Keynesians like Paul Krugman have complained that the US didn’t really do any fiscal stimulus; partly because of “50 little Hoovers,” and partly because Congress got cold feet after the first stimulus package ballooned the deficit.  At times it seemed like he thought America was just too unenlightened to see the wisdom of Keynesian stimulus.  Too much Fox News and too many Republicans.

That got me thinking about a line in the Swedish monetary report that I discussed in my previous post:

Denmark’s GDP increased by about 4 per cent during the third quarter compared with the previous quarter on an annual rate (see Figure 3:13). This was slightly more than expected for December. The recovery of consumption and strong exports contributed to the high growth. However, growth is expected to be dampened this year, among other reasons as a consequence of the fiscal policy austerity package adopted in May last year.

Denmark’s recovery has certainly been much more sluggish than Sweden’s.  I attributed the difference to monetary policy, but I suppose fiscal policy might also have played a role.  Yet that just leads to a deeper question, why would a civic-minded social welfare state like Denmark have pursued fiscal austerity in 2010, a period when output was still quite depressed?  Maybe Alex Tabarrok is right, fiscal policy is much more endogenous than we assume.

In recent versions of the Keynesian model discussed by Eggertsson and Krugman, austerity during a recession can be self-defeating, leading to deflationary expectations that worsen the downturn.  But unless I am mistaken, that result assumes a large closed economy.  Because Denmark chose to fix its currency to the euro, it has little control over its price level, which is set by the ECB in Frankfort.  In that case an internal devaluation might just work, or at least might be worth a shot.  In other words, Denmark behaves more like an American state than an autonomous country.  (Of course that begs the question of why didn’t Denmark devalue.  Does anyone know why Denmark joined the ERM II, but Sweden didn’t?)

In contrast, Sweden has its own monetary policy, and was able to engineer more rapid GDP growth than Denmark.  Their public finances were in better shape because faster NGDP growth means more revenue and less unemployment compensation:

Strong public finances

General government net lending has shown a remarkable degree of strengthening over the first three quarters of 2010. This can primarily be explained by the rapid turnaround of the labour market. Expenditure on unemployment benefit is decreasing, as is expenditure related to sickness and ill-health. Preliminary tax payments also indicate that corporate taxes increased during 2010. For the full year 2010, general government net lending is expected to become positive and to amount to 0.6 per cent of GDP.

I probably shouldn’t spin such an intricate theory based on a few scraps of information.  Perhaps some Nordic readers can tell me whether I have my facts right.

I also found some pretty shrewd observations about the US recovery:

Developments on the US housing market may have led to structural problems on the US labour market. Many unemployed workers need to turn to new industries and regions. At the same time, many of the unemployed are reluctant to move due to the risk of making a loss on the sale of their
homes. .  .  .

In addition, the period during which unemployment benefit may be received has been extended, which may have decreased willingness among the unemployed to seek work. This may have had a negative effect on matching. If these extended benefit periods are seen as a temporary element of a cyclical policy, this effect will be transitory. All in all, it is too early to reach any clear conclusions regarding matching efficiency over the longer term, although an abnormal deterioration of matching cannot be ruled out during the current cycle.

The first point relates to Arnold Kling’s recalculation argument.  The second argument has been made by RBC-types like Casey Mulligan.  I’ve always agreed that there is some truth to these two arguments, but have also insisted that our problems are mostly demand-side.  And I’ve made another argument that I think people have overlooked—that supply and demand shocks get “entangled.”  Both of the problems cited above occurred partly because America’s NGDP fell 8% below trend between mid-2008 and mid-2009.  If that doesn’t happen, there is little chance that Congress extends UI to 99 weeks, and the housing market would have been somewhat stronger.  The Riksbank is exactly right in assuming that the 99 week UI is transitory, and (by implication) that a faster economic recovery would help improve the “supply-side” of the US economy.

