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Working Paper 2020:15
Department of Economics
School of Economics and Management
Lessons from the Swedish
Experience with Negative Central
Bank Rates
Fredrik N. G. Andersson
Lars Jonung
August 2020
1
LESSONS FROM THE SWEDISH EXPERIENCE
WITH NEGATIVE CENTRAL BANK RATES
Fredrik N.G. Andersson and Lars Jonung
Department of Economics, Lund University
Email: fredrik_n_g.andersson@nek.lu.se and lars.jonung@nek.lu.se
August 17, 2020
Abstract: Negative interest rates were once seen as impossible outside the realm of economic
theory. However, several central banks have recently adopted negative policy rates. The
Federal Reserve is coming under increasing pressure to follow suit in the wake of the
coronavirus crisis. This paper investigates the actual effects of negative interest rates using the
Swedish experience from 2015 to 2019. The Swedish Riksbank was one of the first central
banks to introduce a negative interest rate in 2015 and the first central bank to abandon a
negative rate in 2019. We find that negative rates had a modest effect on consumer price
inflation due to globalization, but significant effects on the exchange rate and domestic asset
prices, thus fostering financial imbalances. We conclude by discussing the implications of our
results for larger economies such as the United States.
Key words: Monetary policy, inflation targeting, Sweden, United States, negative interest
rates, forward guidance, quantitative easing.
JEL codes: D78, E40, E43. E47, E50, E52, E65.
A version of this paper will be forthcoming in CATO Journal in the fall of 2020.
2
Introduction1
Interest rates declined in the wake of the international financial crisis of 2007/09. They
remained low for most of the 2010s, only rising modestly towards the end of the decade. In
some European countries, interest rates even became negative. While limited to a few
countries initially, the likelihood of more central banks following suit is growing in the wake
of the coronavirus crisis of 2020. Not least, the Federal Reserve System is under pressure to
adopt a negative federal funds rate (Bernanke 2020, Lilley and Rogoff 2020).
The push for negative rates invites the question: What are their consequences? We examine
this question empirically by analysing the case of Sweden, one of the first countries to
experiment with a negative policy rate and the first country to complete the experiment.2 We
then discuss the implications of our results for larger economies.
The Swedish central bank, the Riksbank, first entered negative rate territory when its deposit
rate for commercial banks became negative in 2009. The Riksbank became a pioneer with this
one small step. However, its main policy rate, the repurchase (repo) rate, remained positive.
This situation lasted for only a brief period. In 2010, the Riksbank moved away from the
negative deposit rate due to a rapidly recovering economy.
The second move came in February 2015, when the Riksbank announced a repo rate of -0.10
percent. This rate was further reduced to -0.50 percent in 2016, a level maintained until
January 2019, when the rate was raised to -0.25 percent. A further increase by 25 basis points
followed in December that year, terminating the subzero regime after five years.
The move to a negative interest rate was an unusual step not only because the Riksbank
became the first inflation-targeting central bank to break the zero lower bound, but also
because the Riksbank broke its previous behaviour of shadowing the European Central Bank
(ECB). Figure 1 illustrates the policy rates in Sweden, the euro area, and the United States in
the period between the introduction of the euro in 1999 to 2019. The Riksbank normally
1 We have benefitted from generous comments by Per Frennberg, Kevin Dowd, Jesper
Hansson, Göran Hjelm and Kurt Schuler. The usual disclaimer holds.
2 To the best of our knowledge, this study is the first trying to assess in a broad manner the
effects of the negative rates in Sweden 2015-2019. Eggertsson et al. (2019) provide a partial
analysis of the impact on the bank-lending channel. Their conclusion was that negative rates
reduced output. They do not examine the effects of negative rates on any other variables.
3
shadows the European Central Bank’s policy rate. Here the 2015-2019 period stands out with
the Riksbank being more expansionary compared to the two major central banks judging from
the main policy rates.3
Figure 1. Central bank policy rate in Sweden, the euro area, and the United States, 1999-2019.
Source: Thompson Reuters Datastream.
