How Sweden Joined Central Banking’s Hall of ShameJames Hertling and Jennifer Ryan
European policy makers have been their own worst enemy in the fight to avoid recession and deflation.
Swedish central bankers’ decision to cut the benchmark interest rate to zero was the latest evidence that moving too fast to remove emergency stimulus is a risky business.
“They’ve blown it,” Nariman Behravesh, chief economist in Lexington, Massachusetts, for consultants IHS Inc., said, referring to policy makers in Europe. “The focus is exclusively on deficit, on debt, on keeping inflation under control. They’ve ignored the threat of deflation and recession.”
Sweden’s not alone in having to reverse tack. The European Central Bank raised rates in 2008 and twice in 2011 to combat inflation that quickly evaporated, and the euro area now faces its third recession in six years. They echoed mistakes made by the Bank of Japan in 2000, when policy makers raised the key rate only to cut it six months later as deflation set in.
All descend from the granddaddy of central bank blunders: tightening in the U.S. that many -- including former Federal Reserve Chairman Ben Bernanke -- blame for deepening the Great Depression that started in the 1930s.
“You got to make sure that when you start to raise interest rates that the economy can sort of take it,” William Dudley, president of the New York Federal Reserve Bank, said in a Sept. 22 interview. “That’s something that we are trying to evaluate at every meeting. There are some reasons to try to be patient.”
Central bankers aren’t the only culprits. Politicians have failed to take advantage of low interest rates to borrow cheaply to juice their economies.
In the euro area, Germany has opposed fiscal stimulus while also rejecting aggressive ECB measures at virtually every turn. In the U.S. and the U.K., austerity has won the political argument, restricting their economies’ capacity to recover from the worst global recession since the 1930s.
In Japan, Prime Minister Shinzo Abe’s plan to raise the country’s sales tax again in December has fueled a heated debate on whether the economy can withstand such a move.
“Fiscal policy rather than monetary policy is where you can point the finger,” said Steven Bell, an economist at F&C Management Ltd. in London. “The countries that have room for fiscal expansion don’t want to do it.”
International Monetary Fund Managing Director Christine Lagarde warned of a “new mediocre” in the world economy this month as the Washington-based lender cut its forecast for 2015 global growth. IMF Chief Economist Olivier Blanchard sees a “major risk of stalling of the euro zone” and called for increased infrastructure spending to spur demand.
Even with that bleak assessment, the fiscal taps worldwide remain tight.
German Chancellor Angela Merkel vowed this month to stay her budget-balancing course and rejected an increase in spending. France has confronted criticism for failing to meet deficit promises.
“We in Germany are showing that growth and investment can be strengthened without leaving the path of consolidation,” Merkel said on Oct. 16. “If we want growth in Europe we have to look first and foremost at mobilizing private capital.”
The latest interest-rate cut in Sweden follows a renewed weakness in the euro-area economy that’s prompted more stimulus, including asset purchases, by the ECB. In the U.K., set to be the fastest growing economy in the Group of Seven this year, Bank of England Governor Mark Carney has shown little sign he’ll begin tightening policy before he’s certain of the recovery. Andy Haldane, the BOE chief economist, said this month the outlook has become gloomier.
In the U.S., the Federal Open Market Committee concludes its two-day meeting today after weeks of volatility in global financial markets. Chair Janet Yellen and her colleagues will focus instead on a robust U.S. outlook and end their bond-buying program as planned, according to 62 of 64 economists surveyed by Bloomberg News. By smaller margins, most also expect the FOMC to reiterate rates will stay low for a “considerable time.”
Just over half of economists expect policy makers to maintain their inflation outlook: 33 of 62 surveyed said they’ll repeat language in September that “the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.” The Fed announces its decision at 2 p.m. in Washington.
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.
That led to criticism they were too quick to raise rates as the financial crisis eased and then waited too long to fight the deflation that ensued.
“They were quite slow in reacting to the slowdown in Europe, its key export market,” said Azad Zangana, an economist in London at Schroders Plc. “The Swedish economy never really took off. That was the mistake, they believed they were in the upswing of a cyclical recovery when in fact they were still reliant on Europe.”
While Swedish 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 euro area sparked monetary easing by the ECB, the Riksbank moved into reverse. The benchmark rate was back to 0.25 percent by July this year.
In the interim, inflation dived, jobs were lost 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,” he said in a telephone interview Oct. 15, “are obvious to other central banks.”