Svante Öberg: Sweden - a low inflation economy
Speech by Mr Svante Öberg, Deputy Governor of the Sveriges Riksbank, at Stockholm University,
Stockholm, 21 March 2006.
Diagrams for the speech can be found on the Sveriges Riksbank's website.
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Introduction
I shall begin by thanking you for the invitation. It is always a pleasure to come back to Stockholm
University, where I myself was a student.
I have worked with economics for most of my professional life. Prior to taking up my post at the
Riksbank I had, for instance, been under-secretary of state at the Ministry of Finance, Director General
of the National Institute of Economic Research and adviser at the International Monetary Fund (IMF) in
Washington. I intend to use the experience this has given me to provide a long-term perspective to the
current economic situation. My theory for the day is that "Things are better now".
I shall cover the following areas in my speech: The first part will deal with the Swedish economy in a
slightly longer term perspective going back to the 1960s. There I shall discuss some episodes during
the past 30 years that have coloured my perception of the Swedish economy and of what is important
for monetary policy. The second part will deal with the current economic situation and current
monetary policy.
Swedish economy 1960-2005
I shall begin with a description of the Swedish economy during the period 1960-2005 and start with a
picture of inflation in Sweden and Germany during this period. Inflation has been higher in Sweden
than in Germany for long periods of time. During the 1960s we more or less kept pace with Germany.
However, during the second half of the 1970s and in the 1980s, inflation in Sweden was several
percentage points higher than that in Germany each year. Since the beginning of the 1990s, inflation
in Sweden has once again been roughly the same as that in Germany. Sweden has become a low
inflation economy.
What, on the whole, has happened since the 1960s? To illustrate this, I shall talk about some of the
episodes of the past 30 years that have had great significance for economic developments and for my
own view of the Swedish economy. I have been able to follow the economic policy decision-making
process connected with these episodes at close quarters from my various posts in public
administration. I would like to emphasise that this is my personal view of developments and not the
Riksbank's official view.
The episode I will talk about include the cost crisis in the 1970s and overheating in the 1980s, the
change in exchange rate and monetary policy, the wage formation reform and budget consolidation of
the 1990s.
The cost crisis of the 1970s
During the 1960s, economic growth in Sweden wad good. GDP growth was at a high level, inflation
was moderate, unemployment was low, foreign trade was largely in balance and public finances were
strong. I usually look at these five economic variables when trying to gain an impression of a country's
overall macroeconomic development and I will return to them often during my speech.
During the 1970s a number of events occurred that had serious consequences for the Swedish
economy. Oil prices rose substantially in 1973, which led to much higher inflation than could be
considered justified by the actual oil price. Internationally, this became the start of a long period of low
growth.
In Sweden the government invested in economic stimulation to bridge over the coming economic
recession. The central wage agreements signed for 1975-76 were therefore at a very high level, which
together with wage drift and increased employer contributions meant that the wage costs per hour
rose by a total of 38 per cent. Sweden's competitiveness thus deteriorated substantially. Our labour
costs per unit produced in industry in relation to the corresponding costs in other countries rose by
around 25 per cent between 1974 and 1977.
At that time, Sweden had an exchange rate regime with a fixed exchange rate. After World War Two,
almost all western countries' currencies were pegged to the United States dollar, which in turn had a
fixed price against gold. The system came into force in 1944 and was called the Bretton Woods
System. When this system broke down in 1973, a currency collaboration was started up between a
number of European countries, known as the currency snake, by which the krona was pegged to a
currency basket dominated by the German D-mark. In 1977 Sweden left the currency snake and the
krona was pegged to a currency basket where the dollar had a double weight in relation to the trade
exchange. In 1991 the krona was instead pegged to the European currency unit, the ecu.
During the 1970s, Sweden was still applying credit and foreign exchange regulations. The credit
regulation limited the banks' lending and foreign exchange regulation limited the opportunities to move
currency, securities and capital across borders. Both types of regulation entailed limiting the
opportunities for efficient allocation of capital and they became increasingly difficult to maintain as time
went by. The credit market was deregulated in 1985 and the final parts of the foreign exchange
regulation were abolished in 1989.
