Svante Öberg: The economic situation
Speech by Mr Svante Öberg, Deputy Governor of the Sveriges Riksbank, at the KOMMEK
fair, Malmö, 21 August 2008.
* * *
GDP growth will slow down this year and next year. Employment will stagnate and
unemployment will begin to rise. Inflation is high but will fall towards the target of 2 per cent
over the coming years. This is the picture of the expected development of the Swedish
economy reported in the most recent Monetary Policy Report published at the beginning of
July.
In my presentation today I shall describe my view of economic developments abroad and in
Sweden, explain how we Executive Board members viewed monetary policy in connection
with the most recent monetary policy decision at the beginning of July and describe what has
happened in the economy over the summer. In the first three sections I will mainly describe
the forecasts from the Monetary Policy Report published in early July, but I will also mention
some data that have been published since then. In the fourth and final section of my speech I
will take up the most important information on developments in the Swedish economy that
has been received since early July.
1. International developments
No end to the financial crisis yet
The problems in the international financial markets continued during the first half of this year.
Although substantial losses have been taken up in the financial institutions' balance sheets,
and they have been allocated new capital to a large degree, we have not yet seen the end of
the financial crisis. Different measures of risk premiums are still at a high level compared with
the period prior to last summer.
One can illustrate the problems in different ways, for instance by means of the so-called
basis spreads, which demonstrate the difference between interest rates between the banks
and the expected policy rate set by the central bank. This measure reflects pricing of the risk
faced by the banks when lending to other banks. The basis spreads increased significantly in
August last year. Sweden has also been affected by the global financial crisis, but to a lesser
extent than many other countries. The basis spreads have, for instance, increased more in
the United States and the euro area than in Sweden. But it is at the same time important to
remember that the crisis has increased the Swedish banks' vulnerability to shocks.
Although the basis spreads have declined somewhat in the euro area and in Sweden since
last spring, they have not returned to the earlier levels yet and one cannot exclude the
possibility of new problems arising that will push risk premiums even higher.
Weaker growth in the USA
Economic developments in the United States continued to deteriorate during the first half of
the year. This was largely connected to problems in the financial markets. In the most recent
Monetary Policy Report published at the beginning of July we were expecting GDP growth in
the United States to slow down to around 1.5 per cent a year in 2008 and 2009.
I agreed on the whole with the picture of international developments presented in the
Monetary Policy Report, but my assessment was that developments in the United States
could be even weaker than we were assuming. There is a risk that we will have to lower the
forecasts even more in coming reports, particularly the forecasts for 2009. GDP growth in the
second quarter of 2008 was actually slightly stronger than we had expected. GDP increased
by 0.5 per cent compared with the first quarter.
Growth in the United States is now largely being upheld by exports alone, which are
increasing at a good rate as a result of world growth and the dollar depreciation (compared
with the level 2-3 years ago). Domestic demand will on the whole not show any increase in
2008 and 2009. I do not believe that the recovery in domestic demand will get started before
the financial system has stabilised and before the fall in US house prices has come to a halt.
House prices have continued to fall during the summer.
Growth in Europe will also slow down
Europe fared better than the United States at the beginning of the year. This is partly
because the financial crisis originated in the United States and the financial market
turbulence has not been as severe as there. Another explanation is that the financial balance
is better in Europe; public sector finances have improved in recent years and the current
account is close to zero. We assumed in the Monetary Policy report that GDP growth in the
euro area would slow down to 1.7 per cent in 2008 and 1.2 per cent in 2009, to reach almost
2 per cent in 2010.
At the beginning of July we had seen little sign of the slower growth in the statistics on
production and in the National Accounts. On the contrary, there had been several positive
