What Sweden can learn from Canada about central banking
Canada last month became the world champion in ice hockey after narrowly beating Sweden earlier in the tournament.
It turns out the Canadians might also have a thing or two to teach their eternal Scandinavian hockey rivals in the field of central banking.
The lessons largely boil down to points. One, smaller central banks can’t afford to stray far from the course set by big central banks in their neighborhoods. And two, monetary policy is probably an ineffective tool in trying to prevent asset bubbles.
Banks that ignore this advice “end up with enormous currency effects,” said Knut Hallberg, a rate analyst at Swedbank AB in Stockholm. And that collides with the goal of maintaining stable prices, he said.
The central banks of Canada and Sweden both live close to much bigger monetary authorities, namely the U.S. Federal Reserve and the European Central Bank. Both operate in export- reliant economies and target 2 percent inflation. What’s more, both face overheated housing markets.
They also employed strikingly similar policies after the global financial crisis of 2008. Both cut their key rates to 0.25 percent in the first two years and then did nothing until the summer of 2010, when they embarked on a series of increases. But that’s where the similarities end.
Mark Carney
In Canada, Governor Mark Carney -- who now heads the Bank of England -- abandoned his monetary tightening trajectory once the main rate hit 1 percent amid criticism he was too concerned over financial stability. In Sweden, the Riksbank stuck the course and kept raising rates for almost another year, bringing its benchmark to 2 percent and triggering a cycle of deflation.
Swedish policy makers are now backtracking as they resort to negative rates and bond purchases to prop up inflation. Though the economy is growing at a healthy pace, headline prices sank on an annual basis in April after falling consistently from August 2014 through January. The underlying price gauge the bank targets was 0.7 percent in April.
“They’ve now ended up in a situation where they are conducting a war policy at the same time as the economy is doing well,” said Annika Winsth, chief economist at Nordea Bank AB in Stockholm. “And they’re sending a signal to households to continue to borrow -- things will stay cheap for a long time.”
Krugman, Bernanke
In Canada, the central bank’s main interest rate is 0.75 percent and the core inflation rate that it tracks topped 2 percent in April. The Bank of Canada is now run by Stephen Poloz, who cut the benchmark rate in January.
In both countries, house prices have continued to climb. Riksbank Governor Stefan Ingves, an architect of Sweden’s text- book handling of its 1990s financial crisis, says his policies reflected a leaning-against-the-wind approach designed to avert property and credit bubbles.
That argument has been pilloried by Nobel laureate Paul Krugman and is now being questioned by former U.S. Fed Chair Ben Bernanke.
“Ironically, the policies of the Swedish central bank didn’t even achieve the goal of reducing real household debt burdens,” Bernanke wrote in his blog in April. “The early returns don’t favor the idea that central banks should significantly change their rate-setting policies to mitigate risks to financial stability.”
Riksbank Wins?
Ingves’s policies also created an internal rift. Lars E.O. Svensson -- a former colleague of Bernanke -- resigned from the Riksbank’s board in 2013 after arguing in favor of lower rates.
Now, Ingves acknowledges it’s dangerous to underestimate the power of currency markets to undermine central bank goals.
Policies that make the krona more attractive mean “the risk will keep increasing that we will get very big capital flows into Sweden,” Ingves said on May 6.
Sweden’s latest policy steps and signals have won it some praise and, ironically, there’s even one economist arguing Canada can learn from the Riksbank.
“By not moving more aggressively on the policy front I think that we are running the possibility of getting caught in a situation like Sweden,” David Watt, chief economist at HSBC Holdings Plc in Toronto. “Why don’t we just get rates back to the lows and begin to assess things?”
It turns out the Canadians might also have a thing or two to teach their eternal Scandinavian hockey rivals in the field of central banking.
The lessons largely boil down to points. One, smaller central banks can’t afford to stray far from the course set by big central banks in their neighborhoods. And two, monetary policy is probably an ineffective tool in trying to prevent asset bubbles.
Banks that ignore this advice “end up with enormous currency effects,” said Knut Hallberg, a rate analyst at Swedbank AB in Stockholm. And that collides with the goal of maintaining stable prices, he said.
The central banks of Canada and Sweden both live close to much bigger monetary authorities, namely the U.S. Federal Reserve and the European Central Bank. Both operate in export- reliant economies and target 2 percent inflation. What’s more, both face overheated housing markets.
They also employed strikingly similar policies after the global financial crisis of 2008. Both cut their key rates to 0.25 percent in the first two years and then did nothing until the summer of 2010, when they embarked on a series of increases. But that’s where the similarities end.
Mark Carney
In Canada, Governor Mark Carney -- who now heads the Bank of England -- abandoned his monetary tightening trajectory once the main rate hit 1 percent amid criticism he was too concerned over financial stability. In Sweden, the Riksbank stuck the course and kept raising rates for almost another year, bringing its benchmark to 2 percent and triggering a cycle of deflation.
Swedish policy makers are now backtracking as they resort to negative rates and bond purchases to prop up inflation. Though the economy is growing at a healthy pace, headline prices sank on an annual basis in April after falling consistently from August 2014 through January. The underlying price gauge the bank targets was 0.7 percent in April.
“They’ve now ended up in a situation where they are conducting a war policy at the same time as the economy is doing well,” said Annika Winsth, chief economist at Nordea Bank AB in Stockholm. “And they’re sending a signal to households to continue to borrow -- things will stay cheap for a long time.”
Krugman, Bernanke
In Canada, the central bank’s main interest rate is 0.75 percent and the core inflation rate that it tracks topped 2 percent in April. The Bank of Canada is now run by Stephen Poloz, who cut the benchmark rate in January.
In both countries, house prices have continued to climb. Riksbank Governor Stefan Ingves, an architect of Sweden’s text- book handling of its 1990s financial crisis, says his policies reflected a leaning-against-the-wind approach designed to avert property and credit bubbles.
That argument has been pilloried by Nobel laureate Paul Krugman and is now being questioned by former U.S. Fed Chair Ben Bernanke.
“Ironically, the policies of the Swedish central bank didn’t even achieve the goal of reducing real household debt burdens,” Bernanke wrote in his blog in April. “The early returns don’t favor the idea that central banks should significantly change their rate-setting policies to mitigate risks to financial stability.”
Riksbank Wins?
Ingves’s policies also created an internal rift. Lars E.O. Svensson -- a former colleague of Bernanke -- resigned from the Riksbank’s board in 2013 after arguing in favor of lower rates.
Now, Ingves acknowledges it’s dangerous to underestimate the power of currency markets to undermine central bank goals.
Policies that make the krona more attractive mean “the risk will keep increasing that we will get very big capital flows into Sweden,” Ingves said on May 6.
Sweden’s latest policy steps and signals have won it some praise and, ironically, there’s even one economist arguing Canada can learn from the Riksbank.
“By not moving more aggressively on the policy front I think that we are running the possibility of getting caught in a situation like Sweden,” David Watt, chief economist at HSBC Holdings Plc in Toronto. “Why don’t we just get rates back to the lows and begin to assess things?”
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