Sunday, September 20, 2015

The Time Sweden Raised Interest Rates to 500%

Crazy things can happen in interest rate markets (Note: I am not predicting that Janet Yellen will raise rates to 500% at the December FOMC meeting). From NYT of  September 17, 1992:
Five hundred percent interest rates in Sweden! Where do I sign up?

You can't. In a move to defend the Swedish krona at all cost against speculators betting on a devaluation of the currency, the Swedish central bank raised its marginal lending rate on Wednesday to a shocking 500 percent. But the rate is imposed only on banks that insist on borrowing extra funds over the next three days. Almost none did...

The aim of the operation is not to pay rates of 500 percent. It is to dramatically demonstrate the government's determination not to devalue the krona, and to drive up rates in the money market, making it more lucrative to hold the currency.

Indeed, one-month money-market rates in Sweden jumped to almost 35.00 percent on Wednesday, up from 21.32 percent late Tuesday, and well above a peak of about 25.00 percent last week.

Shortly after the Riksbank announced the 500 percent rate, domestic credit markets closed up shop for the day. "They may shut down if they want," said the chief dealer of the central bank, Kjell Nordin. "There is only a short time left for trading."

But the punitive rate, announced in the late afternoon after a boost earlier in the day to 75 percent from 20 percent failed to stop the outflow of currency from Sweden, seems to have accomplished its goal. At least for the day.

"I think this measure is sufficient for now," Bendt Dennis, Sweden's central bank governor, said in a radio interview. "The short-term speculators burned their fingers."

Darren Cullen, a Scandinavian analyst for Salomon Brothers in London, explained what happened. "This stopped the outflow of currency. They made it too expensive to short the currency." (A speculator "shorts" a currency by borrowing funds today on the hope that he can repay them later at a profit after the currency declines.)
In November 1992, the bank lost the battle and a managed float regimen for the currency was implemented and remains in effect to this day.

 -RW 

4 comments:

  1. So in the face of an imminent market crash will the Fed raise rates?

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    1. If one is to assume they will maintain their "dual mandate", which is both low unemployment and low inflation, it always seems a possibility IMO.

      For example, unemployment is low right now and they proclaim "data driven" as a badge of some sort, so even if they think the underlying economic fundamentals aren't strong but inflation suddenly jumps to 4% when they are targeting two, there's a strong possibility they will raise in my opinion- even if said action hurts the economy. (I could argue it was already hurt before, but that action just sped up the results)

      The above brings me to an interesting question/thought(in my mind anyway), we all know that 2% inflation is the "magic figure" in the Fed's eyes for inflation, have they ever officially come out and established a long term "magic figure" for unemployment?


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  2. Maybe Krugman gave extra credit to students that posted a response on your blog.

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    1. Woops. I meant to post this in the post where you take down the faux Austrians.

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