Monday, September 27, 2010

Lars E.O. Svensson-The Swedish Ben Bernanke

Scott Sumner discusses the case of Lars E.O. Svensson, the by far most inflationist member of the board of the Swedish central bank, the Riksbank. Svensson has been very critical of the decision by his fellow board members to raise interest rates twice and signal a lot more of the same.

His argument for this is decidedly Keynesian in the sense that he argues that there is "unused capacity" and that inflation is below the 2% target. He further claims that the fellow board members when asked hasn't provided any justification for hiking interest rates.

That assertion is something I find strange as I have in fact read and heard them explain why in the Swedish media. I don't know what they said at their meetings so it is possible that they provide any explanation then, but one would have thought that Svensson would read the media statements.

The explanation is that they realize that it is unhealthy to keep rates that low because it feeds a real estate bubble. Statistics released today shows that mortgage loans increased 10.3% in Sweden in August this year compared to a year earlier. That follows a 12.5% increase in the year between August 2008 and August 2009.

As a result, mortgage debt has reached record highs relative to GDP and household disposable income. The reason for this is that in the past the Riksbank has basically followed the strategy advocated by Svensson (though slightly less zealously than he wanted), a strategy that mirrored that pursued by the Fed in the early 2000s. There too there was concern about "unused capacity" and below target inflation, something which led them to hold down interest rates in a way that fueled a housing bubble.

The rest of the Riksbank board is trying to correct this in a way which is too little and too late, but at least they seems to be aware of the problem. Svensson by contrast, like his former Princeton colleagues Ben Bernanke and Paul Krugman is completely clueless about the link between low rate policies and housing bubbles.