Supply and demand shocks are often treated separately in our textbooks.  In practice they are entangled in all sorts of ways.  The mid-2008 energy price bubble hurt energy-intensive capital goods makers, such as car companies.  That reduced the Walrasian equilibrium real rate, and made monetary policy effectively tighter.  Even worse, the high headline inflation rates frightened the Fed away from cutting rates after Lehman failed in mid-September, even though all the forward-looking indicators suggested a weakening economy and falling inflation.   BTW, the Riksbank seems to have been influenced by the “target the forecast” approach of Lars Svensson–not as much as he or I would have liked, but more so than the Fed.

In recent days the world’s been hit by an adverse supply shock, as worries about Libya drive up oil prices.  Less obvious is the effect on AD.  Although one might assume that high oil prices lead to high inflation, and high inflation leads to high nominal interest rates, nominal bond yields have actually plunged sharply, indicating an expected slowdown in NGDP growth (as compared to the strong growth expected just a week ago.)  Let’s hope the Fed reacts appropriately, and doesn’t repeat its tragic error of September 2008.

In Sweden, labor market flexibility seems to be moving in exactly the opposite direction as the US:

In recent years, the government has implemented a series of measures aimed at getting more people into work. Among other objectives, these measures are aimed at increasing incentives to seek work, which is contributing towards the increase of the labour force.

Whereas the US labor force is growing more slowly than our population, in Sweden it is expected to grow more rapidly for every single year from 2009-13.  Any conservative who favors neoliberal policy reforms should pray for faster NGDP growth—it will speed up the day when we can start to put some flexibility back into the US economy.

A couple items yesterday got me thinking again about Swedish monetary policy.  Here’s a comment Michael Bordo made at The Economist’s “By Invitation”:

If the central bank is successful in maintaining a stable and credible nominal anchor then real macro stability should obtain. But in the face of real shocks central banks also need to follow short-run stabilisation policies consistent with long-run price stability. The flexible inflation-targeting approach followed by the Riksbank and the Norges Bank seems to be a good model that other central banks like the Federal Reserve, should follow.

I strongly agree, but nevertheless was a bit surprised to see Michael Bordo make this argument.  I recall that he had been somewhat more skeptical about QE2 than I was, and I pegged him as being a bit more conservative, or hawkish on inflation.  In previous posts I argued that the Riksbank engineered a more rapid reconomic recovery precisely because they were more stimulative than the Fed, ECB, and BOJ.  So why do we both agree on Sweden?

I think it was Tolstoy who once said:

Successful central banks are are all alike, every unsuccessful central bank is unsuccessful in its own way.

Or maybe it was Dostoevsky.

At any rate, in previous posts I’ve argued that unsuccessful policy makes the stance of monetary policy very difficult to read.  If you are successful in stabilizing inflation expectations, then interest rates might be able to provide a reasonably reliable indicator of the stance of monetary policy.  The same is true of the monetary base.  On the other hand if you run a highly deflationary monetary policy then interest rates may fall to very low levels.  Tight money might look “easy.”  Deflation can also cause the real (and nominal) monetary base to rise sharply, as people and banks hoard base money.   Thus a deflationary monetary policy might look excessively expansive to some, and excessively contractionary to others.  The policy instruments that economists rely on become much less informative under extreme conditions.

Stefan Elfwing recently sent me the newest monetary policy report from the Riksbank.  Here (p. 30) they contrast recent trends in Swedish and US monetary policy:

In December and January, the Riksbank’s final extraordinary loans to the banks (which totalled SEK 5.5 billion) matured. This meant that all of the extraordinary measures implemented by the Riksbank during the crisis have now been completely wound up. As a result of this, the Riksbank’s balance sheet total has come close to the level prevailing before the crisis in 2008. The remaining difference in the balance sheet total is due to the strengthening of the foreign currency reserve carried out by the Riksbank in 2010.

In conjunction with its monetary policy meeting in November, the Federal Reserve announced that it would start to buy government bonds in an amount of up to USD 600 billion until the end of the second quarter of 2011. These purchases are proceeding as planned and are contributing to the continued increase of the Federal Reserve’s balance sheet total.

In addition, the Riksbank has actually been raising interest rates in recent months, and just announced an intention to accelerate the pace of rate hikes.  So how can I argue that the Riksbank has pursued a more stimulative monetary policy than the Fed?  After all, the Fed is continuing its zero rate policy, and just recently announced another $600 billion in QE, to add onto the roughly trillion dollars of assets purchased in 2008-09.

