Why Leaning Against the Wind Is the Wrong Monetary Policy for Sweden

Should inflation targeting involve some leaning against the wind? Sweden provides a case study, since the Riksbank has been leaning against the wind quite aggressively since 2010, stating concerns about risks associated with household indebtedness. The cost is high of this policy, in the form of inflation much below the target and a higher unemployment, arguably as much 1.2 percentage points higher than necessary. In contrast, according to the Riksbank’s own calculations, the benefits of a higher policy rate in terms of a lower probability and less depth of a future crisis is miniscule. Expressed in the form of a lower expected future unemployment rate, the benefit is only about 0.004 of the cost in the form of a higher unemployment rate the next few years. Furthermore, much lower inflation than expected has actually substantially increased households’ debt burden and, if anything, increased any risks. During the last two and a half years, the real value of a given loan has become 5 percent larger than if inflation had been on target. JEL Codes: E52, E58, G21. ∗ Presented under the working title “Inflation Targeting and Leaning against the Wind: A Case Study,” at the NBER 25 Annual East Asian Seminar on Economics, Unconventional Monetary Policy, June 20-21, Tokyo. The paper builds on comments given at Inflation Targeting and Its Discontents, the 2013 IJCB Conference, September 6-7, 2013, Warsaw, hosted by Narodowy Bank Polski (National Bank of Poland). A shorter version has been published under the title “Inflation Targeting and Leaning Against the Wind” by International Journal of Central Banking. (June 2012) 103-114.