Mr Heikensten looks at the current economic situation in Sweden  (Central Bank Articles and Speeches, 15 Feb 99)
Central bank: riksbank | Type: speech | Date: 1999-02-15

## Mr Heikensten looks at the current economic situation in SwedenSpeech

by the First Deputy Governor of Sveriges Riksbank, the Swedish central Mr Lars Heikensten, to Forum '99, the Swedish Federation of Rental Property Owner Stockholm on 15/02/99.I should like to begin with a word of thanks for the invitation to talk here t economic developments, inflation and the interest rate.Before taking a look at the current economic situation and saying something abo deliberations in the Riksbank, however, I feel there may be grounds for adopting a broader perspective and even for striking a slightly optimistic note.

Sweden cer economic problems; further measures are needed, not least to improve the conditi growth.

But at times it may also be fitting to recall the things that have turned outSwedish economic policy was realigned in the early 1990s with the aim of establi regime of low inflation.

Previously, Sweden had had a long tradition in this respect 1970s and 80s the accepted truths were discarded, including the idea that low provides a good foundation for growth and employment.

Following the collapse of the B Woods system, stabilisation policy no longer offered any hard and fast rules.

S external debt - both government debt and the total stock - was allowed to grow at a rate, accompanied by spiralling prices and wages.Today, Sweden is in the sixth successive year of good economic growth.

Growth since has averaged almost 3 per cent a year.

The deep recession and good investment activ then have meant that in this period there has been a supply of unutilised resources. inflation has remained low even though growth may have been somewhat above the level can be regarded as sustainable.

Moreover, Sweden has begun to repay external deb government finances have recovered after the crisis in the wake of the 1980s bubble. years household earned income has been able to grow strongly in real terms, partly the low inflation.

## Altered monetary policy processThe laws that regulate the Riksbank were amended with effect from the beginning of th Monetary

policy's objective is now explicitly stated to be to maintain price sta Riksbank has a new Executive Board, consisting of six full-time members, that indepe decides monetary policy issues.The new Executive Board entails some changes in the work on monetary policy.

The cen attention is the Board's specific monetary policy meetings, which it is envisaged w eight to 10 times a year.

Decisions about the repo rate, for example, will normally those meetings.

A brief account of the Board's decisions is to be presented in a co the day after the meeting; a more detailed picture of the discussions will be avai minutes of the meetings, which will be published with a time lag of six to eight before, the Riksbank will be publishing an inflation report four times a year, wi comprehensive survey of inflationary pressure in the Swedish economy in the comin months.The Executive Board held its first monetary policy meeting last Thursday and discuss inflation prospects.

The Board then decided to lower the repo rate 0.25 percentage point also lowered the corridor in which the repo rate lies by 0.5 percentage point.

The Bo decisions and the arguments behind them were published in a communiqué on Friday.Another feature of the new Riksbank organisation is that each member of the Executive Boa has an individual mandate and one vote.

All the members are in a position to make speec and give interviews on monetary policy in which they express their own view of the situat It follows that the members can hold different opinions and may also express themselv somewhat differently about joint positions.Today I shall base my remarks on the picture that was used for last week's Executive Bo discussion and summarised in the communiqué.

When I elaborate on the communiqué it is my personal opinion I am expressing, though that does not mean that other Board members wer not of broadly the same mind.

## Poorer international prospectsIn the course of last year, international economic prospects became a good deal worse.

A beginning of 1998 it was assumed that a weaker international trend could be offset by o factors, of which one was the good domestic demand.

At an early stage, actually when t Riksbank raised the interest rate in the late autumn of 1997, it was pointed out, howeve the international trend could be weaker than assumed in our main scenario and that the c could lead to a slowdown in Sweden as well.The signals of an international slowdown that would also affect growth in Sweden becam increasingly clear.

The Riksbank therefore successively revised its forecasts in a down direction and eased the monetary stance in June.

This follows from our policy framewor which calls for a lower repo rate when inflation in the forecast period is expected to b the target and vice versa.

The repo rate was cut in two more steps in November, from 4.1 3.60 per cent, followed by a further reduction to 3.40 per cent in December when the for was revised downwards again.Even after the series of downward revisions during the autumn, the December assessment st carried a downside risk of the international slowdown being even more pronounced and prolonged than expected.The uncertainty about international economic prospects has been accentuated somewhat by the economic problems in Brazil and the real's depreciation since the turn of the year world economy may be affected contagiously, either via real mechanisms or via increase financial market turbulence.

Under normal circumstances, the real economic effects in industrialised world from decreased trade with Brazil should be relatively limited.

Ther risk, however, of the crisis also becoming more profound among Brazil's neighbours, lead in time to somewhat larger repercussions in the industrialised countries as well.