In my view the more rapid return to normalcy in Sweden reflects the success of Riksbank policy during 2008-09.  But how do we measure the policy stance of the Riksbank, if both interest rates and the monetary base are partly endogenous?  I favor NGDP expectations, but I’m obviously in the minority.  Fortunately there are two other widely accepted indicators that also point to the expansive nature of Riksbank policy.

When the world crisis became severe in late 2008, the Riksbank allowed the krona to depreciate sharply against the euro:

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This cushioned the blow from sharply declining world demand for Swedish exports, and helped keep Swedish inflation close to the Riksbank’s 2% target during 2009-10.

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And all this was done without any loss in credibility of the Riksbanks’ 2% inflation target, as evidenced by the fact that yields on 10 year Swedish government bonds continue to closely track German yields.

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One argument against my hypothesis is that Sweden did suffer a severe recession in 2009, with real GDP falling slightly faster than the eurozone.  However it is important to keep in mind that just as an individual worker or firm cannot shield itself from unemployment via complete wage and price flexibility, the same argument applies to small open economies that are exposed to a severe worldwide demand shock.  Sweden’s goods exports are close to half of GDP, if one counts goods and services they are well over 50% of GDP.  Swedish goods exports plunged more than 15% in late 2008 and early 2009.  There is simply no way Sweden could avoid a severe recession under those world economic conditions, regardless of whether they did NGDP targeting or not.

You might ask why the big depreciation of the krona didn’t prop up Swedish exports.  It may have to some extent, but consider the following example. Say a casino project  to create one of the best casino sites in Vegas orders a central air conditioning unit from Sweden. However online casinos are transforming rapidly, and a reliable site similar to casinoslotsforum.com aims to keep the readers up to date with all the latest trends and bonus promotions online! Now, assume that the construction project gets canceled because of economic problems in the US.  How much would Sweden have to cut the price on the AC unit to prevent the sale from being canceled?  Would any price cut be enough?  Sticky wages and prices in the aggregate turn nominal shocks into real recessions.  But unfortunately once that happens, price and wage flexibility at the micro level can only do so much.

Here’s some evidence from the Swedish report that supports the preceding hypothetical:

During the crisis, exports of investment and input goods in particular fell dramatically. These sectors are now primarily responsible for the strong increase in Swedish exports. The [recent] development of exports is connected with the increase of investments we now see in large parts of the world.

The depreciation of the krona might have bought Volvo, Saab and Electrolux a few more sales of cars and vacuums, as those prices fell relative to their German competitors.  But modern sophisticated economies like Sweden and Germany tend to focus on complex capital goods and inputs, which depend less on price than on demand conditions in their export markets.

If Sweden suffered a sharp fall in GDP during 2009 (slightly faster than the eurozone), what evidence do I have that monetary stimulus was successful?  I don’t have any conclusive evidence, but the report does indicate that Swedish GDP is expected to rise 5.5% in 2010 and 4.4% in 2011.  Even Germany, often regarded as the most successful of the eurozone economies, is only expected to grow 3.5% and 2.6%, that’s almost 4% less over two years.  Another interesting comparison is Denmark, which like Sweden suffered a sharp fall in GDP in 2009, and yet has a much slower recovery (2.0% GDP growth in both 2010 and 2011.)

Why did the krona rebound in 2010?  There could be a number of reasons, including sound public finances.  But one additional factor may have been the strong economic recovery in Sweden.  Recall that in late 2008 real interest rates soared in the US, but then plunged in 2009.  The original increase was partly due to tight money, and the later decrease may have reflected the weak economy in 2009.  It wouldn’t surprise me if a similar short- and long run dynamic occurred with the Swedish krona.

