Sweden- Moving against the flow

Today while I was reading on other headlines in the economics sections, one article particularly caught my attention. "Sweden Shows Central Bankers How to Fight Next Asset Bubble" By Kati Pohjanpalo. This article highlights the steps taken by central bank of Sweden to fight the rising asset prices. At a time when the banks in the US, Europe and Japan are keeping their borrowing cost low, the increase in repo rate by the central bank in Sweden comes as a surprise.

Most of the central banks had kept the rates low to encourage borrowing and fuel economic growth. And most of the banks have used inflation target as a benchmark to gauge the effectiveness of this step. In USA the inflation has decreased over past many months and the CPI stands at 0.1% in November 2010 ( source US Bureau of Labor Statistics). This has made FED worried and they plan to infuse more than $600 billion funds in quantitative easing to stop the US from moving in a deflation mode. So on the face of it, the steps look reasonable as infusing of more funds in market with reduce the borrowing cost which ultimately make people to spend and help achieve the inflation target that the FED has set.

Now lets compare the parameters to whats happening in Sweden. The inflation in Sweden has been under the target of 2% for past few months but the central banks has increased the repo rate four times. If we apply simple principles of economics, this step should reduce the demand for funding and further reduce the inflation. Now at a time when most of the countries in world are trying to accelerate their growth, why is Sweden doing totally opposite. The comments of other economists provide some very valuable insights in this. Johnny Akerholm, president of the Helsinki-based Nordic Investment Bank, says that "The financial crisis that started more than two years ago was exacerbated by central banks holding rates too low as inflation gauges failed to capture asset-price growth". This essentially means that even when inflation across major countries remained low, the prices of commodities other than prices of consumer goods are increasing. So keeping the borrowing rates low is just further fueling this prices to higher level.

This contrasts with Feds approach who prefer higher inflation and rising asset prices to less than target inflation and weaker growth. Which is the best approach? well only time will tell that but it does raise few questions. Is inflation target alone a most optimum parameter? Does infusion of liquidity and keeping the rates lower really help growth in long term or it may actually have a negative impact( case in point Japan) ?

Any ideas highly appreciated..