The e via financial markets could be greater in the short run but developments to date in this have been better than many feared.The picture in other parts of the world economy at the end of 1998 is somewhat vari Growth in the U.S. economy is still good, whereas the slowdown in the euro area has becoslightly more marked than many observers counted on and we have yet to see an econ recovery in Japan.The sustained strength of the U.S. economy is mainly due to the unbroken growth of consumption - the slowdown that was foreseen in our December Inflation Report has s materialise.

The stock exchange has recovered from last autumn's fall and even reac all-time highs.

Together with a positive development of employment, this has helped the confidence of American consumers.In time, however, a slowdown in the U.S. economy still seems probable; but the course does suggest that it will not occur as soon as the Riksbank expected earlier, in whi trend in 1999 may be stronger.

A more dramatic downturn could occur if the U.S. markets were to fall markedly.

Even without this, economic activity could sla connection with decreased investment on account of falling demand and lower profits, as with a lower consumption propensity among households whose debt burden is already high.In the euro area the available statistics indicate that the slackening of activi autumn and winter was more marked than expected, mainly on account of weaker expo Manufacturers and households differ in their assessments of the future; the former c turn for the worst, whereas consumer confidence has continued to improve.

The direc which confidence moves for these two groups will be crucial for prospects in the e The optimistic trend among households has so far helped to mitigate the consequen decreased external demand.

The question is whether this will continue to be the industrial activity does not take a turn for the better.The Japanese economy has not shown any clear signs of recovering, though in some re it does seem to have stabilised.

The future path here is still highly uncertain.All in all, the statistics point to an international trend in the next two years tha in the Riksbank's main scenario last autumn, though the differences should exaggerated.

Together with lower commodity prices, the weaker international activity result in lower external price pressure.The outlook in 2000 and beyond is, however, very difficult to foresee.

One uncertai endurance of U.S. economic growth.

Will it be possible to maintain the high growth inflation despite the high level of share prices and the low saving ratio?

Anothe concerns Europe: will any slowdown in the United States be offset by a stable rec Europe, underpinned by private consumption?

Finally, can the Japanese economy fi shake off the profound crisis?

A clearly positive outcome in any of these respec provide conditions for a trend that is stronger than the main scenario's.

## Sweden's currency and interest rateThe lower inflationary pressure that was indicated by international developments las was accompanied by a weakening of the Swedish krona that could result in higher infl more

permanently weak krona can lead to higher inflation as a result of higher utilisation as well as higher import prices.In the December forecast the Riksbank envisaged that the krona would appreciate in t coming two years.

Since then, however, the krona has strengthened more markedly than we expected: to date in 1999 the exchange rate has appreciated almost 5 per cent in terms o TCW index and a little more than 6 per cent against the euro.A considerable part of the krona's appreciation and stabilisation should be seen as a re a more normal situation after the financial markets' very turbulent and volatile autumn. height of the unrest, investors sold certain currencies in favour of the safety of currencies.

Currencies of countries which, like Sweden, have a high foreign debt were m exposed.

The currencies of Australia and Canada, which, like Sweden, target inflation wi flexible exchange rate, depreciated markedly last autumn; in the calmer situation sinc turn of the year, these currencies have also strengthened and become more stable.Another factor in the krona's case is that higher expectations of Sweden joining the eur have helped push our currency closer to the value implied by economic fundamentals.

In t run up to Stage Three there was also some apprehension about how the krona might be affected; after the event, this unrest tended to subside.The Riksbank's forecast has thus proved to be on the cautious side to date.

Nonetheless, not consider that developments warrant a revision of our long-term assessment last Decemb namely a gradual appreciation in terms of the TCW index to about 118 by the end of 2000.Since the publication of the December Inflation Report, interest rates in Sweden have fa by almost 0.15 percentage point in the case of the three-month rate and 0.4 percentage for 10-year bonds.In that inflation expectations have not moved down as much as the nominal interest rates real level of interest rates has also fallen and is now historically low.

The pron downward movement may turn out to have included some overshoot in the market, to be followed by an upward adjustment of market rates.

Signs of this have been discernible recent weeks.

Even so, the real level of interest rates is expected to remain low and sho as a stimulus to the Swedish economy, above all in the somewhat longer run.

## The domestic economyIn our December Inflation Report, the GDP growth rate was assumed to be between 2.5 and 3 per cent in 1998, between 2 and 2.5 per cent in 1999 and around 2.5 per cent in 2000. available statistics suggest that our forecast for 1998 is probably correct.

For 1999 an however, we consider that the December forecasts are somewhat too optimistic.One of the items we believe may be weaker is foreign trade.

With the poorer outlook for international economy, net exports could be lower in the years ahead.

Industrial activit then also continue to slacken.

The expectations of Swedish firms are low, above all manufacturing, and this could have a downward effect on investment.On the other hand, the statistics show that private consumption is still strong, with third-quarter increase that exceeded expectations.

House prices and the number of new c registered are continuing to rise and retail turnover is also moving upwards.

Other sig increased lending to households and the growth of the money supply.

