interpreted the Great Recession as being caused by bursting bubbles, whereas in fact the “Ben Bernanke criterion” for judging the stance of monetary policy makes it very clear that the Great Recession was caused by tight money.

I was sad to hear that Lars Svensson decided to retire from the Riksbank. He was a lonely voice of reason in a policy environment increasingly dominated by irrationality:

Svensson, who taught together with Bernanke at Princeton University more than a decade ago, has spent the years since the onset of the global financial crisis arguing that Sweden’s failure to spur inflation has killed jobs. Annual headline inflation accelerated to zero in March from minus 0.2 percent a month earlier and has been below target since January 2012. Sweden’s 8.5 percent jobless rate is the highest in Scandinavia. The departure of the most outspoken member of the Riksbank’s six-member board has added sparks to a global debate on the role of monetary policy. The International Monetary Fund this month urged central banks to do more to stimulate growth, even as record liquidity risks fueling assets bubbles. Ingves, who is also the chairman of the Basel Committee on Banking Supervision, has cautioned against excessive easing, arguing monetary policy can’t ignore household debt growth.

Svensson has again and again pointed out that policy has been too tight, even by the forecasts of the central bank itself. They have set their target interest rates at a level too high to hit their employment and inflation mandate, under any weighting scheme. His opponents talk vaguely about the dangers of potential bubbles, even though that’s not the Riksbank’s mandate, and there are no good macro models suggesting that debt is addressed more effectively through monetary policy than regulation.

I’ve frequently done blog posts providing long detailed discussions of the minutes of the Riksbank. I get the feeling that most readers were uninterested. But in many ways the Riksbank debate was our clearest most transparent window into modern central banking. The views of both sides were very clearly explained. There was no zero bound problem. Here’s what we have learned:

1. The “austerian debate” is a phony debate. There are lots of central banks that are not at the zero bound (Sweden, Canada, Australia, the ECB, etc), and yet even in these cases money is currently too tight. Recall that even Paul Krugman admits that fiscal stimulus is not needed when central banks are not at the zero bound. The problem in the world today is not fiscal austerity; it’s tight money. Today many Fed officials want to scale back on QE.

2. Despite the fact that our mainstream textbooks tell us that low rates don’t mean easy money, most central bankers cannot shake the suspicion that low rates do mean easy money, and that the current relatively low rates are a danger to the economy. This irrational bias is driving policy failure in much of the world. Even central banks at the zero bound (like the Fed) are inhibited in their push for unconventional stimulus by this cognitive illusion.

3. Recall that despite all the problems noted by Svensson, the Riksbank is still one of the world’s more progressive central banks. Things are even worse in much of the rest of Europe.

Most of our central banks are ignoring the flexible inflation mandates that derive from modern new Keynesian models taught at elite universities, and instead have an Ahab-like obsession with killing the Great White Bubble. When I think of the tragic mistakes being made by these central bankers I’m reminded of a comment made by John Cochrane a few years back:

Some economists tell me, “Yes, all our models, data, and analysis and experience for the last 40 years say fiscal stimulus doesn’t work, but don’t you really believe it anyway?” This is an astonishing attitude. How can a scientist “believe” something different than what he or she spends a career writing and teaching? At a minimum policy-makers shouldn’t put much weight on such “beliefs,” since they explicitly don’t represent expert scientific inquiry.

I’d say the same about using monetary policy to address financial/debt/bubble issues. Our models tell us that this is not wise. The Fed tried to pop a bubble in 1929 and it didn’t end well. We need to focus on the dual mandate, prices and output. Yet the “beliefs” of central bankers are so powerful that they don’t seem to be able to block out these cognitive biases, as they plunge the developed world ever deeper into slow NGDP growth, high unemployment, and ballooning public debts.

PS. Stefan Elfwing sent me some very interesting information, (which includes some of Svensson’s devastating criticisms of Riksbank policies), and allowed me to reprint his email, for those interested in Sweden and/or monetary history:

Here is summary of the event during the last half year:

