Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 30 April 2013

Leading Macroeconomist Leaves Central Bank

Maybe not the most compelling title for a post, but the news that Lars Svensson is not renewing his term as Deputy Governor of Sweden’s central bank (HT Saroj Bhattarai) will be of great interest to academic macroeconomists. What I want to suggest here is that it should also be of wider interest.

Apart from making major contributions to the discipline, Svensson has also been extremely influential among policymakers, and is often associated with the idea of flexible inflation targeting. (Here is just one example.) It is interesting news because of why he is leaving. He says: "I have failed to find support for a monetary policy that I believe would lead to better performance, with both a higher inflation rate closer to the target of two percent and a lower unemployment rate." He has for some time been fighting a losing battle to persuade his colleagues that current Swedish monetary policy is too deflationary (see for example Britmouse), and he has decided to give up the fight.

Interest rates in Sweden are low, at 1%, but according to Svensson they should have got there faster and should now be even lower. Here is a plot of inflation (blue, left hand scale) and unemployment.

Inflation is currently zero, so well below the 2% target. GDP growth was 1.2% last year. Unemployment rose in the recession, came down a bit, but has begun to rise again. The case for lower interest rates over the last two or more years looks pretty clear.

So why have most of Svensson’s colleagues not been following his advice? Their concern is that low interest rates are encouraging Swedes to borrow too much. Now of course one of the ways monetary stimulus is supposed to work is that it encourages more borrowing, but the worry is that borrowing in Sweden is dangerously high, and could threaten financial stability. There are echoes here of doubts expressed by some members of the Fed (see here and here) and international organisations (Tim Taylor here). However so far these have been just concerns, which do not seem to have had a major impact in preventing expansionary policy. Except in Sweden.

Svensson’s arguments against such concerns are persuasive (pdf), and I find the argument that there are better financial instruments available to deal with these problems particularly strong. However I want to draw a slightly different parallel, with policy at the ECB. At first sight similarities appear slight: although both central banks are resisting a cut in interest rates from low to very low levels, in the Eurozone growth is negative rather than just slow, and inflation is currently only a little below target rather than zero (although the ECB itself expects it to fall to nearly 1%). In addition, the ECB has not focused on financial stability as a reason for not cutting rates. Yet the parallel is this. In both cases we have central banks making decisions that appear to contradict the wisdom of mainstream macroeconomics. So what, you may say, but in both cases the cost is being measured in unnecessary unemployment, and below target inflation. Compute the cost in terms of lost output, and they are the kind of losses that could cost a politician their job. The cost in terms of human misery is greater still. You may be pretty skeptical of the wisdom of macroeconomists, but do you really think that these central bankers know better?   


  1. I agree that this news should be of wide interest. I have written two posts about Svensson on my blog.

    1. His influential thoughts on low-interest-rate monetary policy and household indebtedness:

    2. His views, consistent with Bernanke and Yellen's, on monetary policy and financial-stability policy:

  2. It's depressing. I always thought of the Riksbank as one of the best central banks.

    Small picky point: "Now of course one of the ways monetary stimulus is supposed to work is that it encourages more borrowing..."

    That's not really right. Just for illustration, in a simple case, take a representative agent NK model, where there is never any borrowing, but loosening monetary policy still works, by making everyone *want* to borrow, so income expands until nobody wants to borrow.

    It's a picky point, but one that needs to be made, if we want to kill this meme that we need to tighten monetary policy and worsen the recession to preserve financial stability.

    1. Smaller picky point: He said "one of the ways" not "the way".

    2. Anonymous: agreed, and that's important. But I don't even think it's *one* of the ways. Now it's true that monetary stimulus may (and nearly always will) cause more borrowing, as a side-effect of successfully creating a recovery. But I don't think that "more borrowing" is a channel in the monetary policy transmission mechanism, except insofar as the stock of money needs to expand, and the stock of money is a liability of banks and central banks.

      I'm trying to gather my thoughts on this. Because this idea that there's a trade-off so central banks daren't use monetary stimulus for fear of increasing debt and worsening financial stability, is influential, dangerous and very wrong. It rests on a fallacy of composition. The true trade-off slopes the other way.

  3. I too find this very depressing.

    Is "too fast" demand growth => "too much" debt => financial crisis => AD shock really so far away from how a "mainstream" macroeconomist thinks about the world since 2008? It doesn't seem like it to me; and that is all the despicable Riksbank hawks are saying. (Substitute monetary policy "too loose" for "too fast demand growth" as appropriate.)

    Just two examples: in the IMF macro conference debate on monetary policy, Woodford presented on NGDPLT, and in particular how we could "aim off" the desired path of NGDP for reasons of financial stability, his preference was for using "macroprudential" tools.

    Charlie Bean popped up in the Q&A and said that filling the NGDP gap - getting UK NGDP back to the pre-crisis trend would, I quote, "run the risk of re-igniting the sort of problems that led to the financial crisis in the first place". Is that so far away from what the Riksbank hawks are saying? "Sure, we could get out of this bust, but a boom will just lead to another bust."

  4. Isn't this a communication problem, an inability of economists to be able to signal to journalists what the size of peer-review groups taking different positions on the big issues of the moment currently are?

