The Riksbank is wrong about the debt: Higher policy rates increase rather than decrease the household-debt ratio

Lars E.O. Svensson 04 September 2013



In the last few years, the Riksbank has conducted a monetary policy that has led to substantially lower inflation than the inflation target and unnecessarily high unemployment. The Riksbank has more recently justified this policy by maintaining that a lower policy rate would increase the household-debt ratio (the ratio of debt to disposable income) and thereby any risks associated with the debt.

But the Riksbank has not presented any analysis of how monetary policy and the policy rate affect household indebtedness. The Riksbank has simply taken as given that a higher policy rate leads to a lower debt ratio than a lower policy rate would.

Does a higher policy rate really lead to a lower debt ratio?

I have examined this issue and find that a higher policy rate leads to a higher debt ratio, not a lower one (Svensson 2013). This result may be surprising to some. The result is actually quite easy to understand once one carefully considers how debt, GDP and inflation are affected by a higher policy rate.

  • A higher policy rate during a year leads to temporarily lower inflation, real GDP, and real housing prices for a few years.
  • After 3-5 years, inflation, real GDP, and real housing prices have returned to the level they would have been at without the temporary policy-rate increase.

For each year from year 0, Figure 1 shows how a higher policy rate during year 1 than a baseline leads to deviations from the baseline of inflation, real GDP, and real housing prices. The deviations of the policy rate and inflation are expressed in percentage points; the deviations of real GDP and real housing prices are expressed in percent of the baseline level.

Figure 1. Responses to a higher policy rate

The temporarily lower inflation leads to a permanently lower price level and permanently lower nominal GDP and nominal housing prices relative to the baseline. Lower nominal housing prices mean that new mortgages will be lower. But a year’s new mortgages are only a small share, say 6-7%, of the total nominal (mortgage) debt. Since the turnover of the mortgage stock is so small, the total nominal debt will fall very slowly. The price level and nominal GDP will fall much faster to their new lower permanent level. This is shown in Figure 2, which shows the deviation from the baseline of the price level, nominal GDP, nominal housing prices, and total nominal debt.

Figure 2. Responses to a higher policy rate

  • Since the nominal debt falls so slowly and the price level and nominal GDP fall much faster, the real debt will rise almost as much and as fast as the price level falls, and the debt-to-GDP ratio will rise almost as much and as fast the nominal GDP falls.

After a few years when the price level and nominal GDP have reached their permanent lower level, real debt and the debt-to-GDP ratio start to slowly fall back towards the baseline. After more than a decade, they have returned to the baseline and the level they would have had in the absence of the temporary policy-rate increase. This is shown in Figure 3.

Figure 3. Responses to a higher policy rate

Disposable income moves in the same direction as GDP but not as much. This means:

  • The ratio of debt to disposable income, the debt-to-income ratio, also first rises during a few years, more than real debt but less than the debt-to-GDP ratio; then it slowly falls back to the baseline.


The conclusion is that a higher policy rate increases the household real debt and the debt-to-income ratio.

  • The higher policy rate indeed reduces nominal housing prices and new mortgages, but since the new mortgages are such a small share of total mortgages, the total nominal debt falls very slowly.
  • At the same time, nominal GDP and nominal disposable income fall much faster, so the debt-to-GDP and the debt-to-income ratios rise.

This is contrary to what the Riksbank has stated in a number of monetary-policy reports and updates. The Riksbank justification of its policy is simply not valid.


Svensson, Lars E.O. (2013). “’Leaning Against the Wind’ Leads to a Higher (Not Lower) Household Debt-to-GDP Ratio”, The Institute for Financial Research, Swedish House of Finance, Stockholm School of Economics. 29 August.



Topics:  Monetary policy

Tags:  Sweden, Riksbank, household debt

Affiliated Professor, Stockholm School of Economics; Research Fellow, CEPR


CEPR Policy Research