Macroeconomics Case Study

Direct Inflation Targeting: The Swedish Experience

OR

Abstract:
The primary objective of monetary policy is to reduce and contain inflation and inflationary expectations. Keeping this objective in view Sweden followed other OECD (Organisation for Economic Co-operation and Development) economies like New Zealand and Canada and adopted Direct Inflation Targeting Monetary Policy. Prior to adopting inflation targeting monetary policy Sweden was subject to frequent macroeconomic swings, with downswings dominating. This led to a build up of high inflation expectations and macroeconomic instability for the welfare state. Finally in 1993, inflation targeting was adopted, including sweeping changes to infuse autonomy and accountability in the functioning of the monetary authority, in this case the Sveriges Riksbank. Over the years, to strengthen the case of inflation targeting, it also introduced a stringent act to contain fiscal profligacy which led to fiscal deficits, which in the case of this welfare state rendered the monetary policy useless. Over time the economy stabilised with stabilisation of the inflationary expectations, a gradual reduction of unemployment rates and generation of fiscal surplus to sustain the welfare activities. The fluctuations in the GDP also moderated over time. The most significant outcome was the stability of prices and inflation expectations for this welfare state.

Pedagogical Objectives:

• To give an understanding of the dynamics of monetary policy
• To analyse the interaction between monetary and fiscal policy
• To give a thorough understanding of monetary and fiscal policy in the case of a welfare economy.
• To enable a thorough analysis of the effect of inflation stabilising and containment of monetary policy on long run unemployment and gross domestic product of a welfare economy.

Keywords :  Sweden, Monetary policy, Fiscal policy, Inflation targeting, IS-LM (investment savings-liquidity money) curve, Transmission channel, Interest rate transmission, Fiscal deficit, Exchange rate, Money supply, Macro economic variables, Structural reforms, Government expenditure