Swedish Central Bank Gains Backing for Revised Inflation Target

  • Key economic players agree with King/Goodfriend report
  • Riksbank now more likely to be given greater flexibility

The Riksbank may finally get what it wants after the country’s key economic players backed calls for Sweden’s central bank to be granted more time to reach its inflation target when aggressive interest cuts risk causing havoc to the economy.

In response to a review of the Riksbank commissioned by parliament, most institutions also called for the bank to change its official inflation gauge to an underlying index, which strips out changes to mortgage costs.

“There should be a possibility for the Riksbank to, due to consideration of financial stability or big disturbances in the real economy, temporarily prolong the monetary policy horizon to reach the inflation target,” Hans Lindblad, head of the Swedish National Debt Office said.

In the review, former Bank of England Governor Mervyn King and Marvin Goodfriend recommended that the Riksbank be allowed more time than the conventional two years to reach its target, as long as it can justify why to lawmakers. King and Goodfriend also proposed that the Riksbank change its inflation gauge to avoid a situation whereby lower interest rates help push down inflation via lower mortgage costs. The Riksbank itself backs their view on a more flexible time frame and says there are advantages to changing the inflation gauge.

Sweden’s Financial Supervisory Authority, the National Institute of Economic Research, the the Trade Union Confederation LO and the National Audit Office have also expressed broad backing for King’s key recommendations, increasing the likelihood that the Riksbank’s inflation target will be revised.

Under fire

Governor Stefan Ingves has come under fire for cutting interest rates too aggressively in his bid to boost inflation. The central bank has failed to reach its 2 percent target for more than five years, and critics argue that its monetary policy is merely increasing the risk of a housing bubble and record household debt.

The fact that private debt as a share of disposable income has almost doubled in the last 20 years has also fueled a heated debate about the role of the world’s oldest central bank.

Until two years ago, the Riksbank kept interest rates higher than justified by inflation to try to stem debt. It then changed tack when it became clear that inflation was failing to pick up. Throughout, it published overoptimistic forecasts which consistently showed inflation hitting its target in about two years’ time.

“The Riksbank has systematically overestimated inflation by a lot, not the least on a 12 to 24 month horizon,” Mats Dillen, head of the NIER, said. “Since the Riksbank is no worse at making forecasts than other forecasters for other key variables such as GDP,” there “may be a risk that the civil servants adjust models that they think will be accepted by the board,” he said.

The Riksbank has cut rates to a record-low of minus 0.5 percent and now expects inflation to reach 2 percent in 2017. The bank is also not ruling out currency interventions to defend its price target.

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