Friday, July 04, 2008

Riksbank, ECB Raise Interest Rates

Yesterday both the Swedish Riksbank and the ECB raised interest rates by 25 basis points, to 4.5% and 4.25%, respectively.

However, they differed in the tone of the statements accompanying the hikes. Although the ECB's statement wasn't as dovish as many financial journalists tried to make us believe, they certainly did not commit themselves to further hikes. As this hike is really too little, too late to prevent inflation from getting worse in the near future, they might still feel compelled to do it again. However, that is far from certain as the ECB have a track record of ignoring its inflation target, always blaming this on "temporary" (normally you don't call things that happens every year "temporary") factors and falsely predicting that inflation will soon fall below the target.

By contrast, the Riksbank was quite hawkish, signaling not just one but two more hikes later this year. This is not likely to be enough either, but clearly it indicates that it takes its inflation target more seriously than the ECB. Not that this is necessarily a good thing. As I described in my recent Timbro report, the root cause of today's problems in the Swedish economy is that the Riksbank took its target far too seriously back in 2005, when it reduced interest rates to as low as 1.5%, in order to push up inflation. The problems with high debt levels and high inflation is what we are seeing now, and it seems unlikely that the Riksbank will be able to push back the inflation created by its previous policy to its target anytime soon without pushing the Swedish economy into a recession.


Blogger Flavian said...

But suppose that the inflation target was 0% and adjusted for changes in the composition of the index, would an inflation target really be a problem?

By the way, measured by last years index composition the present inflation rate in Sweden is 4,5% and, as an example, the present price of a Big Mac in Sweden, is 11,8% higher than it was a year ago.

I personally think that a strict inflation target at minus 1 percent with a maximum deviation of plus/minus 1%, would be ok, given that it really was a mechanical inflation target where the central bank in question would inflate massively if deflation would go above 2% and deflate heavily given that inflation would go above 0%.

Still I believe that a gold standard would be even better, but are inflation targets in them selves really that bad? Is not the problem rather that they are a) to high and b) still ignored?

10:30 AM  
Blogger stefankarlsson said...

Of course it matters what the level is, but the point is that the central bank shouldn't try to counteract supply shocks of either a positive or negative nature with money supply changes. That creates bubbles during period of positive shocks and create unnecessary economic contraction during negative shocks.

11:37 AM  
Blogger Edward Harrison said...


It's good to see a cogent European-based analysis of recent monetarty policy. Over in the US, many believe the Fed's dovish policies are the right way to go. They fear systemic banking risk. Where are you on that issue? My personal view is that the Fed and the ECB have been loose for far too long. See comments here:

What are your thoughts regarding inflation targetting? Too inflexible?


Ed H

4:39 AM  
Blogger stefankarlsson said...

Edward, my fundamental problem with inflation targeting is that it focus exclusively on consumer prices, while ignoring other prices and money supply.

Also, most inflation targets are usually set too high.

1:27 PM  

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