Krugman Slamming Riksbank Fuels Deflation Anxiety: Nordic Credit

The Riksbank, the world’s oldest central bank, has become a sadist in its use of monetary policy, according to Nobel Laureate Paul Krugman.

He says the Stockholm-based central bank’s bias toward tight policy during the financial crisis was a “terrible mistake” that now risks creating a Japan-style deflationary spiral. The criticism has the potential to weaken the exchange rate as international investors “question the Swedish economic development,” according to SEB AB, the Nordic region’s biggest currency trader.

Krugman’s comments go to the heart of a debate that’s splitting policy makers at Sweden’s central bank. Governor Stefan Ingves has consistently warned that low rates risk fueling a credit bubble. The bank’s pro-easing lobby -- two of its six board members -- argue too-tight policy is keeping people out of work and making the 2 percent inflation target harder to reach. Some economists even warn that Ingves risks undermining his debt fight if prices continue to fall.

“The closer you get to deflation, the worse the debt problems get, unless you lower rates,” Par Magnusson, an economist at Royal Bank of Scotland Group Plc in Stockholm, said in a phone interview. “That is fatal. Then you have to do everything in your power to get inflation going, because that’s the only thing that can hollow out the debt and help households pay off their loans.”

‘Sadomonetarist Stronghold’

Ingves, who is also chairman of the Basel Committee on Banking Supervision that Krugman describes as a “sadomonetarist stronghold,” said in an interview this month he expects inflation to return. Yet he was soon wrong-footed by a report that showed prices fell 0.6 percent in March from a year earlier, twice as much as the bank had predicted.

“Whatever their motives, sadomonetarists have already done a lot of damage,” Krugman wrote in his New York Times column published April 21. “In Sweden they have extracted defeat from the jaws of victory, turning an economic success story into a tale of stagnation and deflation as far as the eye can see.”

Most economists now estimate the Riksbank will need to cut its benchmark repo rate by a quarter of a percentage point to 0.5 percent in July. Further easing may follow after that, according to Danske Bank A/S and SEB.

Krona Losses

Since the middle of February, the krona has lost about 4 percent against the euro. It’s the worst-performer this year, after the Canadian dollar, in a group of 10 currencies monitored in Bloomberg Correlation-Weighted Indexes.

Futures on the repo rate expiring in December were yesterday trading at 0.55 percent, indicating an 80 percent chance of a cut. September futures were at 0.60 percent.

The Riksbank, which last cut in December after lowering its guidance on borrowing costs, now sees rates staying at their current level for another year. There is a “greater probability” of a cut in the near term than there was in February, the bank said April 9.

Ingves raised the repo rate by 1.75 percentage points from 2010 and into 2011. The decision prompted criticism from fellow board member Lars E.O. Svensson, who left the Riksbank last year. Svensson, who taught together with former Federal Reserve Chairman Ben S. Bernanke at Princeton University more than a decade ago, said Ingves’s reluctance to cut rates was killing jobs. He characterized the bank’s track record on inflation as “poor.”

Faulting Krugman

Inflation is “far too low,” Roger Josefsson, an economist at Danske Bank in Stockholm, said by phone. “The Riksbank must act -- we see no signs that inflation will pick up any time soon.”

Not everyone takes such a bleak view. SEB faults Krugman for failing to acknowledge that Sweden’s economy has grown faster than most of the Group of 20 nations. Gross domestic product expanded 1.7 percent in the fourth quarter from the previous three months and grew 3.1 percent from a year earlier, Statistics Sweden estimates.

Riksbank Deputy Governor Per Jansson told local newspaper Dagens Industri he found Krugman’s assessment “rather crude,” in an interview published today. Jansson cited Sweden’s growing labor market and strong economic growth rate at the end of last year as arguments to counter the Nobel laureate’s criticism.


“When he formulates himself in this way and sometimes doesn’t have his facts in order, then it is important for us to address that,” Jansson said. “It’s of course unfortunate when such a person writes in this over-simplified and partly incorrect way.”

Even so, Krugman’s comments may affect some offshore investment decisions, according to SEB.

“If more international economists question the Swedish economic development, global reserve managers could get cold feet,” Karl Steiner, senior quantitative FX strategist at SEB, said in a note. That could prompt them to “start to unwind their record holdings of Swedish government securities, which in turn would trigger a more pronounced and long-term depreciation of the krona.”

The Riksbank forecasts headline inflation will remain below its 2 percent target until mid-2015.

Deputy governors Karolina Ekholm and Martin Floden voted to cut the main rate to 0.5 percent this month. Ingves responded to concerns that the bank was missing its inflation target by repeating his warning that the debt burden of Swedish households is “a key issue for us and will remain so for the foreseeable future.”

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