surprises. However, there were tangible signs of a future slowdown in other types of data,
such as corporate and household confidence indicators. The quick figures for the second
quarter now indicate that GDP in the euro area declined by 0.2 per cent compared with the
first quarter, which was weaker than we had expected.
Global growth still strong
GDP growth in the world as a whole has been very strong over the last four years, around 5
per cent a year. Not since the early 1970s, prior to the first oil crisis in 1973, have we seen
such strong growth in the world for such a long period of time. One important explanation for
the rapid growth is that previously planned and closed economies have been transformed
into market economies and opened up to the outside world. The forecasts in the Monetary
Policy Report entail world GDP growth slowing down to around 4 per cent a year in
20082009 and later rising again to around 4.5 per cent in 2010.
Growth in the world was thus expected to remain relatively strong, despite the fact that we
see ahead of us a couple of years of slower growth in the United States and the euro area.
This is because of the strong growth in emerging and developing economies. For instance,
the OECD calculates in its most recent forecast on an average annual GDP growth rate in
the so-called BRIC countries of 4-5 per cent for Brazil, 7 per cent for Russia, 8 per cent for
India and 10 per cent for China during the years 2008 and 2009. The emerging economies
together account for around half of the world GDP and for three quarters of the growth in the
world in 2008 and 2009.
Rising and falling commodity prices in the world market
The strong world growth has been the most important reason behind the sharp rise in
commodity prices. Commodity prices have risen for six years, and these increases have
accelerated over the last two years. Rapid growth has led to an increase in the demand for
energy. It is almost impossible to make good forecasts for the oil price. The Riksbank's
forecasts are therefore based on the prices of forward contracts for oil, that is, the price of
delivering oil in the future. This means that at the monetary policy meeting in July we were
assuming a price for crude oil of USD 130-140 per barrel during the forecast period. Since
April the oil price has fluctuated substantially. First it rose to USD 147 a barrel and since then
it has fallen. At the beginning of this week the oil price was USD 113 a barrel.
Food prices have also risen substantially in the world market, particularly over the past year.
Rising incomes, urbanisation and changes in diet lead to an increase in the demand for food.
As oil becomes more expensive it becomes profitable to use maize and other grains to
produce biodiesel and biofuels. Furthermore, the production costs for foods are rising. Other
factors such as supply shocks and speculation in future price changes also affect
developments. Our assumption in June was that food prices would not continue to increase,
but would stabilise at a high level. Since the beginning of July food prices have fallen.
High international inflation and rising inflation expectations
The upswing in commodity prices in recent years has in turn led to an increase in inflation
around the world. In the United States it has risen to 5.6 per cent and in the euro area it rose
to 4.0 per cent in July 2008. It has risen much more in several emerging economies. For the
world as a whole, the IMF calculated that inflation will rise from around 4 per cent in 2007 to
almost 5 per cent in 2008. Inflation expectations have also risen in several countries.
The most probable development is that inflation will slow down next year. When adjusted for
energy and food prices, inflation has been relatively stable. Normally, inflation slows down
when growth slows down, even if this is with some time lag, and our forecast in the Monetary
Policy Report is for growth in the world to be lower this year and next year. At the beginning
of the summer we were also able to note that, unlike the situation in the spring, monetary
policy expectations had swung towards higher interest rates in several countries. A tight
monetary policy contributes to dampening inflation.
But there is a risk that the inflation process will be more prolonged. It was estimated that
growth in the world will continue to be relatively strong, despite a slowdown in the United
States and the euro area. In a slightly longer perspective, when the slowdown in the United
States and the euro area becomes an upswing once again, there is also a risk that the
problem of rising commodity prices will return. Several emerging countries will experience
rapid growth for some time to come.
2. Developments in Sweden
Weaker growth and labour market in Sweden
Growth will also slow down in Sweden. In the Monetary Policy Report we assumed that GDP
