Mr. Bäckstöm remarks on the Swedish economy  (Central Bank Articles and Speeches, 7 Oct 98)
Central bank: riksbank | Type: speech | Date: 1998-10-07

Mr. Bäckstöm remarks on the Swedish economy Address by the Governor of the Bank of Sweden, Mr. Urban Bäckström, at Svenska Handelsbanken's seminar in New Yor on 7/10/98.First of all I should like to thank Svenska Handelsbanken for the invita meet with you today here in New York.

I arrived late yesterday from the 1998 Annual Meet the International Monetary Fund in Washington D.C.

The discussions in Washington over weekend focused on the current problems in the world economy.

At the centre was of cour crises in emerging markets that began in Thailand last year, which spread to other eco East Asia and Russia and which most recently have been pressuring economies in Latin Am Lately, we have also seen some contagion effects spreading to the industrial co Stockmarkets have been falling and there have also been some problems in connection wi Long-Term Capital hedge fund.However, today I will talk about the Swedish economy.

I shall be using a broad brush to paint you a picture of how our economy has developed in recent years an conclude by saying a few words about the present situation in my country.

## Positive trend in recent yearsThe Swedish economy is now entering its sixth consecutive year of favour growth.

The average annual GDP growth rate since the summer of 1993 is almost 3 per This is an improvement compared to the average that has characterised our economy in t twenty-five years.

It has been accompanied by external surpluses that are larger than years, making it possible to repay foreign debt.

Government finances, moreover, now surplus instead of the earlier deficits, which means that government debt is already be in relation to GDP.The latest figures show that prices in Sweden's economy are virtually stat The falling trend in market interest rates in recent years has been a major factor here reduced house mortgage interest expenditure and thereby temporarily exerted a downward effect on inflation.

The underlying price trend is not, in fact, as low as the CPI figures m but that does not alter the conclusion that in the years ahead, inflation will continueIf Sweden sticks to disciplined fiscal and monetary policies, together wi ways of enhancing economic policy's credibility, we have a real opportunity of reinst tradition of price stability that existed in Sweden prior to the 1970s and 80s.

Let m short historical background to our current economic policy strategy.

## Tradition of price stabilityIn the period from 1830 to the late 1960s, the annual rate of inflation i averaged around 2 per cent.

So if one disregards the 1970s and 80s, low inflation has norm for almost a century and a half.

There are indeed grounds for saying that price st long Swedish tradition.The tradition of price stability did not obstruct the economy's developmen is shown by the fact that from the mid 19th century up to the late 1960s growth in Swamong the highest in the world.

It is rather the case that the favourable outcome was p low inflation and the stability this represents.The decades immediately after World War Two were particularly notable for h growth, low inflation, external balance and an optimistic mood that resulted in the economy's successive expansion.

That was a prosperous period with a good, stable eco trend, a rising standard of living and high employment.After the collapse of the Bretton Woods system in the early 1970s it p difficult to establish an equally robust fixed exchange rate regime.

A firm anchor existed for economic policy in general and wage formation in particular.

Sweden experi series of devaluation cycles, with an expansionary fiscal policy, inefficient wage for growing structural problems.

With the deregulation of the financial sector the problem all too evident.During the 1970s and 80s economic growth in Sweden became weaker than in other countries.

But the economy still became overheated and this, together with an exp public sector activities, meant that unemployment was restrained for the time being .The situation was of course unsustainable.

An inflationary, speculative cannot grow indefinitely; sooner or later it is bound to burst.

There was also a limit resources for financing employment.

## New direction in economic policyIn the late 1980s there was a growing awareness that something would have t done.

The structural problems, high inflation and relatively low growth called for an policy realignment.This realignment involved a variety of measures.

The tax system was refor and so were certain components of transfers.

Sweden, moreover, applied for membership European Union.

Sweden's currency was linked to the ecu and in the autumn of 1992, duri wave of currency speculation, the exchange rate was defended.

Short term interest ra raised to high levels.

The idea was to demonstrate the determination to re-establish loHowever, Sweden's economic policy realignment coincided with a profound economic crisis.

Output fell around 5 per cent over a three-year period, open unemploym up to over 9 per cent and total unemployment to around 13 per cent, figures that completely unknown in modern Sweden.

The government finances deteriorated sharply a budget deficit reached a high of more than 12 per cent of GDP, which was almost w precedent in the industrialised countries.

In the middle of this crisis, moreover, whole of the banking system was threatening to collapse.

In the light of the crisis Asian economies, all this sounds very familiar.Researchers will no doubt be studying whether this dramatic setback in Swedish economy could have been managed differently.

Some things could definitely have arranged in another way both in the late 1980s and once the crisis was over us in nineties.But the vital conclusion is, I believe, that the roots of the profound cris a long way into the past.

An economic policy realignment was essential; a credible oriented policy had been lacking ever since the collapse of the Bretton Woods system in 1970s.

