Monetary Policy And Time-Consistency, Evidence From Sweden (Wonkish)

This is, as Paul Krugman says, pretty wonkish and probably nobody cares but since I discovered that the Svergies Riksbank publishes its monetary policy statements in English I see that it sheds some light on the time-consistency issues posed by monetary policy at the zero lower bound. The cutting edge theoretical work has long indicated that when short-term rates go to zero, the central bank ought to communicate that rates are going to stay low for a while. The Federal Reserve just field tested this idea in August by saying that conditions are likely to warrant low rates until some time in 2013.

The Riksbank turns out to have executed this move back in June 2009, saying:

A lower repo rate and repo rate path are needed to counteract the fall in production and employment and to attain the inflation target of 2 per cent. The Executive Board of the Riksbank has therefore decided to cut the repo rate to 0.25 per cent. The repo rate is expected to remain at this low level until autumn 2010.

From the dawn of time, or at least since the late-1990s, people have wondered what happens if this works. If growth rebounds, why keep rates low? And given that time-consistency problem, can the policy work? What happened in Sweden was that the policy did work, growth rebounded nicely, and, yes, the Riksbank raised rates in July 2010 rather than waiting until their scheduled September meeting.

I’ll draw no conclusions from this but I continue to think Sweden’s experience during the recession should be talked about more. Pretty much all of the countries and sub-national regions who’ve done well in GDP terms (note that Germany, despite healthy labor markets, is in fact unimpressive in growth terms) are natural resource exporters. That’s Canada, Australia, Norway but also Texas and North Dakota. Then there’s Sweden and Israel both of which look to me to be triumphs of currency devaluation.