Inflation Targeting Guru Finds System Has Withstood the TestBy
Ex-Riksbanker Svensson says lower bound hasn’t been reached
Svensson says monetary policy has worked as in the text book
Central banks around the world could be heading down the wrong path by questioning their inflation targeting regimes.
That’s according to Lars EO Svensson, a former Princeton University professor and policy maker at Sweden’s Riksbank who helped write the book on inflation targeting. One lesson stemming from the experience, at least in Sweden, is that once deployed properly the system worked and was found to have far deeper resources than imagined.
“One can only hope that the Riksbank has learned a lesson and won’t raise the rate prematurely again, as it did in 2010-2011,” said Svensson, who has also served as an adviser at the U.S. Federal Reserve and New Zealand’s central bank. “After the rate cuts in 2014 and 2015, unemployment has come down and inflation has risen, so monetary policy works exactly as in the textbook.”
Svensson famously quit the Swedish Riksbank in 2013 after failing to win support for rate cuts. Not long after, the bank made a major u-turn, gave up its focus on financial stability and embarked on an historic stimulus experiment that included negative rates and bond purchases.
Led by the U.S. Federal Reserve, policy makers around the world are now attempting to unwind half a decade of extreme support measures. But there’s also a broader debate about inflation targeting. One key question is whether targets should be raised, which might give future policy makers more room to maneuver.
At least in Sweden’s case -- where the main rate has been at minus 0.5 percent since early 2016 -- that would be unnecessary, according to Svensson.
“The lower bound for the policy rate hasn’t been reached yet,” he said. While the International Monetary Fund has estimated a lower bound of about minus 1 percent, Sweden could go even lower.
Svensson says that’s “in part because the use of cash is rapidly falling” which means people are less likely to stuff wads of bank notes in their mattresses when rates are negative. Also, banks’ profits are not hurt by the low rate.
“We have more tools than before and, at the moment, I think those are enough,” Svensson said.
With inflation again further below target in Sweden, Svensson says the Riksbank’s rates may need to be kept lower for longer. The bank can even afford to let inflation overshoot, he says.
“I think you should regularly look at average inflation over the past five years,” he said. “If the five-year average is near 2 percent, it looks good, but if it’s significantly over or under 2 percent, it indicates that there is a bias in policy that you need to adjust.”
Svensson rejects the argument that Sweden’s extremely low rates have resulted in too weak a krona. To maintain that the krona is “artificially weak” is “incomprehensible,” he said.
“The Swedish economy is doing quite well,” he said. “Unemployment is on its way down, growth is good, and inflation will eventually reach the target. And that’s all happening thanks to the interest rate being quite low and the resulting weak krona.”