It is too early to make a full assessment of the long-run effects of the negative rates. However,
we can already observe some of the short-run consequences. Thus, we focus on how negative
rates affected the Swedish economy from 2015 to 2019. We first discuss why the Riksbank
took the drastic step of adopting negative rates, then we consider the short-run effects of this
policy shift, and finally we turn to the lessons this episode offers for other countries.
The background of the negative policy rate
It is important to understand the background of the Riksbank’s experiment with negative
policy rates. They were introduced not during a time of crisis, as in many other countries, but
during a time of relative prosperity with high growth and record employment levels. They
were the outcome of a long drift in the Riksbank’s approach to monetary policy. Over time,
3 Other central banks such as the Danish National Bank, the Swiss National Bank, and the
Bank of Japan have also adopted negative interest rates.
-1
0
1
2
3
4
5
6
7
Q1 1999
Q1 2001
Q1 2003
Q1 2005
Q1 2007
Q1 2009
Q1 2011
Q1 2013
Q1 2015
Q1 2017
Q1 2019
Percent
Sweden Euro area United States
4
the Riksbank became increasingly dependent on a New Keynesian dynamic stochastic general
equilibrium (DSGE) model, called Ramses. This model came to dominate the Riksbank’s
thinking about the Swedish economy. As inflation fell below the official inflation target of
two percent, despite a relatively strong economy, the model’s diagnosis was simple: high
policy rates caused low inflation. Alternative explanations were discussed but largely
disregarded in practice. The use of this specific model was a key driver behind the move
towards negative rates. A broader analysis that emphasized, for example, financial stability
would likely have resulted in a different policy.
The evolution of the Swedish monetary framework, 1993-2019
The Riksbank announced that it was adopting an inflation target in January 1993 following
the collapse of the pegged exchange rate for the krona against the German mark during the
European exchange rate crisis in the fall of 1992. The target was set at 2 percent within a
tolerance band of plus or minus 1 percentage point. The Riksbank copied these numbers from
the Bank of Canada’s framework.
The initial reaction to the target was skeptical due to Sweden’s history of high inflation in the
1970s and 1980s. However, inflation fell and held steady at around 2 percent from the late
1990s until the early 2010s (Figure 2). From 1993 until 2019, inflation averaged 1.7 percent,
which was well within the Riksbank’s original tolerance band of 1-3 percent4 (Andersson and
Jonung 2018). As a comparison, the average inflation rate in the euro area was 1.8 percent
during the same period, and average inflation in the United States was 1.7 percent. Not only
are the averages similar, but as is evident from Figure 2, the co-movements among the
inflation series are high, suggesting that a large share of the variation in inflation was caused
by global rather than national factors.5
4 The Riksbank abolished the tolerance band in 2010. In 2017 it reinstated a variance band of
the same size as the old tolerance band.
5 For a discussion of the effect of globalization on inflation, see e.g. Ciccarelli and Mojon
(2010) and Auer et al. (2017).
5
Figure 2. Inflation in Sweden, the euro area, and the United States, 1993-2019.
Source: Thompson Reuters Datastream.
Note: Inflation is measured by the respective central banks’ preferred price indices: the
consumer price index with a fixed mortgage rate (CPIF) for Sweden; the harmonized index of
consumer prices (HICP) for the euro area; and the personal consumption expenditure (PCE)
chain-price index for the United States. Each index is constructed differently and some
differences in the measurement of inflation are likely caused by methodological differences.
The early years of the inflation target was a period of experiment for the Riksbank, as it had
no recent experience of implementing inflation targeting. It had to develop its operational and
communication strategies from scratch (Andersson and Jonung 2018).6 The framework that
emerged towards the end of the 1990s was quite simple: the goal was to keep inflation close
to 2 percent, within the band of +/-1 percentage point. The monetary policy strategy was
forward-looking and described by the Riksbank as follows: “[t]he basic rule for monetary
policy is simple: if forecast inflation one to two years ahead is above/below 2 per cent, the
repo rate shall normally be raised/lowered in order to fulfil the inflation target. However, the
rule is not applied mechanically and minor deviations from the target may be weighed against
other factors” (Riksbank 2000).
