Denmark (and Sweden): In ‘deflationary hell’

That´s how a Danish friend summarized the situation. Although not a euro country, Denmark has its exchange rate pegged to the euro so it´s monetary policy hands are tied, being determined by monetary policy at the ECB. The chart illustrates.


A currency peg is much less binding than a common currency arrangement, so why doesn´t Denmark opt-out? I suspect it´s very much afraid of the ‘inflationary consequences’ of such a move. Better to keep living in ‘deflation’!

Sweden would be a good counterpoint (or ‘control’) in an analysis of Denmark, given that Sweden is not in the euro or has a pegged exchange rate, being free to pursue its preferred monetary policy.

Interestingly, there´s not such a great difference in the performance of the two countries, in particular over the last couple of years. I suspect Lars Svensson´s influence has been waning!

This is how the Riksbank recently described monetary policy in 2012 (my bolds):

Poorer economic prospects led to lower inflation

The weak developments in the euro area had a clearly negative impact on the Swedish economy during 2012. Demand in Sweden slowed down and inflationary pressures were lower, which made it more difficult for companies to raise their prices. In recent years the krona has strengthened, approaching more long-run normal levels. This has also contributed to low inflationary pressures.

Inflation undershot the target in 2012

Both CPI and CPIF inflation that is the CPI with a fixed mortgage rate, were on average around 1 per cent in 2012. The fact that inflation was below the Riksbank’s target of 2 per cent was largely due to economic activity abroad being much weaker than expected and the effects this had on the Swedish economy. At the same time, long-run inflation expectations were close to 2 per cent, which shows that the public was still confident that the Riksbank would attain its inflation target.

Low repo rate to attain the inflation target

In 2012 the Executive Board of the Riksbank cut the repo rate from 1.75 to 1 per cent to support economic activity and bring inflation back on target. The forecasts for the repo rate, known as the repo-rate path, were also lowered over the course of the year. The members of the Executive Board were unanimous that the repo rate needed to be cut gradually, but there were differing opinions as to how much it should be cut.

Pretty ‘depressing’ isn´t it? Why on earth can´t the Riksbank offset negative influences from abroad? But that´s always a good excuse for central bankers! And parenthetically I lost some of the esteem for Svensson when I learned from the Riksbank website that on April 13 he´s going to make a presentation entitled “How much relative weight should policy makers place on employment, and how much on inflation?” at the conference “Fulfilling the Mandate of Full Employment: Labor Markets and Monetary Policy”, arranged by the Federal Reserve Bank of Boston.

That´s nothing more than further discussion of the parameter values (on inflation and output gap) in a Taylor-Rule set-up. In other words, a pretty useless endeavor.

Some pictures for Denmark and Sweden are illustrative. The first shows the NGDP (or spending) ‘gap’ in both countries since the crisis began. The second the rate of inflation.


Note that in 2009 there was an ‘effort’ to raise spending back towards trend, more so in Sweden. But that quickly fades once inflation moves up to ‘undesired’ levels. Monetary policy tightens as gleaned from spending falling away from trend.

The next chart is more ‘explicit’.


But according to the Riksbank it was all due to “weakness abroad”! So, ‘welcome to deflationary hell’!

Update: In the comment section James in London mentions House Price Indices (HPI) in the two countries. Below the HPI charts;


HT: James in London

8 thoughts on “Denmark (and Sweden): In ‘deflationary hell’

  1. I try to refrain from comments that might be interpreted as “class warfare” or left-wing etc. And In fact, I prefer free markets, and distrust government to solve anything.

    But I wonder how central bank economists would react if their salaries were tied to real GDP growth, and in exaggerated form. That is, a 1 percent fall in real GDP growth meant a 10 percent salary cut, and a 4 percent real growth meant a 20 percent bonus.

    In the private sector, a CEO who obtains bad results sees some consequences. Do central bank economists ever see consequences? How about tenured academics? No, they can devise ever-more complicated models and posture until the whole economy is ruined.

    Right now, all through academia and central-banker-land, you have economists in sinecures, pontificating about inflation and employment. They are not bearing the brunt of slow growth or depressions.

    • If this is considered an example of “left-wing” commentary, then I guess I can start signing up for SDS any day now. It truly is a shame that policy makers (of the legislative and monetary kind) seem to have little to no pressure on them when it comes to performance. I always sympathized with the idea that legislators should have their pay tied to the GDP Per Capita (or some other such “median income” measure), so why not give the people who control monetary policy a little incentive to get off their asses and stop pursuing the policies of old that are clearly lacking?

  2. Good post. I hadn’t realised how close Sweden was to Denmark in deflation. RGDP has been much stronger in Sweden vs Denmark thus masking the NGDP danger. Also, HPI in Sweden has been very positive for a long time vs strong declines in HPI in Denmark, which boosts confidence. And Sweden has “proper” industry versus Denmark’s pig farms. So things feel a lot better in Sweden over Denmark.

    However, the Swedish Central Bank’s obsession with slowing down the HPI could come back to haunt them given the banking sector’s huge exposure to mortgage lending. Using monetary policy to burst a housing bubble, or is that create a house price bust, seems insane, especially because Swedish HPI is mostly due to a very long period of population growth, including much immigration, bumping up against a near zero tolerance for new housing. Swedish HPI can have nothing to do with “loose” monetary policy as the charts show monetary policy is actually very tight already. Watch out below!

  3. Sweden’s only saving grace is that it is still benefiting from a bit of policy convergence (good structural reforms) with Denmark. They have so much underlying AS growth that household employment is still slowly rising, though not enough to move the jobless rate down.

    To say Svensson’s influence in the Riksbank is waning is almost to put it lightly. He has been repeatedly vindicated by events, and frankly made most of the other Riksbank members look bad in the process. They are none too pleased with this. There was talk recently of denying him reappointment after his term expires (because of his supposed ‘advanced age’, which is nonsense). Lars Calmfors (wow…lots of Larses up there…), perhaps Sweden’s most influential macroeconomist had to come to his defense, and I think that issues has been dropped, but it shows how messy things have become in the Riksbank.

    Here is a somewhat incoherent translation of an article which lays it out:

  4. That is truly awful. Sweden had cut its output gap in half by late 2010, but allowed itself to fall back into recession! It makes me think, maybe that 3% inflation was better for their economy an keeping inflation somewhat elevated would’ve allowed the Swedish economy to make a full recovery by now.

  5. Pingback: Effects on Denmark: Denmark and Sweden In deflationary hell Historinhas | Euro Economy

  6. Pingback: Effects on Sweden: Denmark and Sweden In deflationary hell Historinhas | Euro Economy

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