growth in Sweden will be 2.1 per cent this year and 1.2 per cent next year.
Several factors indicate a slowdown in growth. For instance, Swedish exports will be
negatively affected by the weaker international growth, particularly in the United States.
Moreover Swedish households' consumption will slow down for several reasons. Real
disposable incomes will show weaker development and real wealth will be dampened.
Households' expectations are very pessimistic.
At the same time, there are factors that may to some extent hold back a slowdown. The
financial balance in Sweden is good; the current account shows very large surpluses and
public sector finances are robust. The latter make it reasonable to assume further fiscal
policy stimulation over the coming years. In addition, the Swedish financial sector has fared
relatively well in the international financial turbulence, which reduces the risk of a serious
credit crunch.
But growth will nevertheless slow down. This means that the labour market will deteriorate
towards the end of the year. We assumed in the Monetary Policy Report that the rapid
increase in employment would come to a halt this year and that employment would fall
slightly over the coming two years. We also assumed that the decline in unemployment
would cease and that unemployment will increase slightly in the coming two years.
Inflation is high but expected to fall towards the target of 2 per cent
Inflation was 4.4 per cent in July. This is the highest figure measured since the mid-1990s.
Inflation is now far above the inflation target of 2 per cent.
The upswing in inflation over the past year can largely be explained by rises in energy and
food prices, but higher wage increases and weaker productivity growth also contribute to
higher inflationary pressures. Higher interest rates also contribute in the short term to the
high inflation through rising housing costs. The forecast in the Monetary Policy Report was
for inflation to remain high over the coming year and then to fall towards 2 per cent at the end
of the forecast period.
Continued high inflation expectations
For a long time inflation expectations have been firmly anchored around the inflation target of
2 per cent. There have thus been no special reasons for us at the Riksbank to highlight them
in our reports and speeches. However, since the beginning of 2006 inflation expectations
have gradually risen.
According to the Prospera survey in June, inflation expectations for one year ahead were 3.2
per cent and expectations for five years ahead were 2.6 per cent. The expectations for one
year ahead are largely in line with our own forecast, but the fact that expectations for five
years ahead are way above the inflation target is more worrying.
The rising inflation in Sweden and abroad would not be a problem if it was just a question of
a temporary rise and if inflation expectations remained at a low and stable level. But if
secondary effects arise, or if inflation expectations rise, monetary policy may need to be
tightened. It is important for monetary policy that what started as increases in oil and food
prices in the world market does not spread to other areas and that inflation expectations in
the slightly longer term do not become entrenched at a higher level, but fall back towards the
inflation target once again.
We know that inflation expectations can be largely explained by the actual rise in inflation.
However, we do not know very much about how monetary policy affects inflation
expectations over and above the effect via inflation, and how inflation expectations in their
turn affect long-term inflation.
There is an interesting approach in the academic research which involves the general public
looking at outcomes and gradually learning how the economy functions and how the central
bank reacts. If households are to believe that the central bank focuses on low and stable
inflation they must be able to observe such behaviour. But such a process may take time,
which we in Sweden could conclude in the mid-1990s when our own inflation target was
established. This is an area we need to study more.
Wage costs rising more than before
In the Monetary Policy Report we assumed that hourly wages would increase by an average
of around 4 per cent a year during the three-year agreement period. This is around 1
percentage point a year more than during the previous three-year period. In addition, we
calculated on unit labour costs increasing by an average of almost 3 per cent a year in
20072010, to be compared with largely 0 per cent a year in 2002-2006.
The high inflation rate could affect wages through demand for compensation for the price
increases. However, this does not seem very likely at present. The slowdown in growth and