The Swedish report is a model of elegance, logic, and transparency.  I couldn’t help wondering why our Fed could not produce similar reports.  They clearly lay out their policy goals (2% inflation and output stability), their expectations for the economy, and the expected path of their policy instrument.  When members dissent, the reasons are clearly laid out and explained (as in the abbreviated report):

Forecasts for inflation in Sweden, GDP and the repo rate

Annual percentage change, annual average

	2009	2010	2011	2012	2013
CPI	-0.3	1.3 (1.3)	2.5 (2.2)	2.1 (2.0)	2.6 (2.6)
CPIF	1.9	2.1 (2.1)	1.9 (1.7)	1.5 (1.4)	2.0 (1.9)
GDP	-5.3	5.5 (5.5)	4.4 (4.4)	2.4 (2.3)	2.5 (2.4)
Repo rate, per cent	0.7	0.5 (0.5)	1.8 (1.7)	2.8 (2.6)	3.4 (3.3)

Note. The assessment in the December 2010 Monetary Policy Update is shown in brackets.
Sources: Statistics Sweden and the Riksbank

Forecast for the repo rate.  Per cent, quarterly averages

	Q4 2010	Q1 2011	Q2 2011	Q1 2012	Q1 2013	Q1 2014
Repo rate	1.0	1.4 (1.4)	1.7 (1.6)	2.5 (2.2)	3.2 (3.1)	3.6

Note. The assessment in the December 2010 Monetary Policy Update is shown in brackets.
Source: The Riksbank

Deputy Governor Karolina Ekholm and Deputy Governor Lars E.O. Svensson entered a reservation against the decision to raise the repo rate by 0.25 percentage points to 1.5 per cent and against the repo rate path of the main scenario in the Monetary Policy Report.They preferred a repo rate equal to 1.25 per cent and a repo rate path that then gradually rises to 3.25 per cent by the end of the forecast period. Such a repo rate path implies a CPIF inflation closer to 2 per cent and a faster reduction of unemployment towards a longer-run sustainable rate.

Sweden shows the importance of focusing on your policy goals, and doing what is necessary to achieve those goals.  Michael Bordo had some very good observations in his aforementioned essay:

BASED on the history of central banking which is a story of learning how to provide a credible nominal anchor and to act as a lender of last resort, my recommendation is to stick to the tried and true””to provide a credible nominal anchor to the monetary system by following rules for price stability. Also central banks should stay independent of the fiscal authorities.  .  .  .

The historical examples of the Wall Street crash of 1929 and the bursting of the Japanese bubble in 1990 suggests that the tools of monetary policy should not be used to head off asset-price booms. Following stable monetary policy should avoid creating bubbles. In the event of a bubble however, whose bursting would greatly impact the real economy, non-monetary tools should be used to deflate it. Using the tools of monetary policy to achieve financial stability (other than lender-of-last-resort actions) weakens the effectiveness of monetary policy for its primary role to maintain price stability.

Thus a strong case can be made for separating monetary policy from financial stability policy. The two should be separate authorities which communicate closely with each other. However if the institutional structure does not allow this separation and requires the FSA to be housed inside the central bank then it should use tools other than the tools of monetary policy to deal with financial stability concerns. The experience of countries like Canada, Australia and New Zealand which largely avoided the recent crisis, shows that some countries got the mix between monetary and financial policy right.

Even if Mike Bordo and I don’t see exactly eye to eye on what went wrong in America, we both recognize successful monetary policy when we see it.  Set a nominal target, and do what is necessary to hit the target.  Let others worry about the financial industry.

PS. As in the UK, interest rate changes distort the CPI in Sweden.  Thus the CPIF is the better indicator, as it removes the effects of interest rates on mortgage costs.

Doing Bastiat-style reductio ad absurdum arguments seems to get more difficult each day.  A few week ago I tried to satirize the view that China was the Great Satan of international imbalances, pointing out that the combined current account surpluses of tiny Switzerland and Norway (population 13 million)  is nearly half as large as China’s $289 billion CA surplus (population 1.35 billion.)  Indeed a relatively small block of countries lying between Switzerland to the south and Norway to the north have a combined CA surplus of $397 billion, and a population of only 125 million.

So I was quite startled to see an article in the Swedish press with the following headline:

Sweden ‘threatens the global economy’: study

An American think tank has criticised Sweden for maintaining a constant current account surplus and urged the country to undertake measures to stimulate domestic demand.

“Sweden has not taken sufficient measures to reduce its current account surplus,” non-profit New America Foundation, a non-profit, non-partisan US-based think tank, wrote in a statement on Thursday.

