Report criticizes Swedish central bank inflation measure, urges sweeping changes

STOCKHOLM: Sweden’s central bank should have a clearer role in policing economic threats like household debt levels, a long-anticipated report said on Monday, while recommending a change to an inflation target that may allow less aggressive monetary policy.

Arguing a bitter split over monetary policy has damaged the market’s faith in the central bank, the independent report by former Bank of England governor Mervyn King and US economist Marvin Goodfriend recommended sweeping changes to a central bank that has struggled to keep inflation near its 2 percent target.

A summary of the report, commissioned by the general council of the central bank and due to be published on Tuesday, was seen by Reuters.

The recommendations could give impetus to reform of a central bank under heavy criticism for its pursuit of an elusive inflation target at the risk of creating a credit bubble.

King and Goodfriend said the Riksbank’s 2 percent inflation target should be based on a measure of underlying inflation which strips out the effect of the central bank’s own interest rate changes.

Underlying inflation, or CPIF, has been significantly higher than consumer price inflation over recent years and was 0.9 percent on an annual basis in December, above the 0.1 percent as measured by CPI. That would formalize what the Riksbank long has been using as an informal target.

The report also said the Riksbank should have a greater say in supervising financial regulation rather than solely inflation-targeting – currently the main mandate of the separate Financial Supervisory Authority (FSA).

A review in 2020, recommended by King and Goodfriend, could lead to a further strengthening of the Riksbank’s hand.

“The Riksbank’s mandate should also include financial stability and the Riksbank must have certain formal powers in order to achieve its goal,” the report said.

Swedish households are amongst the most indebted in Europe, leading to worries that sharp fall in prices could capsize the country’s AAA-rated economy.

King and Goodfriend’s report follows widespread criticism that the central bank hiked rates too fast after the 2008-2009 global downturn due to worries over high levels of household debt and then was too slow in reversing course when the economy faltered again.

The board was deeply divided over policy with normally reserved rate-setters airing their grievances openly.

“It is clear from the minutes and the public statements made by members of the Executive Board during the period covered by our investigation that there was not always a respect for the opinions of others,” the report said.

“The scale of differences of opinion and above all how they were expressed damaged the Riksbank’s reputation.”

The report also criticized the board for having too much faith in models for forecasting inflation and future repo rates, leading to a wide difference between the Riksbank’s prognoses and those made by the markets.

“A greater humility regarding these models would not have been out of place,” the report said.

Nobel Laureate Paul Krugman called the central bank’s policy “sadomonetarist” but King and Goodfriend disagreed with US Federal Reserve chief Janet Yellen’s view that Swedish rate increases in 2010 and 2011 were premature, saying they were reasonable given the information known at the time.

They were less impressed with monetary policy in the following years when the euro zone faced huge problems, saying the board did not cut rates fast enough in 2013.

Despite robust growth, consumer prices have been flat or falling for most of the last three years forcing the central bank to slash rates to a record low of -0.35 percent and raising fears of a housing bubble.

A strong crown EURSEK= has capped the effects of ultra-low rates and many analysts believe further rate cuts or expanding the current asset-purchase program will have little effect.

The central bank now says it is now ready to intervene in the currency market.

Critics of the central bank say it paid too little attention to the inflation target when the economy faltered in 2012, instead focusing on worries about a housing bubble.

But they also say its focus on getting inflation back to its 2 percent CPI target has led it to exhaust its monetary policy options, with little effect as there is not much it can do about oil prices LCOc1 at below $30 a barrel and a sluggish global economy.

The target of consumer price inflation of 2 percent has also been widely criticized as forcing the central bank to chase its own tail as rate cuts automatically push down inflation and hikes lead to a pick up in the pace of price increases. The Riksbank should be able to deviate from the CPIF target for periods of time if it is deemed necessary, the report said, and the target should be reviewed every 10 years.

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