the expected weakening of the labour market are factors that weigh against such a scenario.
In addition, we now have three-year agreements in most areas of the labour market which
regulate the agreed wage increases. Nor are there, as there were in the 1970s and 1980s
and are in some other countries, price guarantees in the agreements that provide automatic
compensation for price rises. These were abolished in connection with the so-called
Rehnberg agreement at the beginning of the 1990s.
It is, on the other hand, important that inflation and inflation expectations fall to around 2 per
cent ahead of the next round of collective bargaining in 2010. With the current inflation
forecasts, average inflation over the three preceding years will then have been over 3 per
cent, which may be a problem. However, this would nevertheless mean that real wages prior
to tax increase by around 1 per cent a year during the current three-year agreement period.
After tax the increase is larger, perhaps 2-3 per cent a year.
3. Monetary policy
To summarise, at the monetary policy meeting in July we had a situation with rising inflation
and inflation expectations together with growth coming to a standstill in Sweden and abroad.
Such a situation brings central banks face to face with difficult decisions. Either they tighten
monetary policy despite a slowdown in economic activity, or they accept a higher inflation
rate. This was the choice we faced in July.
Given the course of events outlined in the Monetary Policy Report, the Executive Board
decided to raise the repo rate from 4.25 per cent to 4.50 per cent, and we assessed that a
well-balanced monetary policy entailed raising the interest rate a couple more times over the
year.
Events since the previous meeting in April provided justification, in my opinion, for raising the
interest rate and the interest rate path. The primary reasons were that inflation had increased
and by more than we had previously expected, that inflation expectations had increased and
were above the inflation target and that expectations of interest rates abroad had changed
from falling to rising policy rates. We had revised our inflation forecast upwards for both this
year and next year, despite the higher interest rates.
However, this did not mean that I disregarded growth and employment. The Riksbank's task
is to ensure that inflation is low and stable. If we moreover can support growth and
employment without neglecting the price stability target, we will do so. In practice this often
means that we allow the time for bringing inflation up or down to the target to vary depending
on the prospects for economic activity.
According to our monetary policy strategy, our policy is normally aimed at attaining the
inflation target within two years. The calculation we made in July indicated that it would
probably have required a slightly higher interest rate path than that described in the Report to
bring inflation down to 2 per cent in two years. This would have brought down growth even
lower next year. Given that inflation was deviating so far from target and taking into account
the uncertainty in the financial markets, it would have been better, in my opinion, to aim at
bringing down inflation to around 2 per cent in three years.
I do not believe that the decision in July can be regarded as any severe tightening of
monetary policy. The interest rate is still relatively low. The nominal interest rate prior to the
decision at the beginning of July was at a long-term average of 4.25 per cent. But the real
interest rate was still lower than an historical average. In July the real interest rate was
around 1.5 per cent, but it will rise during the forecast period to just over 2.5 per cent at most.
The interest rate path we described in July entailed a change from a relatively neutral to a
slightly contractionary monetary policy.
We were unanimous on the one decision to raise the interest rate by 0.25 per cent, but not
on the other decision regarding the interest rate path. The majority of the Executive Board
members considered it reasonable to have an interest rate path that involved a substantial
probability of a further two increases during the year, while the minority considered it
reasonable to have an interest rate path that involved some probability of one further
increase. The minority's assessment was that the slowdown of the economy that is now
taking place would dampen inflationary pressures to a greater extent than assumed in the
main scenario. There would therefore be less need to continue increasing the interest rate.
4. Developments during the summer
I have earlier discussed what happened during the summer in the world around us. The trend
of falling growth and rising inflation has broadly continued. One important change is that the
