The Perils of Zero Inflation for Swedish Household Debt

Zero inflation in Sweden the last two years instead of 2 percent, the inflation target, has substantially increased real household debt. Borrowers have made a real capital loss of 4 percent in two years, and lenders, the banks, have made a corresponding loss. The Riksbank’s “leaning against the wind” policy to reduce household debt is counterproductive and not working.

The most recent observation (October 2013) of Swedish CPI inflation from Statistics Sweden is negative, minus 0.1 percent. The inflation rate has been around zero since November 2012. This means that the CPI index, the general price level, is now at the same level as two years ago, November 2011. If the inflation rate had been equal to the inflation target of 2 percent, the price level would now have been 4 percent higher than it was in November 2011.

12-month CPI inflation in Sweden

Source: Statistics Sweden

That the inflation rate is so low has substantial consequences for household indebtedness.

  • The real value of household debt has become 4 percent higher than if the inflation rate had been 2 percent the last two years.

For every borrowed SEK million, the borrower has made a capital loss of SEK 40 000. Furthermore, with low inflation, the nominal value of housing has become lower, in contrast to the nominal debt. Therefore the loan-to-value (LTV) ratio has become higher.

  • A new mortgage in November 2011 now has an LTV ratio that is 4 percent higher than if inflation had been 2 percent.

The reason why the inflation rate is so low is that the Riksbank does not want to lower the policy rate because it is worried that the household debt would then become too high. The Riksbank is “leaning against the wind,” conducting a tighter monetary policy than is justified by the objective of stabilizing inflation around the inflation target of 2 percent and unemployment around a long-run sustainable rate.

  • But this policy is counter-productive. Because the policy leads to an inflation rate substantially below the target, it actually increases the real debt, the debt-to-income ratio, and the LTV ratio, compared to if the inflation rate had been on target. The policy then also reduces household net wealth and the net wealth-to-total assets ratio. The borrowers suffer a capital loss, and the lenders, the banks, make a capital gain.

Household mortgages are now according to the Financial Market Statistics of Statistics Sweden about SEK 2 300 billion. 4 percent of this is about SEK 90 billion. The Riksbank’s monetary policy has thus led to the borrowers losing SEK 90 billion and the banks gaining the same amount. This amount can be compared to the profits of the four major Swedish banks: During the third quarter this year, they were around SEK 4 to 5 billion for each of Handelsbanken, SEB, and Swedbank, about double that for Nordea.

When is the Riksbank going to understand how monetary policy actually affects household indebtedness and act accordingly? And should Finansinspektionen (the Swedish financial supervisory authority), with responsibility for both financial stability and consumer protection in the financial sector, silently watch the borrowers being hurt and the household balance sheets being weakened? And what is the Finance Committee of the Riksdag doing, the committee that supervises the Riksbank and assesses its performance and target achievement?

Here and here there is more to read about how monetary policy and inflation actually affect household debt.

2 Responses to "The Perils of Zero Inflation for Swedish Household Debt"

  1. Adam_Smith   November 22, 2013 at 8:19 am

    “For every borrowed SEK million, the borrower has made a capital loss of SEK 40 000.”

    That’s a bit hypothetical. If the borrower did nothing with the borrowed funds but to repay the loan with interest after two years then the borrowers loss is equal to the interest expense which may have been at less than 4%. If, on the other hand, the borrower invested the funds then whatever return was achieved would offset that cost — perhaps to the point of net profit. Borrowers may, however, been misled two years ago by assuming that a 2% annual inflation target would be achieved. In that case, the problem is less with the failure to achieve the target than in setting it in the first place.

    I am well aware of conventional current theory that prescribes a positive inflation rate, typically around 2%, as beneficial to employment which, on its face, it probably is. But that doesn’t mean that the employment gains don’t come at an unacceptable cost in ever rising levels of public and private debt and instability over the long term.

  2. nmmaier   November 27, 2013 at 12:20 pm

    This is silly article. Is it really the role of the Riksbank to extinguish the debts of households through inflation? What about Swede's who save? Should they be penalized so they lose 2% of their savings every year through inflation? I would say that Riksbank is doing a great job of keeping the currency stable (i.e. no inflation). in this environment, both debtors and savers can make sound judgments how to deploy their capital.