“Its fiscal policy should be more expansionary; it should encourage currency appreciation; and it should open its domestic market to foreign goods.”

I’m worried to death that I have made some sort of terrible mistake.  I know that I have a few Swedish readers; please tell me I haven’t accidentally cited a Swedish version of The Onion, so I can quickly erase this post.

Seriously, I actually respect the New American Foundation much more than the neo-mercantilists who obsess over China.  At least they have the courage of their convictions, and at least they’ve bothered to look at the data.  However I’m not quite sure about the charge that Sweden doesn’t have an open domestic market; doesn’t Sweden have relatively low trade barriers?

Be careful what you wish for.  Tim Worstall sent me this interesting post about the Nordic countries:

The UK’s centre left just doesn’t seem capable of understanding what it is that makes what they claim to want work: imagine the horror there would be if I suggested that Group 4S took over the majority of fire and ambulance services in the UK? Yet that is what Denmark does (really: it’s actually Group 4S that runs them). We can hear the screams already as Gove tries to bring the Swedish school system with its funding following the pupil, essentially a market, to the UK. Can you imagine the piteous wails if someone suggested importing the Finnish schools system (often ranked as the world number 1)? With its division at 15 into academic sheep and vocational goats?

Compare and contrast the the Swedish health care system with the NHS: taxes are raised in county and spent in county (on average, 400,000 people, it’s as if a PCT raised and spent its own money), there are copayments to see the doctor…no, we couldn’t imagine the British centre left allowing such a system to exist, could we? Nor the localism of Denmark: the national income tax rate is 3.76%: the top national one 15%. The vast bulk of the money is raised by the communes which can be as small as 10,000 people. You and I would think that money so raised will be better spent when any and every taxpayer knows exactly who is spending it and where they have a snifter on a Friday night.

This reminded me of a post I did a while back, which discussed an interesting article in the New Yorker on health care in McAllen, Texas:

In 2006, Medicare spent fifteen thousand dollars per enrollee here, almost twice the national average. The income per capita is twelve thousand dollars. In other words, Medicare spends three thousand dollars more per person here than the average person earns.

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I was impressed. The place had virtually all the technology that you’d find at Harvard and Stanford and the Mayo Clinic, and, as I walked through that hospital on a dusty road in South Texas, this struck me as a remarkable thing. Rich towns get the new school buildings, fire trucks, and roads, not to mention the better teachers and police officers and civil engineers. Poor towns don’t. But that rule doesn’t hold for health care.

I had this to say about the New Yorker quotation:

Suppose McAllen was an independent country with universal health care.  How much would it cost the government to insure the entire population?  If independent, McAllen would be poor relative to the US, but it certainly wouldn’t be poor in any absolute sense.  My guess is that it would come in somewhere around Portugal or Slovenia.  And I would also guess that it would spend less insuring the entire population than we now spend insuring the relatively small share of the population covered by Medicare.

Many on the left say we should adopt the European health care system.  A good place to start would be federalism.  The EU is roughly the size of the US, but has 27 members, each with their own health care system.  If we are to copy Europe, the first thing to do is to delegate health care to the 50 states.  No more Medicare and Medicaid.  Any public health care should be fully funded at the state level, just as in Europe.  My guess is that the good citizens of Houston and Dallas are not going to be enthusiastic about spending $15,000 per enrollee in McAllen, when the prestigious Mayo Clinic spends $6688 per enrollee.  If those on the left aren’t enthused about this idea, then let’s not hear any more talk about copying Europe’s health care system.  (After completing this post I noticed that Robin Hanson had an even better idea.)

Liberals often tell me that Swedish vouchers wouldn’t work here, our population isn’t as homogeneous and civic-minded.  I’d think that’s a much better argument against the more socialist aspects of the Nordic system, like generous unemployment benefits.  Reading this stuff I can’t help but think back to posts by people like Paul Krugman, praising our Medicare system for its low administrative costs.  He’s right; they spend very little preventing the health care industry in places like Texas and Florida from systematically looting the taxpayers.  By all means, let’s let each county run and pay for its own health care system.  If not, then stop talking about how the Swedes are superior to us.