6 The Riksbank was the first central bank to adopt a price level target in 1931 following the
collapse of the Swedish gold standard in that year. However, the Riksbank abandoned a stable
price level in favour of a fixed exchange rate in 1933.
-1
0
1
2
3
4
5
6
Q1 1993
Q1 1995
Q1 1997
Q1 1999
Q1 2001
Q1 2003
Q1 2005
Q1 2007
Q1 2009
Q1 2011
Q1 2013
Q1 2015
Q1 2017
Q1 2019
Percent
Sweden (CPIF) Euro area (HICP) United States (PCE)
6
In the early 2000s, the Riksbank became more reliant on formal economic modelling.7
Eventually in 2007, the Riksbank adopted a new operational strategy and a new
communication strategy. A central component of the new strategy was forward guidance, in
which the Riksbank began to publish forecasts of its own policy rate two to three years into
the future (Andersson and Jonung 2019). The forecasts were produced using a combination of
quantitative methods and qualitative discussions, with the DSGE model taking a major role in
generating the quantitative forecasts and framing the qualitative discussion (Goodfriend and
King 2015).
The old simple rule-of-thumb approach that if the inflation forecast was above the target, the
Riksbank would increase interest rates, and vice versa, was abandoned. The new assumption
imposed on the models was that “that the repo rate will develop in such a way that monetary
policy can be regarded as well-balanced. In the normal case, a well-balanced monetary
policy means that inflation is close to the inflation target two years ahead without there being
excessive fluctuations in inflation and the real economy” (Riksbank 2007, p. 3). In other
words, the Riksbank moved away from a more flexible approach where the forecast
influenced the interest rate decision to one where the forecast itself played an important role
as a policy instrument and in influencing the policy rate decision.8
Forward guidance and the forecasts of the Riksbank model soon dominated the discussion
within the Board of Directors. The use of traditional economic indicators and qualitative
judgements about the economy lost out. As Goodfriend and King (2015, p. 89) put it: “[t]here
is something surreal about the precision of the guidance provided by individual board
members as to the future path of the repo rate when contrasted with the sheer uncertainty
about the future and the fact that markets took rather little notice of the published path in
determining their own expectations.”
7 The model is partially based on a Phillips curve linking the real economy to inflation, and a
Taylor rule to describe the behaviour of the central bank (Adolfson et al. 2007).
8 The new approach drew criticism from Goodfriend and King (2015, p. 7) in their review of
the Riksbank: “there was heavy reliance, among both the majority of the Board and the
dissenters alike, on forecasts produced by models developed by Riksbank staff. Although such
models are useful in putting together consistent quantitative forecasts, inevitably they are
based on strong assumptions and can act as no more than a starting point for a discussion of
the challenges facing monetary policy at any particular juncture. They cannot be used
mechanically.”
7
Members of the Board spent much time arguing over whether the interest rate forecast several
years into the future should be a few tenths of a percentage points higher or lower
(Goodfriend and King, 2015). The discussions rarely acknowledged that the forecasts were
uncertain. Instead, several members apparently believed in monetary policy fine-tuning,
where the smallest change in a forecast would have measurable effects on the macroeconomic
outcome. In other words, the Riksbank became a hostage to its own model.
The shift towards the new strategy continued with the Riksbank abolishing the tolerance band
in 2010. The new inflation target became “close to 2 percent” without further specification.
The combined effect of forward guidance and of abolishing the tolerance band gave rise to a
debate whether the Riksbank had fulfilled its target or not. Because average inflation was
below 2 percent, but well within the original tolerance interval, critics argued that the
Riksbank had voluntarily chosen to set aside the inflation target for some unexplained reason.
The Riksbank struggled to respond to these criticisms, because it had contributed to the view
that it could fine-tune the economy by monetary policy and keep inflation exactly on the
target. The new reliance on specific numerical forecasts, setting out a path into the future
where the Riksbank always ended up meeting the target of 2 percent, helped to give the
illusion of a high degree of control over future events by its policy.