It was high time to put this right.

## Making the new regime credibleAfter

the long period of high inflation, together with extensive eco problems and massive government deficits, the task of inspiring confidence in economic new direction proved difficult at first.

Economic agents listened to the new approach w and hesitation.As we know from other countries, however, creating confidence in a new reg with low inflation is a rather long process that takes time.

Moreover, if the work inflation low and government finances in order is to be combined with low interest r stable growth, it is a task that never ends.In recent years the low-inflation regime has gained increased credibility.

B disciplined monetary policy for price stability, a major contribution to this has com consolidation of government finances.

In just a few years a budget deficit at 12 per c has been turned into today's surplus.In order to underscore its ambitions for public finances, the Government long-term objective:

as the average level over a business cycle, government finance generate a surplus at 2 per cent of GDP.

A surplus will make it possible to reduce pub that future challenges which the Swedish economy may encounter can be accepted wit leading to problems for government finances.Considering the public debt that has accumulated in the 1990s and the fac government finances in Sweden are relatively sensitive to cyclical factors, I find th reasonable.Besides the increased awareness of the importance of stable finances, conditions for achieving Sweden's budget target have been improved by institutional cha the budget process.

Sweden now has a budget process that is inherently more disciplined thereby contribute to maintaining sound finances.Further steps are being taken to consolidate economic policy's focus on st The independence which the Riksbank already has in practice is to have a formal legal of next year.

The monetary policy objective of price stability will be enshrined in l Riksbank will be accountable for fulfilling it.This new Riksbank legislation has already been approved once by the Riks (Sweden's parliament) and the final decision is due this autumn.

The reform is backed political parties, whose combined representation in the newly elected Riksdag is over 80According to the timetable for the new legislation, the Riksdag's final d will be made sometime in the middle of November.

It will be followed by the appointment Riksbank's new Governing Board, which will consist of eleven Delegates.

One of its majowill be to appoint the Riksbank's new Executive Board.

This Board will consist of six members who will direct the Riksbank and decide monetary policy as of January 1999.

## The present situationSweden's monetary policy is conducted in a flexible exchange rate regime and an explicit inflation target.

We sometimes use the following simple rule of thumb to what governs our actions: if the overall assessment of inflation indicates that in one time the rate of inflation will deviate from the 2 per cent target, then the repo r adjusted accordingly.

Our approach is symmetrical, which means that it is equally impo avoid undershooting the target, as it is to avoid overshooting it.The Riksbank's appraisal of inflation up to the autumn of 2000 and the mon policy conclusions that can be drawn from this are presented in the Inflation Report we last week.

In order to visualise the consequences for the future path of monetary p report is based on the working assumption of an unchanged repo rate.

As the Swedish k judged to be undervalued at present, we also assume that the exchange rate follows a represents a gradual appreciation.The technical assumption of an unchanged repo rate and the presumed path fo exchange rate are then incorporated in the main scenario for inflation.

As inflati course is not a straightforward matter, we also include assessments of uncertainties. picture of inflation prospects amounts in practice to an estimate of probabilities.The assessments in the main scenario imply favourable economic fundamentals: a growth rate between 2.5 and 3 per cent between 1998 and 2000, low inflation and a government surplus.

Domestic demand in the main scenario is expected to generate a rel limited increase in inflation's underlying rate, from 1.1 per cent at present to 1.6 p end of next year and 2 per cent in the autumn of 2000.The 12-month change in CPI inflation is expected to be somewhat below t inflation target in one to two years time but the figure at the end of the period is approximately 2 per cent.

All this means that at the end of the period under review, relatively well in line with the Riksbank's target.It should be underscored, however, that the assessment of inflation prosp more difficult than usual on account of the financial turbulence.

This naturally r international unrest but the political situation after the general election in Sweden h mark on price setting, above all in the currency market.Inflation prospects and the future path of monetary policy accordingly dep two - contrary - factors: on the one hand, the international economic trend could be w we have counted on and thereby lead to lower inflation; on the other, a sustained weak rate that has no counterpart in a weaker real economy could generate increased inf pressure.Our monetary policy conclusion is that we will go on analysing the cour events and appraise monetary policy continuously in the light of new information.

Hopef analysis in the Inflation Report should give an indication of our line of reasoninginflation outlook in Sweden and the future path of monetary policy that is as clear as the global economy's present state of uncertainty.The unsettled situation in international financial markets has meant that are shifting to currencies which are historically secure.

As a result, other currencie those of smaller economies, have weakened.

This tendency has been evident for the Sw krona in recent weeks and very clear in the last few days.

The recent path of the Swedi not consistent with the development of our economy's fundamentals.

Under these circumst the Riksbank has chosen to use currency interventions to underscore that the movements krona's exchange rate have been unduly abrupt and exaggerated.