Riksbank inflation target not credible in the
beginning but eventually achieved
Inflation expectations:
The Swedish experience
Target announced
Target applies
Credibility achieved
12
10
Lars E.O. Svensson
8
Stockholm School of Economics and IMF
6
4
Web: larseosvensson.se
2
Inflation Expectations Symposium
Federal Reserve Bank of Minneapolis,
March 30, 2015
The views expressed in this presentation are those of the author and
do not necessarily represent those of the IMF or IMF policy. !
0
-2
1991
1992
1993
1994
1995
CPI inflation, Y/Y, percent
Unemployment
1996
1997
1998
Inflation next 2 years
Repo rate
1999
2000
Inflation next 5 years
Source: Aragon Fondkommission, Statistics Sweden.
1
3
Inflation expectations well anchored to target
1997-2011
Outline
!  Inflation expectations anchored at the target: Good or bad?
!  Anchored inflation expectations: Consequences of
undershooting a credible inflation target
12
CPI inflation, Y/Y
1yr inflation expectations
2yr inflation expectations
Unemployment
10
•  Increased unemployment
•  Unanticipated increase in real debt
8
!  Do Swedes have “near rational” expectations (Akerlof,
Dickens, and Perry 2000)?
6
•  Moderate undershooting of target (< 1 pp) doesn’t seem to shift
expectations much
•  Large undershooting the last few years and debate seems to shift
expectations
4
2
!  Problems if credibility of inflation target lost?
!  How to restore credibility?
0
-2
96
2
97
98
99
00
Source: Statistics Sweden.
01
02
03
04
05
06
07
08
09
10
11
4
5-year moving averages:
CPI inflation expectations close to 2 %,
CPI inflation below 2 %
1996: Inflation target gradually becomes credible
4.0
A
3.5
CPI inflation, Y/Y, 5yr moving average
1yr inflation expectations, 5yr moving average
2yr inflation expectations, 5yr moving average
3.0
π e =π = π *=2
2.5
C
B
2.0
1.5
1.0
0.5
u=u*
0.0
00
01
02
03
04
05
06
07
08
09
10
11
Source: Statistics Sweden.
5
From 1997: Inflation expectations stuck at 2 %,
but monetary policy still tight:
Inflation too low, and unemployment too high
Before 1996: Inflation target not credible, tight
monetary policy, and high unemployment
πe
A
π − π e = −γ (u − u*)
A
B
π = π *= 2
u*
7
π e = π *=2
π = 1.4
u
C
B
D
u* u
6
8
8
Money-market participants’ expectations have also
drifted down. Credibility loss?
CPI inflation and unemployment 1976-2012,
and benchmark long-run Phillips curve 1997-2011
16
CPI inflation, Y/Y, percent
12
π t = 6.8 − 2.70 (ut − ut −1 ) − 0.75 ut −1 + ε t
1976Q2
( 0.73)
8
( 0.18)
π = 6.8 − 0.75 u
1991Q4
1993Q4
2011Q3
4
2
1.4
0
0.6 p.p.
1998Q1
0.8 p.p.
-4
1
2
3
4
5
6
7
8
9
10
11
12
Unemployment, percent
Source: Svensson (2015), “The Possible Unemployment Cost of Average Inflation
below a Credible Target,” American Economic Journal: Macroeconomics 7(1), 258-296.
9
Recently, household inflation expectations have shifted down,
after large undershoot and much debate and criticism of the
Riksbank
6
Inflation and household inflation expectations
5
4
4
3
3
2
2
1
1
0
0
-2
-3
11
Riksbank inflation-forecast credibility eroded?
6
5
-1
Percent. Source: TNS Sifo Prospera.
Percent. Source: TNS Sifo Prospera.
-1
CPI inflation
Hhold 1-yr expectations
Hhold 1-yr expectations excl extreme values
-2
-3
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
10
12
Percent increase to February 2015 in the real value of a given
loan, compared to if inflation had been 2 percent
(depending on when the loan was taken out)
Inflation below household’s expectations increases
household real debt burden (Fisher deflation)
5
4
Nov 2011
5
CPI inflation
Hhold 1-yr exp's, lagged 1 yr, excl extr vls
4
3
3
2
2
1
1
Inflation surprise
0
0
-1
-1
-2
-2
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Note: Dashed lines are 5-year trailing moving averages
13
The real value of an SEK 1 million loan taken out in
Nov 2011, actual and for 2 percent inflation
15
Sum up
6.5 % higher real debt
!  A credible inflation target in principle good: Allows monetary
policy to stabilize real economy more
!  Persistent undershooting a credible inflation target increases
unemployment and household real debt burden
!  Large undershooting erodes credibility of inflation target:
Inflation expectations shift down
!  “Near rational” inflation expectations?
!  Overshooting low inflation expectations reduces unemployment
and household debt burden
!  But difficult to increase inflation with ELB (not ZLB) and low
inflation expectations
!  How difficult to meet the target and restore its credibility if
credibility is lost?
14
16
The leaning: Policy rates in Sweden, UK, and US;
Eonia rate in euro area
Extra slides
17
19
The leaning: Inflation in Sweden, euro area, UK,
and US
Prospera and firms inflation expectations
18
20
The leaning: Real policy rate in Sweden, UK, and US,
real Eonia rate in euro area
21
Ex post evaluation: Riksbank policy-rate increases from
summer of 2010 have led to inflation below target and higher
unemployment (and probably a higher debt ratio)
85% LTV cap
Source: Svensson (2013), “Unemployment and monetary policy – update for the year 2013,”
Svensson (2013), “Leaning against the wind increase (not reduces) the household debt-to-GDP ratio”,
posts on larseosvensson.se.
22