The early-1990s banking crisis and the birth of inflation targeting

Sweden entered 1990 with inflation near 10% and a krona pegged to a basket anchored to the ECU, financed by a credit-fuelled property boom through the 1980s. When that boom turned to bust and confidence in the peg collapsed, the Riksbank briefly defended the currency with an overnight lending rate reported as high as 500% in September 1992 before abandoning the peg in November 1992 and letting the krona float. Two major banks, Nordbanken and Gota Bank, had to be taken into state ownership as loan losses mounted, and the overall banking-crisis support package eventually cost an estimated 4% of GDP. Output fell for three consecutive years, and open unemployment rose from under 2% in 1990 to around 8% by 1993. Seeking a new anchor for monetary policy once the fixed exchange rate was gone, the Riksbank unilaterally announced an inflation target of 2%, within a band of plus or minus 1 percentage point, in January 1993, making Sweden one of the earliest adopters of inflation targeting. Inflation expectations fell toward that target over the following two years, a sign the new regime gained credibility quickly.