oil price and other commodity prices have begun to fall, which may further slow down price
increases. The dollar has risen in value against the euro and the krona, which also means
that the krona has weakened against a weighted average of other currencies. The financial
market turmoil has also continued.
I intend to conclude by summarising the important new information on developments in the
Swedish economy since the monetary policy meeting at the beginning of July. Statistics
during the summer confirm the picture that growth in the Swedish economy is slowing down
and that inflation remains high.
Seasonally-adjusted, the GDP figures for the second quarter remained largely unchanged
compared with the first quarter. This was a weaker outcome than we expected in the July
Monetary Policy Report. There is a clear trend towards falling GDP growth from around 1 per
cent a quarter two years ago to close to zero over the past six months. At the same time we
know that GDP growth figures for the first and second quarters are usually revised upwards
in later National Accounts publications, so we will not know the final outcome until a couple of
years from now. In addition, one should bear in mind that monetary policy looks ahead. We
cannot affect what has happened during the second quarter of this year. It is only to the
extent that the new information affects our forecasts for the coming years that it is important
to monetary policy.
The National Accounts also indicate that productivity continued to decline in the first two
quarters. We had assumed that productivity would increase. Hourly wages increased by 4
per cent from January to May this year, compared with the same period last year, according
to preliminary wage statistics from Statistics Sweden and the National Mediation Office.
Normally the figures are revised upwards in statistics published somewhat later, but the
statistics nevertheless indicate that there have not yet been any unexpected rises in the rate
of wage increase. If anything, it looks to be slightly lower than anticipated. However, so far
this year wage costs per produced unit nevertheless appear to have increased by more than
we had expected as a result of the weaker productivity.
Employment continued to increase during the second quarter of this year, but unemployment
remained largely unchanged compared with one year ago. The outcomes were close to the
forecasts. The number of hours worked per week continued to increase during the first half of
the year, which contributed to a decline in productivity.
The Economic Tendency Survey in July was also weak. It fell and now indicates that the
Swedish economy is much weaker than normal. It is mainly households that are contributing
to the low level. This is the most pessimistic that households have been about the Swedish
economy for 15 years. The confidence indicator for the Swedish business sector fell, but it is
nevertheless at a level corresponding to the average since 1996.
The Economic Tendency Survey also shows that sales prices in the wholesale and retail
trade continued to rise to a large extent and that continued increases are predicted for the
third quarter. Households' and companies' inflation expectations continued to rise. They even
rose more than is indicated by statistical correlations between inflation and inflation
expectations. However, inflation expectations as measured in the bond market, what is
known as breakeven inflation, have declined.
Inflation rose from 4.0 per cent in May to 4.3 per cent in June and 4.4 per cent in July. This is
around a tenth more than we estimated in our Monetary Policy Report. Compared with the
forecast in the Report, it is primarily electricity prices that have been higher than calculated.
Food prices increased by 8 per cent, which is more than in almost all of the countries in the
euro area and could indicate that what started out as price increases in the world market
have begun to spread to other goods. On the other hand, oil and other commodity prices
have fallen, which may dampen inflation in the future. However, the krona has weakened,
which makes imports more expensive.
To sum up: the picture presented in July largely remains unchanged - with lower growth and
high inflation. But GDP growth has so far this year been weaker than anticipated. Inflation is
at its highest level since the mid-1990s. However, oil and other commodity prices have fallen.
At the same time, productivity has been lower and resulted in increased wage costs.
At the Riksbank we are now working hard on producing new forecasts for the coming years.
At the beginning of September my colleagues and I will take a new monetary policy decision.
We will then once more take a stance on economic developments and on how the interest
rate should be set to attain our inflation rate of 2 per cent.
The economic situation

