Three years ago Sweden was regarded as a role model in how to deal with a global crisis. The nation's exports were hit hard by slumping world trade but snapped back; its well-regulated banks rode out the financial storm; its strong social insurance programmes supported consumer demand; and, unlike much of Europe, it still had its own currency, giving it much-needed flexibility.
By mid-2010 output was surging, and unemployment was falling fast. Sweden, declared The Washington Post , was "the rock star of the recovery".
Then the sadomonetarists moved in.
The story so far: in 2010 Sweden's economy was doing much better than those of most other advanced countries. But unemployment was still high, and inflation was low. Nonetheless, the Riksbank – Sweden's equivalent of the Federal Reserve – decided to start raising interest rates.
There was some dissent within the Riksbank over this decision. Lars Svensson, a deputy governor at the time, vociferously opposed the rate hikes. Svensson, one of the world's leading experts on Japanese-style deflationary traps, warned that raising interest rates in a still-depressed economy put Sweden at risk of a similar outcome.
Sure enough, Swedish unemployment stopped falling soon after the rate hikes began. Deflation took a little longer, but it eventually arrived. The rock star of the recovery has turned itself into Japan.
So why did the Riksbank make such a terrible mistake? That’s a hard question to answer, because officials changed their story over time.
At first the bank’s governor declared that it was all about heading off inflation. “If the interest rate isn’t raised now, we’ll run the risk of too much inflation further ahead . . .” But as inflation slid toward zero, the Riksbank offered a new rationale: tight money was about curbing a housing bubble, to avert financial instability. As the situation changed, officials invented new rationales for an unchanging policy.
In short, this was a classic case of sadomonetarism in action.
I'm using that term (coined by William Keegan of The Observer ) advisedly, not just to be colourful. As I define it, sadomonetarism is an attitude, common among monetary officials and commentators, that involves a visceral dislike for low interest rates and easy money, even when unemployment is high and inflation is low.
You find many sadomonetarists at international organisations; in the US they tend to dwell on Wall Street or in right-leaning economics departments. They don’t, I’m happy to say, exert much influence at the Federal Reserve – but they do constantly harass the Fed, demanding that it stop its efforts to boost employment.
And when I say that the dislike for low rates is visceral, I mean just that. While sadomonetarists may offer what sound like coherent analytical rationales for their policy views, they don’t change their policy views in response to changing conditions – they just invent new rationales. This strongly suggests that what we’re looking at here is a gut feeling rather than a thought-out position.
Where does this gut dislike for low rates come from? It has to reflect an instinctive identification with the interests of wealthy creditors as opposed to usually poorer debtors. But it’s also driven, I believe, by the desire of many monetary officials to pose as serious – and to demonstrate how tough they are by inflicting pain.
Whatever their motives, sadomonetarists have done a lot of damage. In Sweden they have extracted defeat from the jaws of victory, turning an economic success story into a tale of stagnation and deflation as far as the eye can see.
And they could do much more damage in the future. Financial markets have been fairly calm lately – no big banking crises, no imminent threats of euro breakup. But it would be wrong and dangerous to assume that recovery is assured: bad policies could all too easily undermine our still-sluggish economic progress.
So when serious-sounding men in dark suits tell you that it’s time to stop all this easy money and raise rates, beware. Look at what such people have done to Sweden.