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BPEA Article

Practical Monetary Policy: Examples from Sweden and the United States

Abstract

In the summer of 2010, the Federal Reserve’s and the Swedish
Riksbank’s inflation forecasts were below the former’s mandate-consistent
rate and the latter’s target, respectively, and their unemployment forecasts were
above sustainable rates. Conditions in both countries clearly called for policy
easing. The Federal Reserve maintained a minimum policy rate, soon started to
communicate possible future easing, and in the fall launched QE2. In contrast,
the Riksbank started a period of rapid tightening. I find the arguments against
the Federal Reserve’s easing and the arguments for the Riksbank’s tightening
unconvincing. Although the Swedish economy subsequently performed better
than expected, probably an important reason was that the market implemented
much easier financial conditions than were consistent with the Riksbank’s
policy rate path. Without the policy tightening, performance would have been
even better. The U.S. economy meanwhile performed worse than expected
because of factors other than monetary policy. Without the policy easing, performance
would have been even worse. In short, the Riksbank did the wrong
thing but was lucky, whereas the Federal Reserve did the right thing but was
unlucky.

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