Paul Krugman recently commented that Sweden has done much better than Denmark since 2008. Denmark’s currency is pegged to the euro while Sweden’s currency floats. Krugman (correctly) believes the euro has been a disaster. So then why this comment?
A couple of years ago Sweden was widely considered a role model, with the best recovery in the advanced world. Now, not so much, thanks to slowing growth — perhaps because of the central bank’s bubblephobia.
Meanwhile, who knew that Denmark was doing so badly? I don’t think that you want to place too much blame on the peg to the euro; this would be a drag if Denmark had entered the crisis overvalued, but it doesn’t look as if this was the case. Instead, the likely culprit is a very high level of household debt.
I find this puzzling. Mark Sadowski has some excellent comments that suggest that the difference in monetary policy pretty much explains the differing economic performances of Denmark and Sweden. Sweden devalued sharply in late 2008, and then engaged in aggressive QE and even a bit of negative IOR:
Note that between August 2008 and March 2009 the kronor depreciated by about 16% relative to the euro. The fact that Sweden’s NGDP only fell 4.4% peak to trough instead of 7.8% like Denmark is directly attributable to this fact. The Swedish Riksbank was unconstrained by the requirement of maintaining an exchange rate peg when the crisis hit and so was free to pursue a more expansionary monetary policy than the Danish National Bank.
Note also that Sweden opened up a very wide lead in NGDP with respect to the other currency areas between 2009Q4 and 2010Q4. NGDP grew by 13.4%, 6.9%, 6.9% and 11.2% in 2010Q1 through 2010Q4 respectively. Thus NGDP soared by 9.6% year on year between 2009Q4 and 2010Q4.
Was there anything that the Riksbank did during that period that might account for this?
The Riksbank increased its monetary base by more than the Fed early on in the crisis. By October 2008 it was already 121% larger than in August compared to 25% for the Fed. By December 2008 it was 225% larger compared to 101% for the Fed. However, unlike the Fed which moved to a zero interest rate policy by December 2008, the Riksbank did not lower its repo rate to 0.25% until August 2009.
Although the Riksbank was slower to move to ZIRP, during this time (this lasted through June 2010) it maintained a (-0.25%) deposit rate, the first central bank to institute a negative interest rate, and the monetary base was maintained in the range of 270% to 350% larger than it had been in August 2008. In contrast the Fed was paying (+0.25%) on reserves and the monetary base was only 100% to 140% larger than it had been in August 2008 during this period.
But then the Riksbank got what Krugman correctly calls “bubblephobia.” They stopped listening to Lars Svensson. And this is the part that’s interesting—they started raising interest rates. No more zero bound. They raised them repeatedly beginning in 2011, all the way up to 2%. Back to “normal” monetary policy. Now everyone including Krugman would say the Riksbank is steering the nominal economy.
Does this sound familiar? Yup, it’s what the ECB did at the same time. In 2011 the eurozone was doing about as well as the US, but by 2013 NGDP growth in the eurozone was falling far behind US rates.
Some people might argue that the eurozone is not a good comparison; the southern members have severe structural problems. That’s the beauty of the Swedish example—Sweden is a neoliberal economy with strong fundamentals. Not much debt. Good at exporting. Etc., etc. And what happened when the Riksbank tightened money in 2011? Here’s Mark again:
Between 2010Q4 and 2013Q3 Sweden’s NGDP has only grown at an average rate of 1.7% annually. This is barely faster than the 1.6% and 1.3% rate it has averaged in Denmark and the Euro Area respectively, and it is dramatically slower than the 3.9% rate it has averaged in the US.
Has the Riksbank done anything differently? Most definitely yes.
By January 2011 its monetary base was reduced to only 2% more than it had been in August 2008. Starting in July 2010 the repo rate was raised in quarter point increments until it reached 2.00% in July 2011 where it remained until December 2011. Since then the Riksbank was eased somewhat with the monetary base now back up to 23% larger than it was in August 2008 and the repo rate having been reduced to 1.00% by December 2012 and to 0.75% only on December 18, 2013.
In contrast the Fed has maintained its zero interest rate policy throughout and has initiated not one but two separate QE programs since the Riksbank left the zero lower bound.
Krugman seems to believe that monetary policy rulz when exchange rates are flexible and interest rates are above the zero bound. So why not cite Sweden as a textbook example of the folly of tight money? Why make vague comments about household debt?
Does fiscal policy explain what’s going on? Once again, Mark:
What about fiscal policy?
In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance takes into account any changes in the general government budget balance due to the business cycle. Thus changes in the cyclically adjusted balance are mostly due to discretionary fiscal policy, and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature. The best place to find CAPB data is the IMF Fiscal Monitor. You can find the CAPB on the bottom half of Table 2 on page 70:
Between calendar years 2007 and 2010 the Sweden’s CAPB decreased by 1.6% of potential GDP, which was expansionary. But for comparison, the CAPB of Denmark, the US and the Euro Area decreased by 4.6%, 5.3% and 3.1% of potential GDP between 2007 and 2010 respectively. And in 2010, the year that Sweden soared into the lead, Sweden increased its CAPB by 0.7% of GDP whereas Denmark, the US and the Euro Area decreased theirs by 0.3%, 0.2% and 0.2% of potential GDP respectively. Thus the year Swedish NGDP took off, her fiscal policy stance was actually contractionary in contrast to the expansionary policy stance of the other three currency areas.
. . .
Sweden’s CAPB has decreased by another 1.9% of potential GDP between calendar years 2010 and 2013. In contrast Denmark, the US and the Euro Area have increased their CAPBs by 1.8%, 4.4% and 3.7% of potential GDP between 2010 and 2013 respectively. Thus on average Sweden has had an expansionary fiscal policy during 2011-13 while the other three currency areas have had contractionary fiscal policy, and the currency area which has easily led in NGDP growth since 2010Q4, namely the US, has had the most expansionary monetary policy and the tightest fiscal policy of these four currency areas during this period.
And so it would seem that good monetary policy in 2008-2010 and bad monetary policy in 2011-13 completely account for Sweden’s relative boom, and then bust.
If you aggregated all of Mark Sadowski’s data-filled comments over the past few years into one paper, you’d have arguably the best single analysis of the interaction of monetary and fiscal policy in the developed world since 2008. And yes, I’m including Ivy League academics like Paul Krugman, who has certainly said many wise things about the euro-debacle.
PS. Unlike me, Mark is highly skilled at the technical side of macro. And in all the long comments I quoted I couldn’t find even one misspelled word. That just doesn’t happen in comment sections. He repeatedly defends my analysis despite being a moderate Democrat on other issues. Who is this guy? If there was any justice in the world, econ departments would be fighting over the opportunity to interview him at the AEAs.
Off topic. Am I the only one who never realized how big Andromeda is? It’s like monetary policy; you may not see it, but it’s THERE.