What Yellen Needs to Learn From Sweden, Fast

By Simon Kennedy  

Photographer: Melanie Stetson Freeman/The Christian Science Monitor via Getty Images

People shop in one of the many H&M stores, on March 11, 2014 in Stockholm, Sweden.

Forget the bigger-than-forecast drop in U.S. retail sales, the surprising tumble in U.K. inflation to a five-year low, and the slide in German investor confidence.
For central banks around the world, the most informative piece of economic data released anywhere this week was the news that Swedish consumer prices fell 0.4 percent in September from a year earlier.
The seventh monthly decline of the year leaves the Riksbank dicing with deflation. The world’s oldest central bank has already undershot its 2 percent inflation target for
almost three years, and is now poised to respond by the end of this month by cutting its benchmark repo rate from a record low of 0.25 percent.
So why should this development in a country of fewer than 10 million people be of anything but passing interest to Federal Reserve Chair Janet Yellen and her international counterparts? Because the Riksbank may deserve some of the blame for the current quagmire and others can learn from its experience.
Back in July 2010, the Swedes began fretting that rising household debt and home prices needed to be checked even though inflation was half their goal. So they chose to “lean against the wind” and lifted the repo rate from 0.25 percent to a peak of 2 percent 12 months later.

Sadomonetarists

While inflation did climb -- reaching 3 percent in April 2011 -- it didn’t stay there for long. And by December that year, as a debt crisis in the neighboring euro area sparked monetary easing by the European Central Bank, the Riksbank was throwing itself into reverse. The benchmark rate was back to 0.25 percent by July this year.
In the interim, inflation dived, jobs were cost and debt climbed even higher. Nobel laureate Paul Krugman labeled Governor Stefan Ingves and his colleagues “sadomonetarist.”
One person who objected to the monetary tightening was Lars E.O. Svensson, who quit the Riksbank’s six-member board last year. He now says Sweden shows that raising rates prematurely can leave an economy in worse shape than before.
“The lessons are obvious to other central banks,” he said in a telephone interview yesterday.
Sweden isn’t alone in history. A tightening of monetary conditions in the U.S. is blamed by many for the Great Depression that started in the 1930s. In 2000, the Bank of Japan raised its key rate only to cut it six months later as deflation set in. The European Central Bank raised rates in 2008 and twice in 2011 to combat inflation that quickly evaporated.
The good news is that there are signs other central banks are learning from those experiences.
“History has not looked kindly on attempts to prematurely remove monetary accommodation from economies that are in or near a liquidity trap,” Chicago Fed President Charles Evans said this week. “Unless the economy is fundamentally strong and the previous impediments to growth have receded sufficiently, the odds remain high that some unforeseen shock could cause the monetary authority to retreat right back.”