How Sweden Turned Itself into Japan

Three years ago Sweden was widely 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 programs 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 — and a former Princeton colleague of mine — vociferously opposed the rate hikes. Mr. 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. But he found himself isolated, and left the Riksbank in 2013.

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.

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