* They have kept the repo rate at 1% (despite worse economic figures before each meeting) * Lars’ critique in the last published minutes was extra severe http://www.riksbank.se/Documents/Protokoll/Penningpolitiskt/2013/pro_penningpolitiskt_130212_eng.pdf“Deputy Governor Lars E.O. Svensson began by stating that in order to assess which monetary policy should be conducted it is important to view monetary policy in a broader context. He claimed that what we have been witnessing for some time now is a clear and serious failure of monetary policy. His first point in support of this claim was that CPIF inflation was close to the target of 2 per cent in 2010 but that since then it has steadily trended downwards to arrive at or below 1 per cent in 2012. At the same time,unemployment is now high and rising, and far above a long-run sustainable rate. He wondered what happened in 2010 that can explain the fall in CPIF inflation. From and including the monetary policy meeting in June 2010, the majority on the Executive Board steadily raised the repo rate at every monetary policy meeting, from 0.25 in June 2010 to2 per cent in July 2011, an increase of 1.75 percentage points. Mr Svensson referred to an article he wrote for Brookings Papers on Economic Activity in the autumn of 20111 inwhich he showed that these repo-rate increases began despite the fact that the CPIF forecast in June 2012 was below the target and the unemployment forecast well above a reasonable long-run sustainable rate (Figures 1 and 2, from the Brookings article). Since December 2011, the majority on the Executive Board has, somewhat reluctantly, lowered the repo rate to 1 per cent in December 2012, a cut of 1 percentage point. On average, the repo rate has been approximately 1.5 percentage points higher than if it had remained at 0.25 per cent till now. In terms of the real policy rate, this has entailed a much tighter monetary policy than in the euro area, the United Kingdom and the United States despite the fact that inflation in Sweden has been lower than in these economies while unemployment is now approximately as high as in the United Kingdom and United States (Figure 3).” * Svensson wrote, for the first time in Swedish (world?) history, a 6 page reservation to the Riksbank’s Account of monetary policy for 2012 to parliament:The aftermath was a bit bizarre. When announcing the account, there was a link to Svensson’s reservation on the English version of the Riksbank’s homepage. However, there was no link on Swedish version of the homepage. The reservation was instead buried deep down in the report section. Here is a link to Lars’ reservation:http://www.riksbank.se/Documents/Rapporter/RPP/2013/probil_dir_B_130319_eng.pdf“I enter a reservation against the Account of monetary policy in 2012, because I consider the account to be incomplete and in several respects misleading and thus it does not offer an adequate basis for an assessment of the Riksbank’s monetary policy. Target attainment is currently poor, since inflation is way below the inflation target and unemployment is way above a reasonable long-run sustainable rate. An important issue is whether target attainment could have been better with a more expansionary monetary policy, but a thorough analysis of this issue is missing in the account. That monetary policy has not been more expansionary is, as far as can be judged, because it has to a great extent been conducted for the purpose of limiting household debt. However, extensive research and several inquiries show quite unequivocally that the policy rate has little effect on the household debt ratio. The fact that this is the case is not indicated in the account. A more expansionary monetary policy with an unchanged low policy rate since 2010 would according to a preliminary calculation have held CPIF inflation close to the target, led to much lower unemployment and led to an insignificantly higher debt ratio in the short term, while not affecting the debt ratio in the long term.” Shorter in market monetarism terminology: The NDGP growth in 2012 was 1.6% (RGDP: 0.8%), idiots! . Regards

Stefan Elfwing . PS I have taken an interest in Swedish monetary policy during the 30s. It is truly fascinating. There was a very intense and high-level debate when Sweden implemented PLT inspired by Knut Wicksell (he was not involved in the debate since he died 1926). The leading op-ed commentators for the three largest newspapers in Sweden were Bertil Ohlin, Eli Heckscher, and Gustav Cassel (He wrote about 1500 op-eds on economic issues during almost 50 years!) .

http://www.riksbank.se/Upload/Dokument_riksbank/Kat_publicerat/Artiklar_PV/2011/er_2011_1_carlson.pdf Here is a summary by Benny Carlsson: . Bertil Ohlin summarized the experiment in 1936 . “The paper currency is nowadays regarded as an alternative to the gold currency not only temporarily in times of crisis but permanently. The pioneering work of educating financial opinion, which has been carried out primarily by Wicksell, Cassel and Keynes, is coming to fruition. A rejection of the antebellum gold standard does, however, not necessarily imply that a restoration of an international monetary system is hopeless. However, it seems probable that gold within such a system will play the role of servant rather than “tyrant”. [—] The experience of a rational monetary policy gained during five years of a paper currency system is a precious advantage. A future monetary system will surely combine several elements of the old gold standard and the paper standard of the crisis era.” . First Wicksell, then Cassel, and placed third, Keynes:-) . Here are character portraits of Wicksell, Cassel, Heckscher, Ohlin and Myrdal by Carlsson and Jonung: http://econjwatch.org/file_download/119/2006-09-carlsonjonung-char-issue.pdf The first four represent the whole liberal spectrum (Wicksell was a hard-core utilitarian). It is a shame that it was Myrdal who won the war of ideas after W2. http://research.stlouisfed.org/fredgraph.png?g=hKa We actually caught you in the beginning of 60s:-) Then, 35 years of stagnation due to the closest to real socialism that has been implemented in any western country (and incompetent monetary policy). Tax/ngdp was 25.2% in 1959 and 52.3% in 1991 when the big crisis hit Sweden.

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