Central Banking Revolutionary

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Central Banking Revolutionary

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Bibliographic details

• Authors: PRAKASH LOUNGANI
• Published: March 1, 2023

Overview

• Profile of Lars E.O. Svensson, former deputy governor of Sweden’s Riksbank and affiliated professor at the Stockholm School of Economics.
• Author: Prakash Loungani.
• Publication: F&D Magazine, March 2023.
• Theme: Svensson’s role in developing and promoting inflation targeting, inflation forecast targeting, and policy innovations (including negative interest rates), and his advocacy for separating monetary policy from macroprudential policy.

Career trajectory and background

• Education and early career:
  • Completed an MS in physics and applied mathematics at the Royal Institute of Technology in Stockholm in 1971.
  • Switched to economics following undergraduate economic history courses; earned a doctorate in economics in Stockholm and spent a year at the Massachusetts Institute of Technology.
  • First job at the Institute for International Economic Studies at Stockholm University; later moved to Princeton University by 2001.
• Professional roles:
  • External advisor to the Riksbank in the early 1990s.
  • Returned to the Riksbank as deputy governor in 2007; left at end of term in mid-2013.
  • Affiliated professor at the Stockholm School of Economics.
• Personal note: At age 75, Svensson remains active in research.

Key contributions to monetary policy

• Advocate and developer of inflation targeting:
  • Argued for monetary policy to target “a narrow range for the inflation rate.”
  • Riksbank adopted inflation targeting with a 2 percent long-term goal in early 1993, aiming to achieve it by 1995.
• Flexible inflation targeting:
  • Urged that central banks recognize dual responsibility to keep inflation near the target and the economy close to full employment; opposed being “inflation nutters.”
• Inflation forecast targeting:
  • 1997 paper recommended central banks select a path for current and future rates so that their own forecasts for inflation and employment “looked good” for reaching the inflation target and full employment.
  • Encouraged publishing interest rate paths; Norges Bank, the Riksbank, and the Czech National Bank adopted such practices.
  • Emphasized transparency and forward guidance because monetary policy effects unfold with a long lag.

Crisis response and policy innovations

• Role during the Great Recession:
  • Advocated for sharp interest rate cuts and clear communication that central banks were not “inflation nutters” and would keep rates “low for long.”
• Negative interest rates:
  • Argued for moving to negative interest rates by levying fees on deposits to push banks into making loans.
  • Danish central bank adopted negative rates in 2012; European Central Bank and several others followed.
  • Quoted assessments: Ken Rogoff—“if done correctly … negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment.”
• Impact:
  • Enhancements in monetary management advocated by Svensson and others helped central banks prevent the Great Recession from turning into another Great Depression.

Riksbank disagreement, exit, and aftermath

• Policy conflict:
  • By July 2009, the Riksbank had cut rates to 0.25 percent.
  • Svensson wanted to cut to zero and consider negative rates; colleagues began raising rates in 2010.
  • Opposed “leaning against the wind” (raising rates to counter financial-stability risks such as rising house prices and mortgage debt when inflation/output considerations did not support it).
• Departure:
  • Left the Riksbank at end of his term in mid-2013 after “not managed to get support for a monetary policy” he preferred.
• Validation of Svensson’s stance:
  • By 2014, rate hikes had failed to tame housing price inflation and had led to deflation and economic weakening; Riksbank cut rates to zero.
  • In 2015 the Riksbank ventured into negative interest rate territory.
  • A subsequent IMF working paper by Rima Turk deemed the negative-rate experiment successful.

Views on monetary policy versus macroprudential policy

• Position:
  • Monetary policy should focus on inflation and output goals; financial stability considerations should be left to macroprudential policy.
  • Argues the two policies are “different and best conducted separately.”
• Evidence and influence:
  • Presented calculations showing that benefits of raising interest rates for financial stability (by lowering crisis odds) are small and uncertain, while costs in terms of higher unemployment and deflationary pressures are high and more certain.
  • Svensson’s cost-benefit analysis featured in a 2015 IMF staff paper on “Monetary Policy and Financial Stability,” concluding that in most cases the costs are higher than the benefits.
  • Philip Turner: using favorable empirical magnitudes to the opposing case, Svensson “decisively won this debate.”

Ongoing research and challenges to received wisdom

• Recent work focuses on:
  • Showing that commonly used indicators of housing price overvaluation—such as the house-price-to-income ratio—are misleading and can lead to poor policy actions by financial agencies.
  • Challenging the view that households with higher levels of outstanding mortgage debt cut back more on spending in a crisis.
• Reputation:
  • Praised for encouraging rigorous rethinking of conventional positions; described as “preternaturally calm but hard-nosed, polite but forthright.”

Source: Central Banking Revolutionary, F&D Magazine, March 2023. Prakash Loungani.

Content in this bundle

• F&D March 2023: People in Economics - Central Banking Revolutionary
  • F&D March 2023: People in Economics - Central Banking Revolutionary (Markdown version)
  • F&D March 2023: People in Economics - Central Banking Revolutionary (PDF)