A few weeks back I complained that Obama was trying to force me to divorce my wife.  According to The Economist, the Swedish government doesn’t do that:

In Sweden 88% of women aged between 25 and 54 take part in the labour market. It helps that the country’s extensive day-care facilities for children are largely reserved for workers, and that couples file their tax returns separately so that households do not get hit by higher marginal tax rates on their second incomes.

A larger share of Sweden’s older people, too, remain in the labour force than anywhere else on the continent, not least because they accrue higher retirement benefits for each year they work after the age of 61. If other Europeans aged between 55 and 64 were as industrious as older Swedes, the continent could reduce the gap in hours with America by almost a quarter, according to the MGI.

The rest of Europe could also learn from Denmark’s efforts to beat unemployment and from the Netherlands’ success in getting youngsters into work. To echo an old joke, heaven is where women and older people work like the Swedes, the young work like the Dutch and the unemployed find jobs like the Danes. Hell is where workers get into unemployment like the Americans and out of it like the Italians.

And we are falling behind them in neoliberal reforms.  Again, from The Economist:

Sweden offers a more encouraging lesson. In the aftermath of its banking bust in the early 1990s it not only cleaned up its banks quickly but also embarked on a radical programme of microeconomic deregulation. The government reformed its tax and pension systems and freed up whole swaths of the economy, from aviation, telecommunications and electricity to banking and retailing. Thanks to these reforms, Swedish productivity growth, which had averaged 1.2% a year from 1980 to 1990, accelerated to a remarkable 2.2% a year from 1991 to 1998 and 2.5% from 1999 to 2005, according to the McKinsey Global Institute.

Sweden’s retailers put in a particularly impressive performance. In 1990, McKinsey found, they were 5% less productive than America’s, mainly because a thicket of regulations ensured that stores were much smaller and competition less intense. Local laws restricted access to land for large stores, existing retailers colluded on prices and incumbent chains pressed suppliers to boycott cheaper competitors. But in 1992 the laws were changed to weaken municipal land-use restrictions, and Swedish entry into the EU and the creation of a new competition authority raised competitive pressures. Large stores and vertically integrated chains rapidly gained market share. By 2005 Sweden’s retail productivity was 14% higher than America’s.

The restructuring of retail banking services was another success story. Consolidation driven by the financial crisis and by EU entry increased competition. New niche players introduced innovative products like telephone services like https://www.circles.life/au/plans and internet banking that later spread to larger banks. Many branches were closed, and by 2006 Sweden had one of the lowest branch densities in Europe. Between 1995 and 2002 banking productivity grew by 4.6% a year, much faster than in other European countries. Swedish banks’ productivity went from slightly behind to slightly ahead of American levels.

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Even in America there would be benefits. But, alas, the regulatory pendulum is moving in the opposite direction as the Obama administration pushes through new rules on industries from health care to finance. So far the damage may be limited. Many of Mr Obama’s regulatory changes, from tougher fuel-efficiency requirements to curbs on deep-water drilling, were meant to benefit consumers and the environment, not to curb competition and protect incumbents. Some of the White House’s ideas, such as the overhaul of broadband internet access, would in fact increase competition. The biggest risk lies in finance, where America’s new rules could easily hold back innovation.

I didn’t always agree with President Clinton, but at least he did deregulation, welfare reform, NAFTA and cut the capital gains tax.  I can’t recall a single thing that Obama has done that a classical liberal would approve of.  Even where his private views may be libertarian (free trade with Cuba, gays in the military, ending the abuses of the national security state, medical marijuana, a smaller military, etc) he seems to lack the courage of his convictions.  No wonder he generates so little enthusiasm.

Tea Partiers complain that Obama wants to make us like Sweden.  If only that were true.  I fear we are headed toward Brazilian-style “big government.”  Lots of spending and lots of poverty.

I have a friend who teaches development.  He tells me that he would often run into the following problem.  He’d carefully work through the logic of some argument, explaining how A implies B, and B implies C. The student would nod his head in agreement.  At the end he’d say; “So here’s the policy implication, right?”  And the student would shake his head and say; “No, you don’t understand, China is different.”  (BTW, it could have been any country.)

