Most economists and market participants don’t usually spend much time looking at Swedish monetary policy. Today should be different given the decision by the Riksbank — the country’s central bank and the world’s oldest — to part ways with its peers in advanced countries by raising interest rates because of worries about the collateral damage and unintended consequences of an ultra-low regime.
By raising its main repo rate 25 basis points, Sweden exited a negative rate paradigm that had been in place for five years. The action came after officials there publicly expressed concerns that persistent negative yields distort the behavior of households and companies adversely.
This is a big policy move for Sweden, especially so because it faces what economists call “small country” conditions — that is, it’s too small to directly impact other economies or to resist spillovers from the actions of larger economies.
By increasing interest rate differentials compared with the rest of Europe, the rate increase could strengthen the currency and, together with the higher cost of borrowing domestically, weaken the economy. It’s a risk that the Riksbank said it would monitor closely.
This is also the most explicit signal yet of growing concerns in Europe about the collateral damage and unintended consequences of protracted and excessive reliance on unconventional monetary measures, particularly negative interest rates and large-scale purchases of securities. Potential distortions to a well-functioning economy and financial systems include:
- Undermining the provision of long-term financial protection products to households, which, together with negative returns on savings, goes against the objectives of monetary stimulus by encouraging higher (rather than lower) savings.
- Undermining the banking system’s traditional role in intermediating loanable funds while, simultaneously, encouraging excessive risk-taking by nonbanks.
- Subsidizing zombie companies, thus slowly eroding the growth and productivity potential.
- Encouraging economy-wide resource misallocations.
The loud Riksbank message to other central banks is that being “the only game in town” for too long can make them not just ineffective but also counterproductive. If Sweden can hold out as the monetary policy outlier in Europe — and it’s far from easy given the “small country” conditions — this could well be looked back at as the beginning of the end of a historic policy experiment, one that worked initially but was subsequently undermined by the failure of politicians to enable the much-needed pivot to a more comprehensive pro-growth policy response.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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