GDP growth will slow down this year and
next year.

Employment will stagnate and
unemployment begin to increase.

Inflation is high, but will fall towards the
2% target over the coming years.
Outline

International developments

Developments in Sweden

Monetary policy

What has happened during the summer
Basis spread
Difference between interbank rates and expected policy rates
Basis points
120 120
MPR
Sweden 2008:2
USA
100 100
Euro area
80 80
60 60
40 40
20 20
0 0
jan-07 apr-07 jul-07 okt-07 jan-08 apr-08 jul-08
Sources: Reuters EcoWin and the Riksbank
BIS Review 100/2008
GDP growth in the USA
Quarterly changes in per cent calculated at an annual rate,
seasonally-adjusted data
8 8
6 6
4 4
2 2
0 0
-2 -2
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken columns represent the Riksbank's forecasts in MPR 2008:2. The dot is the outcome for Q2 2008.
Sources: Bureau of Economic Analysis and the Riksbank
GDP growth in the euro area
Quarterly changes in per cent calculated at an annual rate,
seasonally-adjusted data
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken columns represent the Riksbank's forecasts in MPR 2008:2. The dot is the outcome for Q2 2008.
Sources: The OECD and the Riksbank
GDP growth in the world
Annual percentage change
8 8
6 6
4 4
2 2
0 0
1970 1975 1980 1985 1990 1995 2000 2005 2010
Note. Broken columns represent the Riksbank's forecasts in MPR 2008:2.
Sources: the IMF and the Riksbank
Oil price, Brent crude
USD per barrel
160 160
MPR 2008:2
140 140
120 120
100
100
80 80
60 60
40 40
20 20
0 0
00 01 02 03 04 05 06 07 08
Sources: Intercontinental Exchange and the Riksbank
The Economist's commodity price
index for food
Index 2000 = 100, USD
300 300
MPR 2008:2
250 250
200 200
150 150
100 100
50 50
0 0
00 01 02 03 04 05 06 07 08
Source: The Economist
Inflation in the USA, the euro area and
the world
Annual percentage change
6 6
5 5
4 4
3 3
2 2
USA
1 1
Euro area
World
0 0
00 01 02 03 04 05 06 07 08
Note. Broken lines represent the IMF's forecast.
Sources: The Bureau of Labour Statistics, Eurostat and the IMF
GDP growth in Sweden
Quarterly changes in per cent calculated at an annual rate,
seasonally-adjusted data
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken columns refer to the Riksbank's forecasts in MPR 2008:2.
Sources: Statistics Sweden and the Riksbank
Employed
1000s of persons, seasonally-adjusted data
4800 4800
Employed (ILO-definition)
Employed (EU-definition)
4600 4600
4400 4400
4200 4200
4000 4000
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken line represents the Riksbank's forecast in the MPR 2008:2.
Sources: Statistics Sweden and the Riksbank
Unemployment
Per cent of labour force, seasonally-adjusted data
10 10
8 8
6 6
4 4
2 2
0 0
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken line represents the Riksbank's forecast in the MPR 2008:2.
Sources: Statistics Sweden and the Riksbank
Inflation (CPI)
Annual percentage change
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken line represents the Riksbank's forecast in the MPR 2008:2.
Sources: Statistics Sweden and the Riksbank
Inflation expectations - 1 and 5 years ahead
Annual percentage change
4 4
1 year ahead, all
5 years ahead, all
3 3
2 2
1 1
0 0
96 97 98 99 00 01 02 03 04 05 06 07 08
Source: Prospera Research AB
Wages, productivity and unit labour costs
Annual percentage change
10 10
Unit labour costs
Labour costs per hour
8 8
Productivity
6 6
4 4
2 2
0 0
-2 -2
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Note. Broken lines and columns represent the Riksbank's forecasts in the MPR 2008:2.
Source: Statistics Sweden
The policy rate in Sweden
Per cent
5 5
4 4
3 3
2 2
1 1
0 0
00 01 02 03 04 05 06 07 08 09 10 11
Note. Broken line represents the Riksbank's forecast in the MPR 2008:2.
Source: The Riksbank
GDP growth in Sweden
Quarterly change in per cent, seasonally-adjusted data
2,0 2,0
1,5 1,5
1,0 1,0
0,5 0,5
0,0 0,0
-0,5 -0,5
00 01 02 03 04 05 06 07 08
Sources: Statistics Sweden and the Riksbank
CPI and CPIF
Annual percentage change
5 5
CPI
4 CPIF 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
95 96 97 98 99 00 01 02 03 04 05 06 07 08
Note. The CPIF is the CPI with a fixed interest rate.
Sources: Statistics Sweden and the Riksbank
Summary

The picture presented in July remains largely
unchanged, with lower growth and high inflation.

But GDP growth has so far this year been weaker
than expected.

Inflation is at its highest since the mid-1990s.

But crude oil and other commodity prices have
fallen.

At the same time, productivity has been lower,
which has led to increased wage costs.