The growing reliance on the Ramses model and on interest rate forecasts are key components
in understanding the introduction of negative interest rates in Sweden. The DSGE model
perspective dominated policy discussions within the Riksbank and shaped the decisions made
by the Board of Directors. Alternative views were discussed but downplayed.
The introduction of negative interest rates
The global financial crisis of 2007-09 had only a temporary effect on the Swedish economy.
The financial system survived the crisis intact with the help of early emergency measures by
the Riksbank. Nominal property prices continued to grow throughout the crisis while
household debt levels stabilized at record levels. The real economy was hit by the Great
Recession and the Swedish economy declined by roughly 5 percent in 2008 and 2009. The
output loss was temporary and the economic recovery began in the second half of 2009. Real
GDP had already surpassed its pre-crisis level by 2010. Inflation rose above the Riksbank’s
official inflation target (Figure 2). Strong growth and higher inflation caused the Riksbank to
8
begin to normalize its policy by gradually raising its policy rate to 2 percent in 2011.
However, inflation began to decline following the euro crisis and the weakening of the euro
area economy. By 2014, inflation was at only 0.5 percent (Figure 2).
As inflation fell, the Riksbank reduced its policy rate first to 0.75 percent in December 2013,
and then to zero in 2014. Despite a falling policy rate, inflation did not pick up. The Riksbank
faced growing blame from some economists and the media. Critics focused on the inflation
number and ignored the relatively high growth rate of almost 3 percent and the high
employment in 2014.
In response to these objections, the Riksbank announced the introduction of a negative policy
rate and a program of quantitative easing in February 2015. The Riksbank claimed that a
negative rate was needed to defend the credibility of the inflation target, thereby assuming
responsibility for inflation falling short of the target and presuming that a negative rate would
soon return inflation to the target. It expected its interest rate to be positive again before the
end of 2016 (Riksbank 2015). These predictions proved wrong, and the Riksbank maintained
its negative interest rate policy throughout the boom until December 2019, when it raised the
interest rate to zero percent. However, the Riksbank chose to continue with its quantitative
easing, totalling almost 300 billion Swedish kronor by 2019, a sum close to 6 percent of GDP.
Effects of negative policy rates
The aim of the negative policy rate was to raise domestic inflation. Inflation did indeed
increase slightly after the introduction of negative rates, reaching the inflation target of 2
percent by 2018 before falling back to 1.5 percent in the second half of 2019. Based on this
outcome, it is tempting to conclude that the policy of negative rates was at least partly
successful in raising inflation. However, Swedish inflation is highly dependent on the state of
the euro area economy. Swedish inflation falls when euro area unemployment increases, and
vice versa (Figure 3). The correlation between the Swedish inflation rate and the euro area
unemployment rate is -0.8. In contrast, the correlation between the Swedish inflation rate and
the Swedish unemployment rate is lower, only -0.3.
The Swedish economy is highly integrated with the European economy. Swedish exports as
share of GDP increased from 30 percent during the 1980s (before Sweden’s membership of
9
the European Union in 1995) to between 45 and 50 percent in the 2010s. Slightly more than
50 percent of Swedish exports go to the euro area. Sectors that do not directly export to the
euro area are still highly integrated with the euro area economy through their supply chains.
Developments in the euro area thus directly affect the Swedish economy. As a result,
improved economic conditions in the euro area are a more important factor behind the rise in
inflation than the Riksbank’s policy based on negative rates.1
Figure 3. Inflation in Sweden and unemployment in the euro area, 2010-2020.
Source: Thompson Reuters Datastream.
The rise in inflation in Sweden was matched by a similar increase in inflation in the euro area,
where inflation rose from -0.3 percent in February 2015 to 2 percent in the middle of 2018,
and then to 1.4 percent in January 2020 (Figure 2). This is almost the same pattern as in
Sweden, where inflation rose from 0.9 percent in February 2015 to 2 percent in the middle of
2018, and then to 1.2 percent in January 2020. That most of the movement in Swedish
inflation correlates with changes in the euro area economy clearly indicates that the
Riksbank’s influence over the Swedish inflation rate is modest due to the forces of a high
level of economic integration. The Riksbank’s declining influence over the domestic inflation
rate forced it to become increasingly extreme in its policy.