Both Paul Krugman and I have felt this frustration when looking at the actions of the Fed, ECB, and Bank of Japan.  It goes sort of like this:

You say inflation is currently below target.  “Yes”

You say inflation is expected to remain below target for years to come.  “Yes.”

You say output is below the natural rate.  “Yes”

You say output is expected to remain below the natural rate for years to come.  “Yes.”

Ergo monetary policy should be made more expansionary.  “No.  You don’t understand, this cycle is different.”

I’ve racked my brains for an answer.  So has Krugman.  Once I even delved into pop psychology, arguing that monetary policymakers needed to have a relentlessly logical attitude in applying theory to policy.  No common sense judgments about whether interest rates “seemed to low.”  I argued this was similar to the autistic cognitive profile–blocking out any extraneous factors.

Stefan Elfwing just sent me a Google translation of an article on Lars Svensson, which led me to recall all this frustration:

Lars EO Svensson wants the federal funds rate is 1.75 percent in three years, not 3.8 percent as the Riksbank’s majority wants.

He was also against the latest interest rate rise from 0.50 to 0.75 percent.

His colleague on the Executive Board, Karolina Ekholm, voted for the increase but also want a lower interest rate over the next few years because of the doubts that exist about the global economy.

For Lars EO Svensson is the “obvious” to select a rate and interest rate forecasts that are considerably lower than the Executive Board a majority of four members chosen because it gives better effectiveness.

Our forecasts for CPIF inflation below the target most of the period and resource utilization is low.  If the interest rate path is lower we get a better effectiveness.

That sounds very logical.  So why don’t his colleagues agree?

Lars EO Svensson has repeatedly asked his colleagues on the Executive to explain why they disagree with, he has asked them to point out errors in their reasoning.  The answers are lacking.

Unfortunately I don’t speak Swedish, and I think something got lost in translation.  But I gather the other members of the board have not been able to point out errors in Svensson’s logic.

He points out that although the Finance Committee stated that it would be desirable that the Riksbank is very clear about why various policy decisions taken or not taken.

I am surprised by the disagreement about some things that should be obvious, for example, that one should not raise rates when the forecast for inflation and resource utilization is too low.

That’s why transparency is so important.  It isn’t because a central bank doesn’t know what it should be doing; it’s needed to make sure the central bank in fact does do what it knows it should be doing.

Lars EO Svensson has been accused of being an academic theorist who hide behind their models and research reports. Especially when he, in the midst of financial crisis, would have zero interest, and led a discussion about having a negative interest rate.

I see no contradiction between theory and practice.  Monetary policy should not be controlled by the brain without the ghosts of the facts and analysis.

I guess Svensson’s fellow board members did not benefit from being educated by John Stuart Mills’ father:

I recollect also his indignation at my using the common expression that something was true in theory but required correction in practice; and how, after making me vainly strive to define the word theory, he explained its meaning, and shewed the fallacy of the vulgar form of speech which I had used; leaving me fully persuaded that in being unable to give a correct definition of Theory, and in speaking of it as something which might be at variance with practice, I had shewn unparalleled ignorance. In this he seems, and perhaps was, very unreasonable; but I think, only in being angry in my failure.

Svensson continues:

The last interest rate path should not uncritically be taken as a starting point.  Any interest rate decision should stand on its own and not lean on the previous.

In a post entitled “Losing Face” I showed that central bankers don’t like to admit that their previous policy decision was wrong.

Svensson continues:

Although my colleagues do not seem to want to listen to his argument, he has not tired of sitting on the Executive Board.

Not a minute have I regretted that I took the job.  It was a challenge I could not say no to.  I got the chance to turn 15 years of research in practice.

All six members have an individual responsibility to make independent decisions and justify them.

My job is to do what I do and continue to do so.

Lars Svensson is one of the few policymakers who will come out of this debacle with his reputation intact.  I’m surprised Krugman hasn’t mentioned him in his blog posts.  (They are colleagues at Princeton.)

PS:  Two Swedish posts in one day!  What other American blog provides such complete coverage of Nordic events?  My half Swedish–half Norwegian grandmother would have been proud.