Sweden’s central bank may set the direction for other policy makers as it looks beyond conventional inflation targets to asset-price growth in an effort to prevent the next bubble.
“Not countering asset-price increases has been the conventional wisdom among central banks, but what has it actually resulted in?” said Tina Mortensen, an economist at Citigroup Inc. in London. “Surely the current crisis has made central bankers rethink policy; Sweden is actually facing this problem” because “asset prices and monetary policy are a hot topic,” she said.
Riksbank Governor Stefan Ingves has raised the repo rate four times since July even as inflation remains below the bank’s 2 percent target. The increases occurred as house prices move above pre-crisis levels and credit growth hovers near 9 percent. While Sweden raises rates, the U.S., the euro region, Japan and the U.K. are keeping borrowing costs at record lows.
The financial crisis that started more than two years ago was exacerbated by central banks holding rates too low as inflation gauges failed to capture asset-price growth, according to Johnny Akerholm, president of the Helsinki-based Nordic Investment Bank. He says most policy makers are repeating the mistake.
“We are practically re-running the same situation these days,” he said in his bank’s Dec. 17 newsletter. “Rates are low and the central banks are ‘printing money’ while virtually all prices, except the consumer prices in industrial countries, are increasing rapidly.”
Policy makers in Europe and the U.S. have started to warn of the risks associated with low rates. Bank of England Monetary Policy Committee member Andrew Sentance voted for a seventh month to raise the benchmark from a record-low 0.5 percent at the bank’s Dec. 9 meeting. Paul Fisher, the bank’s markets director, told the Daily Telegraph last week that rates should be “normalized” to about 5 percent.
European Central Bank Executive Board member Juergen Stark says monetary policy should address the threat of financial imbalances and wants forecasting models to provide broader gauges of the economy. He’s spent the past year warning that an extension of the ECB’s liquidity program risks sowing “the seeds for new imbalances.”
Still, ECB President Jean-Claude Trichet said as recently as Dec. 2 the bank will keep providing emergency funds to banks through the first quarter. The ECB’s benchmark rate has remained at a record low 1 percent since May 2009.
Mopping Up Bubbles
In the U.S., Kansas City Fed President Thomas Hoenig said this month the “continued high level of monetary accommodation” may “destabilize the economy.” The Fed has kept its main rate at zero to 0.25 percent since December 2008. The Fed said last month it will buy $600 billion of Treasuries through June, helping keep yields low.
“There’s a risk that if policy makers react to a bubble bursting by aggressively loosening monetary policy, it may lead to new damaging bubbles emerging,” said Ben May, an economist at Capital Economics Ltd. in London. “The conventional wisdom amongst policy makers has been that you shouldn’t lean on bubbles and that the best thing to do is just to try to mop them up when they burst. In hindsight, that looks like a mistake.”
Swedish headline inflation has lagged behind the Riksbank’s target since December 2008. Inflation adjusted for mortgage costs will remain below target through 2013, the bank estimates.
Growth vs Debt
House prices, by contrast, rose for a 19th consecutive month in the quarter through November, gaining at an annual rate of 5 percent. The Riksbank, which raised its repo rate to 1.25 percent on Dec. 15, said then higher rates are needed to slow credit growth.
The bank is also trying to steer the fastest economic rebound in the European Union as it estimates growth of 5.5 percent this year. It expects the repo rate to average 3.3 percent in 2013, while economic growth will slow to 2.3 percent in 2012.
“The focus on issues such as the level of household debt suggests the Riksbank might rather have a period of slightly weaker growth or below-target inflation than a surge in indebtedness and perhaps another boom in house prices,” May said.
Fed Chairman Ben S. Bernanke said in a Nov. 16 speech that policy makers “have to keep an open mind” on the possibility of using interest rates to pop asset bubbles. He added that the “best approach here, if at all possible, is to use supervisory and regulatory methods.”
Outside Europe and the U.S., Bank of Israel Governor Stanley Fischer has incorporated bubble fighting into policy in a country where housing supply is shaped by government control of land. Fischer, who also oversees Israel’s banking regulation, left the benchmark rate at 2 percent this week in part because house prices cooled.
According to Mortensen at Citigroup, regulation alone has done little to cool Sweden’s house-price growth. Banks, which have had to cap mortgage lending at 85 percent of a property’s value since Oct. 1, “just seem to come up with alternative products” to bypass the rule, Mortensen said.
“I wouldn’t be surprised, given what we have just been through, if this leads to some kind of rethinking, also globally,” she said.