By Simon Johnson and Niklas Pollard
STOCKHOLM (Reuters) - Sweden's central bank believes it can avoid Japan's deflationary fate after cutting interest rates to zero; critics say it no longer has any safety margin should a shock hit the economy, and even compare its record with U.S. policy mistakes of the 1930s.
Defying conventional economics, Sweden is enjoying one of the healthiest growth rates in Europe even though the consumer price index has been flat or fallen in every month but one this year.
Far from holding off purchases in the expectation of lower prices later, Swedes are snapping up current bargains thanks to years of tax cuts, falling unemployment and a housing boom.
Nevertheless, the Riksbank felt the need to cut its repo rate more than expected on Tuesday to zero. The central bank also said it would delay tightening policy until the middle of 2016, aiming to ward off the kind of deflationary spiral which condemned Japan to a "lost decade" of repeated recessions.
The Riksbank was quick to move after the global financial crisis, raising rates in 2010 and 2011. Since then it has cut them, but only slowly due its fears that rising household debt would inflate a housing bubble.
This has drawn fierce criticism, including from a Deputy Governor, Lars Svensson, who quit last year over the bank's inaction. He drew parallels with the United States, where the rolling back of reflationary policies that had helped to end the Great Depression pushed the economy back into recession in 1937.
"The whole aggressive leaning-against-the-wind was a big mistake, the Riksbank's 1937," he said in an email to Reuters.
Nobel laureate Paul Krugman has also accused the Riksbank of being engaged in "sadomonetarist cliches".
Now the bank is playing catch-up. Rates are below the level they were in 2009 at the height of the global financial crisis when the economy contracted by more than 5 percent.
In contrast to the euro zone, which faces the risk of both deflation and recession, Swedish economic growth is expected to pick up to 1.9 percent this year - the Riksbank lifted its forecast even as it cut rates. Public debt is modest at around 40 percent of GDP.
NO NEW JAPAN
"We are not going to be a new Japan because if you look at growth in the Swedish economy over the last 5-6 years we have had an economic development that is significantly stronger than they have had in Japan," Riksbank Governor Stefan Ingves told reporters after the latest interest rate decision.
"Where there is a similarity at the moment is that inflation is too low. In other respects, we are completely different."
Some economists are unworried about the flat prices. "A lot of people see it as quite a good situation. For those who have jobs, it raises their purchasing power. I don't think it's a big problem," Danske Markets economist Mikael Grahn said.
But others are perplexed by the weakness of consumer prices. The European harmonised HICP measure, which excludes owner-occupied housing, has been in positive territory but on a downward trend, touching 0.0 percent in September.
"It is a bit hard to understand why," said Mats Dillen, Director General of the National Institute of Economic Research. "We have inflation that is a little lower than in the euro area despite a better development in the economy, more traction in the labour market and more oomph in trade."
The concern is that Sweden is walking a tightrope. While the economy may be fine for now, any shock either at home or abroad could push it into a Japanese-style quagmire.
"The problem at the moment is that we don't have any margin," said Ake Gustafsson, an economist at Swedbank, referring to the dangers of a shock such as a fall in house prices. "If you are in negative territory too long economic actors expect prices will continue to fall. It's then you get this kind of serious downward spiral."
The Swedish crown has fallen almost 15 percent since the start of the year against the dollar and 5 percent against the euro. But this has not resulted in many imported goods becoming more expensive. In September, food prices edged down 0.1 percent on the year while clothing was down 1 percent.
"It is a pretty exceptional situation," said Hans Holmstedt, purchasing director at Axfood (ST:AXFO), which owns 252 grocery stores across the country and has annual sales of 37.5 billion crowns (3.18 billion pounds).
Russia's ban on Western food imports, imposed in retaliation against sanctions over the Ukraine crisis, has led to tumbling prices for commodities such as dairy products, pork and vegetables. Good harvests have also put pressure on grain prices.
HOUSING WORRIES
Such subdued prices and the record low interest rates are raising major concerns. Swedes have made liberal use of cheap loans over the course of the housing boom. This has pushed household indebtedness to above 170 percent of disposable income, one of the highest levels in Europe.
A report by Swedish bank SEB said the rate cut could further boost private lending and asset prices. But with responsibility for curbing the debt binge recently shifted to other authorities, the Riksbank is now focussed on reviving inflation.
With rate cuts exhausted, the next step would be unorthodox measures such as offering cheap long-term loans to banks and private sector asset purchases, as the European Central Bank has done. But amid brisk business activity, liquidity is not a problem, economists said.
Ingves would not rule out unconventional measures this week but said the Riksbank did not believe they would be necessary. But with the development of prices still baffling economists and pleasing consumers, it is best not to say never.
"If you had said to me a few years ago that we would have this level of rates and this level of growth I would have said not in my lifetime," said Annika Winsth, chief economist at Nordea, the Nordic region's biggest bank.
(Additional reporting by Robin Vetter and Johan Ahlander; Editing by Alistair Scrutton and David Stamp)