Here's a Swedish Lesson for Central Banks Seeking Inflation

  • Review recommends policy makers be given more flexibility
  • Says parliament should set and define inflation target

This is the story of a central bank that for years and years (and years) missed its inflation target. Then, one day, there was a report suggesting that maybe, we should let it miss its target occasionally.

In a widely anticipated review of Swedish central bank policy by former Bank of England Governor Mervyn King and professor Marvin Goodfriend, flexible inflation targeting is held up as the answer. Provided a number of checks and balances are in place.

“Around the world, central banks are debating the appropriate objective of monetary policy and no international consensus has yet been reached,” the two said in the report released on Tuesday in Stockholm. “The experience of Sweden is of importance to the rest of the world as well as to its own citizens.”

King and Goodfriend prescribed a series of measures for Sweden, including giving parliament the power to decide the level of the inflation target, currently at 2 percent. Policy makers in Stockholm have cut rates well below zero, unleashed an unprecedented bond purchasing program and warn they may intervene in the currency market to restore price growth.

The recommendation may feed debate outside Sweden. European Central Bank officials are facing the same disinflationary pressures, but have so far resisted any rethink of their own inflation goal. A deepening plunge in the price of oil has also raised questions on whether price gauges should include volatile oil and energy components.

The Riksbank has shown openness to changing its inflation target. Deputy Governor Cecilia Skingsley told Bloomberg on Monday that the bank has the scope to make “smaller changes” in the framework such as shifting the price measure targeted and reintroducing a tolerance band, without legal changes.

The bank received some relief on Wednesday when a key survey showed that inflation expectations over the next five years rose to 1.9 percent in January from 1.8 percent at the end of last year.

The bank has been roundly criticized for not meeting its inflation goal, in part after it raised rates too quickly in 2010 amid concern over household debt growth. Nobel Laureate Paul Krugman famously branded the Riksbank’s policy “sadomonetarist” for its effects on employment.

King and Goodfriend didn’t fault Swedish policy makers for raising rates prematurely, arguing they were “confronted with even bigger challenges than were faced by other central banks.”

The two recommended ensuring that Swedish legislation be adjusted to make clear that any decision on the country’s exchange rate regime “is a matter for government.” In this regard, what happened in Switzerland, which was forced to abandon a cap on the franc, is “a cautionary tale,” King said at a press conference.

Swedish legislators have thrown themselves into the debate triggered by the report. The country will review policy this year and then propose changes to Riksbank laws.

Finance Minister Magdalena Andersson said part of that may include instituting a dual mandate that also includes employment.

In any event, central bankers around the world will no doubt again be monitoring what happens in Sweden.

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