    There was the 'A Manifesto for Economic Sense' of last year, but that failed to cut through into general debate.

    And I have it from the BBC that they won't use the term 'liquidity trap' as the BoE and Fed don't use it.

  5. "At first sight similarities appear slight: although both central banks are resisting a cut in interest rates from low to very low levels, in the Eurozone growth is negative rather than just slow, and inflation is currently only a little below target rather than zero (although the ECB itself expects it to fall to nearly 1%)."

    The eurozone HICP for April just came out and it showed year on year inflation at 1.2% and inflation excluding energy, food, alcohol and tobacco at 1.0%, so mission accomplished.

  6. Surely this is a classic example of how giving up the fiscal policy tool is just tying an arm behind your back?

    If you're worried about growth and worried about private borrowing -> print the money, give it to the government to spend.

    1. Or just allow deficits to stay high and government debt to increase. Since government debt represent private sector net financial assets that allows the private sectors borrowing to increase secured by the safest financial asset - government debt.

  7. Macro economists especially the ones at CBs look to have a sort of compulsive disorder regarding models. Nicely theoretical of course.
    But if we looks at the crisis we are now in, it would not have been remotely as bad as it is, if especially CBs had done their job better (or proper).

    A large part of the regulation of banks is CB's duty. Might not be in all countries in the same way. But with monetary policy instruments they have a lot in house to push banking policies into a certain direction. Nevertheless we have hardly seen anything in this field and the post-crisis changes also have been marginal.

    CBs let massive RE bubbles develop and in general iso trying to get them under control often made them even worse. And the next bubbles look to be already in the pipeline.

    There is simply much too little work done in this sector while the model part of the sector looks completely overcrowded. While it is not really rocket science what would be the predominant theory's recipe for the crisis.

    This has a lot of social political consequences. CBs and banks in general simply donot look in control of things. Being unable to judge seperate issues everything coming from that angle will be looked at sceptically.
    As this is around the economy (THE main issue at the moment), all other ones (Euro, banking, cuts/austerity) are connected to it. So simply is political issue no1. Which means it has stopped being technical largely and it has become nearly completely political. You simply have got a completely different rulebook. A large part of the work is simply nearly useless it simply will not happen as there is no political platform (and electoral platform) for it.

    Next crisis is far more likely to come from an angle that is simply missed by regulation in the wider sense than from failed monetary policies.
    In other words you cannot keep missing the plot in the public spotlight for several times in a row. You will not get away with it.

  8. Economics are probably the main issue.
    But the way the electorate looks at it is imho pretty twisted at the moment.
    Normal crisis it was clear: in case of a dip you had a bad time getting reelected.

    This times things are somewhat different.
    All the Western world is a complete mess in one way or another. You can get away with it like Obama did:
    - not a strong other candidate;
    - with half the electorate (more someting like 70% now) living from paycheck to paycheck they expect their government to do the same. Even if taking a hit now would be better they simply would not take that alternative as it is not in their system;
    - rest (countries) is crap as well. There might be better policies but they are clearly not out there.

    So you might get away with a lot of crap at the moment.
    Merkel's economic policies at home hardly look sustainable as it is called. Simply created a lot of long term costs with expenditure rising and taxes being at the max. But Steinbruck is even 'crapper' than Romney.
    Obama moving to a social system for which there is no platform to finance it in the population (they are probably able to finance it, but are like Spain and Co not willing to do that). While in that combination it looks a large part of the failed European models.
    -Rutte got reelected while his policies were imho moronic. Not much to do with stimulus, not kicking the bottom out of the RE market is simply largely a policy mistake. And he still is not really punished FOR THAT. He is punished but not for that.
    - In France it worked a bit different they rather had in order to get rid of Sarko a guy that makes his country look like the sick man of Europe (which was imho nearly certain to happen). Probably has a lot to do with distrust in politics in general with the rise of populists as one of the main symptoms.

    There is simply a platform for austerity. And cleaning up the debt mess. In Northern Europe at least. The South has not much to say as long as they cannot come up with a more credible plan for financing things than 'we borrow the money on Germany's guarantees'. Politics there is simply using that as well.
    South is such a big mess as a majority of the people (or at least a blocking minority) want one of the alternatives that is not on the table (the 'Germany Pays' gambite).

    If you want to attack politics you have to make them look bad in the public eye. And they simply seem to get away with it at the moment. Policies are hardly working, set up of the monetary union now and very likely in the future is a mess. Half the banking sector is bust. RE is still bubbly and has not bottomed out, agingcosts are hitting in. A perfect mess but they can sell it and the population belives it. Except the usual suspects that donot like austerity as their welfare or civil servant paychecks would be cut. They are clearly seen as biased.
    Well all next to the problem that everybody want their neighbours to face the cuts and not themselves (which is also not going to work). And the reasons why things go so slow.

    Except in the South of Europe where all governments look simply zombies. Having to defend the status quo but not being able to finance that. They will always fail and so will the next one till they fall of the cliff or finally wake up.

  9. Really interesting article and the comments simply make this topic even better.

    Keep it up


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