The situation was different when the inflation target was introduced in 1993. The Swedish
economy was less integrated in the European economy and the Riksbank’s influence over the
7
8
9
10
11
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13
0
1
2
3
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Jan-20
Unemployment Euro Area, %
Inflation Sweden, %
Inflation in Sweden Unemployment in the euro area
Negative policy
rate
10
domestic inflation rate was much higher. In fact, Sweden had just experienced a twenty-year
period of relatively high and volatile inflation compared to its main trading partners.
However, the influence has since gradually declined. Thus, the historically high correlation
between the inflation and the state of the domestic economy has also declined.
In the past, inflation increased during booms and declined during recessions. Today that
correlation is much weaker. For example, in 2014 when inflation was low, pushing the
Riksbank to introduce negative rates, the economy was booming. Growth was close to 3
percent and the employment rate for 16-64 year olds hit a record level, at close to 80 percent
(Figure 4). The employment rate was even higher than during the pre-crisis boom of 2008.2
Rather than being countercyclical (tightening during booms), monetary policy became clearly
procyclical. The Riksbank’s raising of rates in 2019 actually coincided with the economy
moving towards a slowdown. The booming economy without increasing inflation is visible in
the current account balance, which declined from steady surpluses of between 5 to 6 percent
2008-2014 to a surplus of 1.7 percent in 2018. Rather than causing inflation, the boom caused
rapidly rising imports.
Figure 4. Employment rate for 16-64 year olds born in Sweden, 2005-2019.
Source Statistics Sweden.
Note: The employment rate for the total population is lower due to substantial refugee
migration during the last five years. The employment rate for the population born in Sweden
is thus a more accurate measure of the state of the labor market.
70
72
74
76
78
80
82
84
86
88
90
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Percent
Employment rate Pre-crisis record
Negative policy
rates
11
Reduced control over the domestic inflation rate does not imply that the Riksbank has no
influence over the Swedish economy. There are still markets that are highly influenced by its
policy. For example, Figure 5 illustrates the change in the krona-euro exchange rate in
relation to the difference between the Riksbank’s repo rate and the ECB repo rate. Between
2015 and 2019, when the Riksbank maintained a lower policy rate than the ECB, the value of
the Swedish krona declined from an average exchange rate of approximately 9.25 per euro
between 1999 and 2012, to roughly 10.50 per euro. This corresponds to a depreciation by 12
percent. This weakening of the Swedish currency is one of the largest in modern times. Only
the so-called “super-devaluation” of 16 percent in 1982 and the depreciation following the
collapse of the pegged exchange rate in 1992 of about 20 percent match the present persistent
decline of the currency.
A depreciating currency should contribute to higher inflation. However, since the pass-
through rate is low, the rise in consumer price inflation due to the depreciation is small. The
overall increase in inflation between 2015 and 2019 from all factors affecting inflation was
one percentage point. The exact effect of the exchange rate depreciation is difficult to gauge;
however, it is unlikely to account for the entire increase in inflation. The contribution by the
weakened exchange rate was less than a percentage point. Although the inflationary effect of
the depreciation is small, the persistent weakening of the exchange rate may affect economic
growth negatively in the future. Empirical evidence suggests that the many devaluations of
the fixed exchange rates of the krona from the 1970s to the early 1990s reduced growth over
the long term by lowering investments in new innovations by Swedish firms when they
shifted from competing through quality and innovation to gaining market share through a
weak exchange rate (see, e.g., Jonung 1991).
12
Figure 5. Change in the krona-euro exchange rate and difference between the Riksbank and
ECB repo rates, 2009-2019.
Source: Thompson Reuters Datastream.
