Sunday, July 09, 2006

How Euro No Vote Could Secure Social Democratic Victory

One of the arguments used by many in the "Yes" camp in the Swedish referendum on joining the Euro in 2003 was that it would lead to lower interest rates, something the "No" camp denied. The "Yes" camp was wrong and the "No" camp was right, of course, as there is no reason to believe that large currency areas will necessarily have lower interest rates than smaller currency areas ( already then,interest rates was lower in Switzerland than in the Euro-zone)and we have since then seen how both short-term and long-term interest rates in Sweden have fallen below Euro-zone levels.

But what both sides got wrong was that it is not necessarily the case that low interest rates is a good thing. Indeed, it is a bad thing when the cause of low interest rates are central bank manipulation.

And it is certainly the case that today's low Swedish interest rates are largely a result of central bank manipulation, something which is illustrated by the fact that money supply growth is running at 11.5%. And while short-term Euro interest rates have risen from 2% to 2.75% since the referendum, short-term Swedish interest rates have fallen from 2.75% to 2.25% (after reaching a low of just 1.5% during the second half of last year). While Swedish interest rates appear to be heading up now, they are not likely to rise any faster than in the Euro-zone, likely leaving the current interest rate spread unchanged, at least during the coming months.

As not only Austrian business cycle theory, but also many non-Austrians would recognice, the stimulus from artificial supression of interest rates will in most cases give the economy a short-term boost, but it will not raise long-term growth, something which of course implies by logical necessity that in the period between "short-term" and "long-term" there will be an economic downturn (at least compared to what it otherwise would have been. If structural growth is high enough however, as in China, growth might still be positive) resulting from today's low interest policies.

We are now however still living in the "short-term" period, meaning that today's high economic growth in Sweden can to a large extent be attributed to the supression of interest rates by the Riksbank.

This could have political consequences. In just a little over two months, Sweden will have a general election and the race looks tighter than ever, with the centre-right opposition running neck in neck with the ruling Social Democrats and their partners, the communist Left Party and the Green Party.

The centre-right opposition parties look better organized than ever and generally seem in much better shape than the left-wing parties, particularly as parliamentary chaos might ensue if there is a left-wing majority, as the Social Democrats wants to continue as a minority government, while the Left Party and the Green Party both insist that they must be made part of the government.

The only thing the Social Democrats have going for them is really the current strong cyclical upswing . A cyclical upswing that is largely driven by the Riksbank's low interest policies. If the Social Democrats ultimately manage to gain a narrow majority together with the Left Party and the Green Party, this will on the margin have been the result of the low interest policies of the Riksbank (which is probably the reason for the negative left-wing reaction to the recent interest rate hike ). On the margin, the half a percentage point difference in interest rates could be responsible for tipping over the balance in favor of the left-wing bloc. A low interest rate policy which given the downward pressure on consumer price inflation created by deregulation and increased competition in the retail sector (food prices have fallen due to the increased presence of low-price chains like Lidl and Netto), is a natural and unavoidable result of the existence of an "independent monetary policy" based on inflation targeting.

Ironically thus, what many considers as one of the mayor personal defeats for Prime Minister Göran Persson, the 2003 Euro no vote, could help him escape a defeat in the far more important vote of the 2006 general election.


Blogger Flavian said...

I think that you are wrong: The price of easy money in Sweden is also felt by the consumer, filling up his car or having a meal in a restaurant.

Inflationary monetary policies do not cause much good even in the shoert run, and I am sure that the Social Democrats would be far stronger if monetary poicies had been strictly non-inflationary.

A non-inflationary currency makes the wallet get swollen not with paper but with purchasing power.

8:29 AM  

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