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.
VIEWED from one perspective, the euro area is a minor miracle. Instead of collapsing in a heap, as seemed possible two years ago, the currency club is not just intact but has a new member, Latvia, which joined in January. An economic recovery has been under way since last spring and appears to be strengthening. But seen from another standpoint the euro zone is an accident waiting to happen. As inflation slips ever lower, a slide into Japanese-style deflation looks increasingly likely. That would raise an already onerous debt burden in real terms and pull down growth.
The actions of the European Central Bank (ECB) will be crucial if such an outcome is to be averted.
Premier Li Keqiang this month announced that China’s military budget will increase 12.2% to 808.2 billion yuan ($131.6 billion) this year.
The dominant narrative is that, as large as it is, the spending plan is roughly in line with the expansion of the Chinese economy. For instance, Paul Burton of IHS IHS -0.35% Defence believes Beijing’s budgets are “broadly in keeping with recent year-on-year growth rates, tracking slightly above annual gross domestic product growth.” Samuel Perlo-Freeman of the Stockholm International Peace Research Institute agrees. Apparently using some variant of Beijing’s 3.5% inflation target for this year, he computes the after-inflation increase in military spending for 2014 as 8.4%, not too far from the official growth target of 7.5%.
This narrative is incorrect for two important reasons. First, it looks like there will be little or no inflation in China this year, so adjusting the nominal 12.2% figure to arrive at the real number is inappropriate. True, consumer prices rose 2.5% in January and 2.0% in February, but the producer price index fell during the period, down 1.6% in the first month of the year and 2.0% in the second. Because manufacturing is far more important to the economy than consumer spending, analysts are now worried that China is entering a deflationary period if it has not done so already.