Another market that was highly affected by negative interest rates was real estate. Negative
interest rates boosted property prices and household debt levels to new record levels relative
to income. As in other countries, property prices increased rapidly prior to the global financial
crisis of 2008, raising concerns of a future correction and possibly a financial crisis
(Andersson and Jonung 2016). Nevertheless, Sweden suffered only briefly from the crisis of
2008 and avoided a full-scale banking crisis. House prices (Figure 6) and household debt
levels (Figure 7) stabilized in 2010-2012 after the crisis. Temporarily higher interest rates
during the economic recovery phase limited the rise in prices and debts. As the Riksbank
softened its policy in 2012-2014 due to the euro area crisis, they slowly began to creep
upwards again.
Negative rates accelerated the speed of increase. Prices in relation to disposable income rose
by 50 percent between 2012 and 2017, with most of the increase occurring after the
introduction of negative rates in 2015. Rising prices and debt levels forced the financial
supervisory authority (Finansinspektionen) to take action, imposing a string of credit controls
on households, such as amortisation rules and debt ceilings, beginning in 2016. The controls
dampened the rise in real estate prices and in debt, but also contributed to growing
inequalities, because they mostly affected younger households and those without assets.
Nonetheless, the credit controls did not arrest the upward trend in real estate prices. Prices
-1.5
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0
0.5
1
1.5
-1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1
SEK / EUR exchange ra te
Difference between Riksbank repo-rate and the ECB repo-ra te
13
increased from roughly four times disposable income in 2009 to six times in 2018. This
compares to 1.5 times disposable income in the year 2000. In other words, property prices
quadrupled in relation to disposable income between 2000 and 2018.
The average household debt ratio increased from 110 percent of disposable income to 187
percent during the same 20-year period. The Swedish pattern stands in contrast to the United
States, where the household debt ratio was 105 percent of disposable income in 2018, having
declined from a record 144 percent in 2007.
Figure 6. Average property prices (for flats) in relation to disposable income, 2009-2018.
Source: Statistics Sweden.
3
3.5
4
4.5
5
5.5
6
6.5
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Average property prices in relation to
disposable income
Repo
-
rate is lowered
Negative policy rates
Credit controls.
14
Figure 7. Household debt in relation to disposable income, 2009-2018.
Source: The Riksbank.
While the impact of negative rates on domestic inflation rate was small, probably negligible,
the effects of negative rates on the housing market and on household debt levels were large.
Imbalances that had already begun to emerge before the Great Recession worsened. Real
estate prices rose rapidly, contributing to rising wealth inequality. Household debt reached
record levels. The exchange rate of the Swedish krona depreciated by more than 10 percent,
with no major impact on the domestic rate of inflation. In addition, monetary policy turned
procyclical during the experiment with negative rates, contributing to record high
employment. In short, the negative policy rates contributed to an economy suffering from
“overheating”.
Was there an alternative policy? The Riksbank law permits the Riksbank to revise the
inflation target as economic conditions change. The Riksbank is not required by law to
maintain 2 percent inflation at any cost. There is no evidence of the Swedish economy
suffering from low inflation. In fact, the economy performed quite well when inflation was
below the target, growing by 2 to 3 percent per year and registering high employment
figures.9
9 Using international data, Borio et al. (2015) find little evidence of low inflation, or even
deflation in consumer prices, having a negative effect on the real economy. However, they do
find a negative relation between asset price deflations and economic growth.
1.50
1.75
2.00
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Household debt i n relation to
disposable income
Repo-rate is lowered
Negative policy rates
Credit controls.
15
A policy that avoided negative interest rates would have implied lower consumer price
inflation and a less overheated labour market, but would also have dampened the depreciation
of the exchange rate and the rise of property prices. The risks of a future financial correction
with potentially severe economic consequences would have been lower. Despite having the
legal right to alter the inflation target, the Riksbank chose to experiment with the Swedish
economy. In our view, it did so partially because of the narrow perspective that dominated the
monetary policy discussion within the Riksbank. The negative interest rate experiment was a
choice, not a necessity forced upon the Riksbank.
Lessons from Sweden
The Swedish experiment with negative interest rates offers several lessons. Due to
globalization, the relationship between the state of the domestic economy and the consumer
price inflation rate has been weakened (see, e.g., Auer et al. 2017). This is demonstrated by a
large number of studies on the “flattening of the Phillips curve,” a phenomenon observed in
many countries including the United States. However, central banks maintain a strong
influence on mostly domestic markets, such as the housing market, and on financial markets
directly affected by the domestic interest rate, such as the foreign exchange market.
