For years I’ve been fighting against the (new) conventional wisdom in economics—that the 2008 crisis shows that monetary policy must move beyond macro stability, and focus on asset price bubbles. Unfortunately, Ambrose Evans-Pritchard reports that we seem to have achieved our first important success. I say unfortunately, because it came at the expense of Sweden:
The Riksbank has been trying to “lean against the wind” to curb house price rises and consumer credit, pioneering a new policy that gives weight to the dangers of asset bubbles. But this is proving easier said than done without hurting the productive economy, suggesting that it may be better to use mortgage curbs or other means to rein in property mania.
But Jeremy Stein says that regulation doesn’t “get in all the cracks,” you need to smash asset price bubbles with a monetary sledgehammer. Or like a tidal wave that gets in all the cracks of a leaky old boat. Here are the results:
Sweden has become the first country in northern Europe to slide into serious deflation, prompting a blistering attack on the Riksbank’s monetary policies by the world’s leading deflation expert.
Swedish consumer prices fell 0.4pc in March from a year earlier, catching the authorities by surprise and leading to calls for immediate action to avert a Japanese-style trap.
Lars Svensson, the Riksbank’s former deputy governor, said the slide into deflation had been caused by a “very dramatic tightening of monetary policy” over the past four years. He called for rates to be slashed from 0.75pc to -0.25pc to drive down the krona, and advised the bank to prepare for quantitative easing on a “large scale”.
Prof Svensson said Sweden was at risk of a “liquidity trap” akin to the 1930s, with deflation causing debt burdens to ratchet up in real terms. Swedish household debt is 170pc of disposable income, among Europe’s highest.
The former Princeton University professor wrote the world’s most widely cited works on deflation, his advice being sought by the US Federal Reserve’s Ben Bernanke during the financial crisis.
You can’t “get in all the cracks” without hitting AD hard.
And then after being warned by Svensson, and a wide range of bloggers from market monetarists to Paul Krugman, the Riksbank has the gall to claim no one could have foreseen it:
Sweden’s Riksbank admitted in its latest monetary report that something unexpected had gone wrong, perhaps due to a worldwide deflationary impulse. “Low inflation has not been fully explained by normal correlations between developments in companies’ prices and costs for some time now. Companies have found it difficult to pass on their cost increases to consumers. This could, in turn, be because demand has been weaker than normal,” it said.
Yes, and when that Korean captain ordered those 300 children to stay inside the ship as it was sinking, while he waltzed away, no one could possible have foreseen a bad outcome. Right?
An exaggeration? Of course. But consider the following:
1. The Riksbank was given a legal mandate to target inflation and unemployment, not asset price bubbles.
2. For several years they have been explicitly ignoring this mandate. They have set interest rates at a level so high that their own internal research unit has consistently predicted that they would fall short on both the inflation and employment front. There’s no dispute about these facts. The board included one of the world’s leading monetary experts, Lars Svensson, and a bunch of amateurs who are in completely over their heads. They repeatedly ignored Svnesson’s warnings, even accusing him of being rude. Eventually he got so frustrated with their incompetence that he resigned.
And now they claim no one could have foreseen this policy failure?
This is exactly what would have happened in the US in the mid-2000s if the Fed had tried to pop the housing “bubble.” It’s exactly what did happen in 1929 when the Fed popped the stock price “bubble.”
Will this stop the bubblemongers? Don’t count on it. They are so convinced they are right that no amount of information will sway them.
If Sweden wants to regain its reputation for monetary policy excellence then they will fire the entire Riksbank board, put Svensson in charge, and give him a veto over any proposed additions to the board.
PS. Of course it’s NGDP that really matters, not inflation. Which is why market monetarists were ahead of the curve on these issues. It really doesn’t make much difference if the ECB inflation rate is 0.5%, or 2.5%. As long as NGDP growth in Europe is ultra-slow, the debt and jobs crises will continue.
PPS. Lars Christensen linked to an excellent new paper by Clark Johnson, discussing Ben Bernanke’s take on the events of 2008. Clark’s analysis is influenced by Keynes’s Treatise on Money. (A better book than the General Theory.)
Bernanke reveals frustration that the Fed’s effort to lower long term rates did not bring recovery: “We have gotten mortgage rates down very low. You would think that would stimulate housing, but the housing market has not recovered.”
Bernanke scarcely regards the underlying monetary problem, which was the rise in systemic demand for money. His discussion in the following pages returns to the importance of targeting a low inflation rate – apparently through all phases of the business cycle – and the importance of letting financial markets know the central bank’s interest rate targets. These are the targets identified above as ill-chosen, and use of which Bernanke has himself criticized in the past.
. . .
In in pre-Fed writings, Bernanke acknowledged the ability of central banking to satisfy demand for liquidity, and thereby to boost demand for goods and services – even under extreme conditions. There is no evident reason why such methods would not work several years after a banking crisis, or for that matter, immediately after.
HT: Paul Krugman