Make us your home page

Fed shouldn't try to pop bubbles — just ask Sweden


To pop or not to pop, that is the question for central bankers.

Whether 'tis wiser for the economy to suffer the booms and busts of irrational exuberance, or to take arms against a sea of bubbles and by opposing end them. In other words, should the Federal Reserve try to clean up only after a bubble has already popped, or should it actively try to pop bubbles so the cleanup is easier?

Now, as you might have guessed, the choice isn't so simple. While nobody thinks policymakers can afford to ignore financial froth anymore, the economy can't afford for them to pay too much attention to it, either. Raising rates would eventually burst any bubbles we may be experiencing — but that would come at the cost of higher unemployment. Regulating away a bubble makes more sense, since it wouldn't hurt the rest of the economy, but it's not clear that regulators can actually pull this off.

That's a lesson Sweden has more than learned. Sweden has become the unlikely guinea pig for raising rates to fight a bubble. Now until a few years ago, Sweden had been what the New York Times' Neil Irwin called the "rock star of the recovery": Aggressive fiscal stimulus had helped it bounce back from the crisis faster than almost any other country. But, despite still-low inflation, its central bank, the Riksbank, began to worry that it had bounced back too fast and that households were taking on too much debt, up to 174 percent of their income. That's why, over the protests of Lars Svensson, one of its deputy governors and one of the world's leading monetary economists, Sweden's central bank began hiking rates in July 2010.

When inflation refused to show up, the Riksbank said it still needed to do so, to keep a housing bubble in check.

This didn't just cripple Sweden's recovery. It crippled Swedish households. And in doing so, it paradoxically made a crisis more likely. See, Sweden's economy had been doing better than most others, but not so much that it could withstand seven rate hikes while joblessness was still high. This premature tightening kept unemployment from falling much further, and made inflation fall well below target — into negative territory.

And this is the key point: Low inflation means higher real-debt burdens. So raising rates to try to stop households from taking on more debt actually increases their inflation-adjusted indebtedness. It's a policy with almost all costs and no benefits — and that's according to the Riksbank's own calculations. As Svensson points out, the central bank estimates that the benefits of raising rates to try to pop a bubble are only 0.14 percent of the costs. No wonder the Riksbank recently reversed course and cut rates back near zero.

So Sweden isn't trying to pop its bubble anymore. It's trying to make it less dangerous instead. It's using what economists call "macroprudential regulations" to try to limit risky debt — for example, by making borrowers pay back their mortgages faster. Central bankers realize they can't make policy that helps the financial economy but hurts the real one without it eventually rebounding onto the financial one, too. Instead, they need to give the real economy the policy it needs, and the financial one the regulation it needs.

It's a matter of slowing, not stopping, the bubble — and surviving it if it does pop.

Fed shouldn't try to pop bubbles — just ask Sweden 07/10/14 [Last modified: Thursday, July 10, 2014 6:32pm]
Photo reprints | Article reprints

Copyright: For copyright information, please check with the distributor of this item, Washington Post.

Join the discussion: Click to view comments, add yours

  1. Posh Guy Harvey RV park to open in Tampa Bay with $250,000 cottages


    Love those Guy Harvey T-shirts with the soaring marlins? In the not too distant future, you might be able to kick back in your own Guy Harvey cottage in the first-ever Guy Harvey RV park.

  2. Port Tampa Bay secures $9 million grant to deepen Big Bend Channel


    Port Tampa Bay has secured a $9 million grant from the U.S. Army Corps of Engineers for the widening and deepening of the Big Bend Channel in southern Hillsborough County.

  3. Tampa International Airport morphing into a mini-city unto itself


    TAMPA — By the end of the 2026, Joe Lopano wants Tampa International Airport to function as its own little city.

    Artist rendering of phase two of the $1 billion construction expansion of Tampa International Airport. The airport is transforming 17 acres of airport property that will include at least one hotel, retail and office space and a gas station, among other things.
[Courtesy of Tampa International Airport]
  4. Lost Highway: As FHP struggles to recruit, speeding tickets plummet

    State Roundup

    TALLAHASSEE — The number of speeding tickets written by Florida state troopers has plunged three straight years as the agency grapples with a personnel shortage and high turnover.

    State data shows FHP troopers are not writing violations for speeding or other infractions like they did back in 2011, even though there's 1 million more licensed drivers in Florida.
  5. Kidpreneurs — and adults — capitalize on gooey, squishy Slime craze


    Aletheia Venator and Berlyn Perdomo demonstrate the stretchiness of their slime. - Berlyn Perdomo and her friend, Aletheia Venator, both 13, make and sell slime which can be seen on their instagram site @the.real.slimeshadyy [JIM DAMASKE   |   Times]