Households are optimistic about their own economic situation, one reason being the growth of real disposwage income; a marked increase in 1999 is implied by the low level of inflation an cuts.

Another contributory factor is probably the fall in interest expenditure.

The households will be crucial for private consumption's future path.As I see it, however, there are certain grounds for fearing that even consumptio somewhat weaker than we counted on in December, when our forecast include comparatively strong consumption activity in the coming years.

While household optimistic about their own economic situation, the view of Sweden's economy employment's future development is more dismal.

Poorer international economic pros and the more pessimistic expectations of firms are liable to dampen the optim households and thereby private consumption.The statistics on industrial capacity utilisation continue to present a varied pic level, however, we consider that in the coming two years the Swedish economy will st some surplus capacity and this is expected to be somewhat larger than we envisa December.

The crucial question here is the future development of households' expect Continued optimism could result in sustained domestic demand that tends to offset t subdued international trend and the weaker investment activity.

## Construction and property marketFor

this Forum it may also be appropriate to say something about the situation construction sector.

Construction activity shows a cyclical pattern, with strongly in upward phases.

An upswing here may therefore entail risks of inflation.In a historical perspective, the level of construction activity in Sweden in rece been very low.

As a result, smaller firms have had to close and construction labour abroad or gone to other domestic sectors.

There are now many indications that cons activity is picking up again, though the rate of the recovery is difficult to asses demand has grown and there is a large need for new housing as well as for renovati Riksbank does not produce independent estimates; the available figures suggest, howe in the coming decade between 20,000 and 45,000 new dwelling units need to be built year and between 30,000 and 40,000 units a year need to be renovated.

Activity ma grow rapidly in certain regions.Now that construction is recovering, the increased concentration among constr companies and producers of construction materials, as well as the shortages in categories of skilled labour, are liable to push costs and wages up.

Certain pro bottlenecks are already discernible; in the business tendency surveys from the Institute of Economic Research, labour shortages are reported by 7 per cent of con firms as against 2 per cent in March 1998.

These shortages are accompanied by a high level of unemployment among construction workers; part of the explanation is unemployment is high in certain regions and those who are unemployed there are reluc move a long way to regions where labour demand is stronger.Bottleneck problems in the construction industry are being studied on behalf Government by industry representatives.

This Construction Sector Group has found approximately one-third of unemployed construction workers lack occupational exper and around 6 per cent also lack formal training.

In that the average age of co workers is rising and young people do not find construction work attractive, the bproblems may become even greater in the future.

In order to prevent this from leading sizeable problems, proposals have been put forward for increased mobility, improve competence and marketing of construction courses, for example.Construction costs are measured by the factor price index (FPI); the largest item is wage The price of completed dwellings, on the other hand, is measured by the building price i (BPI), which also includes the construction companies' productivity and profit margins.

T indexes do show relatively large price increases but there are no actual signs of any risks of an inflationary development in Sweden in the coming years, provided that bottleneck problems do not increase.The rising costs associated with earlier upswings in activity have been connected with contemporary subsidy systems as well as the high degree of concentration in the construc market.

The revised system for financing residential construction has appreciably reduced of these problems: construction companies as well as consumers are exposed more directly production costs.

But the problem of concentration in the construction market still re and may be a future cause for concern.

## Future monetary policyIn the main scenario in the December Inflation Report, the 12-month change in the CPI w projected to be 1.2 per cent in December 1999 and 1.4 per cent in December 2000.

Inflatio underlying rate in those months was expected to be 1.7 and 1.8 per cent, respectively.

Riksbank also noted that as the slowdown in international activity could prove to be marked and more prolonged, the downside risk in the assessment was greater than the upsi risk.

In recent months the international picture has tended to shift in that direction.Immediate inflationary pressure in Sweden has been lower than the Riksbank counted on i December.

The outturn for inflation in December 1998 was 0.3 percentage point below th figure in the Report's main scenario; around 0.1 percentage point of the difference c attributed to lower interest expenditure and approximately 0.1 percentage point to lower market prices for oil.

Moreover, underlying inflation has been somewhat weaker tha expected.As I mentioned earlier, the Executive Board considered that the prospects for internat economic activity and inflation are somewhat more subdued than they were in December and this will probably lead to economic activity and inflation in Sweden being slightly weak the next two years than the Riksbank counted on earlier.CPI inflation is accordingly expected to be below the 2 per cent target in one to two time.

To some extent this is a consequence of transitory factors that are judged to ha permanent effect on either inflation or the inflation process and should therefore not in the formulation of monetary policy.

These transitory factors - altered indirect taxe subsidies as well as lower interest expenditure - are projected to lower the CPI by betwe and 1 percentage point in the coming two years.

But even excluding the transitory factors considered that inflation will be below the target in 1999 and 2000.In the light of its assessment, last Thursday the Executive Board decided to ease the mon stance.

The future formulation of policy is something that will also be discussed i Inflation Report, which will be published on March 25th.