Mervyn King Puts Sweden in the Dock as Price Regime Queried

  • Former BoE chief co-authors study with Carnegie's Goodfriend
  • Sweden acts as forerunner in debate over inflation targeting

The debate over whether central banks should target headline inflation in an era of slowing global growth could take a step forward in Sweden this week.

Parliament in Stockholm will receive a review of Swedish monetary policy from 2011 to 2014 that has the scope to challenge the bank’s price target, its inflation forecasting record and past decisions to use interest rates to limit household debt. The report will be presented on Tuesday by its authors, former Bank of England Governor Mervyn King and Carnegie Mellon University professor Marvin Goodfriend.

Even the recommendation of minor adjustments could have wider ramifications in the European policy debate, as European Central Bank officials facing the same disinflationary forces are so far resisting any rethink of their own 2 percent inflation goal. Oil’s plunge from almost $55 per barrel six months ago to below $30 in January has worsened the period of very low inflation, and has refocused attention on price gauges that exclude volatile oil and energy elements.

I hope that “the Riksbank admits that structural forces, such as globalization and digitization, are affecting inflation right now in a way that it can’t do anything about,” said Robert Bergqvist, chief economist at SEB AB in Stockholm. “I hope that they will move in that direction.”

Policy makers in Stockholm have come under increased criticism that they are endangering financial stability by resorting to unprecedented stimulus measures, including negative rates, to revive inflation. Sweden’s headline inflation has hovered near zero for more than three years.

According to Annika Winsth, chief economist at Nordea Bank AB, the King and Goodfriend report will probably pave the way for changing the definition of the inflation target that will allow the Riksbank to conduct a less aggressive monetary policy.

One potential change is to re-introduce a tolerance interval of one percentage point on both sides of the 2 percent target. Another is to change the definition of the target in line with most other central banks so that it doesn’t include changes of mortgage rate costs. Minutes from the Riksbank’s latest board meeting last month showed most of the six board members were open to considering such changes to the inflation target.

“There’s the potential for smaller changes in the framework that wouldn’t need changes to the legal framework,” such as changing the measure targeted or reintroducing the tolerance band, Riksbank Deputy Cecilia Skingsley said in an interview in Brussels on Monday.

As upward pressure on the krona from investors fleeing falling rates in the euro-area has increased, threatening a downward price spiral domestically, the Riksbank has cut its main lending rate to a record low of minus 0.35 percent and launched an unprecedented government bond purchasing program. Last month, Governor Stefan Ingves also warned the bank may intervene in the currency market should the krona strengthen too much.

“They’ve been very aggressive lately, which can be explained by the very low inflation,” said Anna Breman, chief economist at Swedbank AB. “At the same time, they have been questioned and have had some pressure to more quickly return inflation to the target.” 

Breman sees no need for a reintroduction of the interval as the target is already flexible. Still, she said it would make sense to change the target variable from CPI, which includes changes to mortgage costs, to an underlying measure such as CPIF or CPIF excluding energy.

“In reality, the Riksbank steers monetary policy towards CPIF” and “a change of the target variable would make this clearer,” Breman said in a note.

Politicians are also looking into changes in the Riksbank law. Prime Minister Stefan Loefven said in December that he thinks Sweden should investigate whether the bank should take the labor market more into account. Fredrik Olovsson, chairman of the Finance Committee, said that a review of the law will start later this year, probably in summer. The details will be decided on later, he said in an interview in parliament.

“It’ll be a broad overview looking at everything from how the board is appointed, to the inflation target,” Olovsson said. “The law has been in place for about 20 years, and the world looks different today.”

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