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Riksbank’s Fight with Deflationary Pressures Haunting Sweden

 3 min read / 

Last year Riksbank, the Central Bank of Sweden, had received severe criticism from Nobel Laureate Paul Krugman for its high repo rates despite high Swedish unemployment and low inflation. Since then, as Krugman forecasted, Riksbank’s high interest rate policy didn’t do much but to increase it’s debt further, simultaneously immersing the country in deep deflation.

Nevertheless, an unexpected move came from Stefan Ingves, the Governor of Central Bank of Sweden, early this week when he cut the main repo rate to negative points. The krona remained stable over the week against the dollar at SEK8.3944 but fell 0.8% against the euro to SEK9.5762 after the Riksbank moved to a negative main repo rate policy.

Draghi ‘s bond buying program for ECB, which had the effect of weakening Euro to its rivals, has first pushed the Danmarks Nationalbank to cut its rates several times to peg against Euro. Now Riksbank joins the jamboree, and most probably will be followed by Norgesbank of Norway.  Furthermore, SNB also remains on negative rates.

Considering all of these economic tendencies to seek comfort in fiscal policy, shall we consider the traditional Keynesian theory, which gives privilege to monetary policy at times of turmoil, outdated? The only country that didn’t join the long queue of countries that go below zero to revive their economy is Keynes’s homeland, as pound sterling rose to USD1.5403 and EUR1.35.

Going back to Riksbank’s QE and low rates, the bond buying plan envisaged for now comprises SEK10bn (USD1.2 bn) in the upcoming five years in government bonds. Ingves says that the bank will expand the bond purchase even further if necessary and gives the green-light to buying bonds that have maturities of more than five years. Still, the Riksbank prefers to refrain from mortgage-backed securities given the risk of overheating in Sweden’s housing market (as Swedish household debt has increased over the past 20 years, following an increase in the bond prices). Still, to get the inflation rate at 2% Riksbank seems to be willing to take a lot of risk: Ingves said that another repo rate cut, increased purchases of government bonds and lending to companies by banks are on the way.

In early January, Sweden’s Finance Minister supported the low inflation target of ECB but added:

“to what extent and how it affects Sweden is also about how the Riksbank will act in the future. But I have noticed that even the Riksbank has also discussed the use of more unconventional methods”

Magdalena Andersson, Sweden’s Finance Minister

However, in early February, she blamed Europe for Swedish stagnation and lowered her GDP estimate of 2.7% to 2.4% for 2015. In the meantime, the household pessimism prevails, CPI forecast of Riksbank fell to 0.1% and the unemployment rate decreased only slightly compared to 2014. Although Swedish economy is recovering, it will take a lot of effort to reignite its golden era.

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