Rather than acknowledging their reduced influence over consumer price inflation, central
banks have turned to increasingly extreme measures in their effort to raise this inflation rate,
such as negative policy rates and quantitative easing. While quantitative easing and low
policy rates started out as elements of a crisis policy during the international financial crisis,
they have become common tools also during normal times of economic prosperity.
In Sweden, the gravitation towards extreme measures was connected with a growing
dependence on an economic approach to monetary policy heavily influenced by a DSGE
model based on a Phillips curve relationship to link the real economy to inflation, and a
Taylor -rule to model central bank behavior. The low inflation rate was interpreted as a crisis
in itself, warranting a crisis policy response.
While the effect of an expansionary monetary policy on consumer price inflation is modest,
imbalances tend to grow elsewhere in the economy. To address those imbalances,
policymakers tend to (re-)introduce various forms of controls such as credit controls. These in
16
turn distort the workings of markets. For example, they limit the effectiveness of monetary
policy by restricting some of the channels through which monetary policy operates. The
central bank ends up in a vicious cycle of overstimulating the economy while trying to control
the negative side effects of the expansionary policy through various credit controls. The
lessons from the past that credit controls distort markets and are commonly inefficient in
achieving their aims are forgotten.
Are these lessons from the Swedish monetary experiment unique or are they valid also for a
larger economy? The flattening of the Phillips curve and thus a reduction of central bank’s
influence over the consumer inflation rate is a global phenomenon that has been observed for
quite some time (see, e.g., Atkeson and Ohanian 2001, Blanchard 2016, Smets and Wouters
2007). Why the Phillips curve has flattened remains uncertain. A wide range of explanations
have been suggested: digitalization, expectations, improved policy, wage stickiness,
demographical change, structural change, and globalization, among others (for a discussion
see, e.g., Conti et al. 2017, Hooper et al. 2020, Kiley 2015). The specific reasons for the
flattening are of less importance here; the fact that it is flatter is the key.
A negative interest rate in a large economy such as the United States would likely have a
larger impact on consumer price inflation than a similar policy in Sweden. Still, the effect is
likely to be relatively small. The effect on the US housing market and financial markets are
likely to as large if not larger than in Sweden. The trade-off between a small increase in
consumer inflation versus larger financial imbalances is the same in the United States as in
Sweden. A narrow focus on consumer inflation runs the risk of destabilizing asset markets
when the central bank’s influence over the consumer inflation rate is waning. There is little
international evidence for low inflation, or even moderate deflation, having a severe negative
effect on the real economy. There is on the other hand ample evidence of financial imbalances
causing severe economic damage not just in the short run but also in the long run. The
negative effects of the crises are sometimes re-enforced by growing political populism in the
wake of the crisis (Eichengreen 2018).
Conclusions
The Governor of the Swedish Riksbank, Stefan Ingves, described the use of negative interest
rates an “experiment” never tried before (Dagens Industri 2017). The experiment ended in
17
2019. We conclude at this early stage that the costs to Swedish society of negative interest
rates most likely exceeded the benefits.
Negative rates were the outcome of a narrow focus on consumer inflation and the flattening of
the Phillips curve. To increase consumer inflation the Riksbank felt forced to take extreme
measures. Housing markets and financial markets respond quickly while consumer inflation
remained largely unaffected.
There are clear lessons from the Swedish experience for the United States, in spite of the
differences in size and the international role of the dollar and of the Fed. Negative policy rates
would foster a more rapid house price inflation, more demand pressure and a depreciating
dollar, with only minor effects on the US consumer inflation rate – as the evidence from
Sweden suggests. International evidence suggests that low inflation has no measurable
negative effects on the economy. However, history shows that inflated asset prices carry the
risk of a financial correction with potentially large negative economic consequences.
18
References
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Equilibrium Model for Monetary Policy Analysis”, Swedish Riksbank Economic Review 2:
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