The idea behind an exchange rate regime with a fixed exchange rate is that inflation in Sweden will
adapt to inflation in other countries. Economists usually call this international inflation functioning as a
nominal anchor. However, it did not succeed, as Sweden did not manage to stay even with other
countries regarding inflation and cost developments. The economic policy conducted and the way the
economy functioned during the 1970s were not compatible with a fixed exchange rate. This resulted in
a series of devaluations, a smaller one of 3 per cent in 1976, two of them, 6 per cent and 10 per cent,
in 1977, one of 10 per cent in 1981 and a large devaluation of 16 per cent in 1982.
Overheating in the 1980s
The 1980s thus began with two devaluations in 1981 and 1982. The background to these was that the
end of the 1970s and beginning of the 1980s had been very problematic. GDP growth had been poor,
and production actually fell a couple of years. Unemployment had risen to 3-4 per cent, which was
then regarded as a very high level. Inflation had soared to levels of 15 per cent. The current account
and public finances showed a substantial deficit. Sweden found itself in a situation with weak real
growth and twin financial deficits.
I took part in the preparations for the devaluation in 1982, in connection with the change of
government that year. The preparations were led by Kjell-Olof Feldt, Erik Åsbrink and Michael
Sohlman. I had the task of making calculations of economic developments over the coming years,
based on different economic policy alternatives. Two of the alternatives concerned expansionary fiscal
policy to bring down unemployment and a strongly contractionary fiscal and monetary policy to
eliminate the twin deficits. In both cases, substantial problems remained in the Swedish economy.
The third alternative concerned a devaluation of 20 per cent in autumn 1982, combined with a price
stoppage and pegging the krona to the D-mark. The calculations indicated that industrial production
and investment would increase, public finances would improve, the current account deficit would
disappear, employment would increase and unemployment would be kept down. After Kjell-Olof Feldt
had made contact with the Nordic finance ministers and central bank governors, as well as the
German central bank governor, the size of the devaluation was altered to 16 per cent and the planned
pegging of the krona to the German D-mark was postponed indefinitely.
I had reason to return to these calculations later on during the 1980s and I could observe that they
were pretty accurate on most points, except with regard to price and wage developments. I had
assumed that inflation and wage increases would adjust downwards to the international level. For
devaluation to be successful, price and wage developments must be kept down after the devaluation.
However, this was not the case. Sweden had an inflation rate much higher than that in Germany every
year of the 1980s.
Economic policy was not sufficiently strict during the 1980s to keep down price and wage increases
after the devaluations in 1981 and 1982. Although public sector finances improved substantially, this
was primarily due to automatic improvements resulting from a number of years of good growth. While
monetary policy was strict in the sense that both nominal and real interest rates were kept at a high
level to protect the krona, at the same time credit regulations were abolished in 1985, which led to a
huge credit boom that increased demand and pushed up property prices.
The excessive price and wage increases led to Sweden's cost level once again deteriorating
substantially in relation to other countries. At the end of the 1980s, relative costs per produced unit
had increased to the level prevailing prior to the devaluations at the beginning of the 1980s and we
once again had problems with the twin deficits in the current account and public finances.
The problems were aggravated by an international economic downswing at the beginning of the 1990s
and by the fact that household saving increased considerably after the tax reform implemented at the
beginning of the 1990s. The property bubble that had arisen in the wake of the deregulation of the
credit market burst, which resulted in the whole of the Swedish banking system being on the verge of
bankruptcy in 1992. Large currency flows in autumn 1992 made fiscal policy spending cuts necessary
and led to a powerful defence of the Swedish krona by the Riksbank with interest rates creeping up in
stages. In the end, it was necessary to give up. The krona was allowed to float, leaving the peg
against the ecu in November 1992, and it depreciated by 20-25 per cent.
The conclusions I have drawn from developments during the 1970s and 1980s are that the economic
policy conducted together with the functioning of the economy during this period could not lay a
foundation for macroeconomic stability and good economic growth. Price and wage formation that got
out of hand in the 1970s, a series of devaluations that created considerable pressure in the economy
during the 1980s, deregulation of the credit market that triggered a large credit boom, which could not
be counteracted by monetary policy as this was detailed to defend the krona's fixed exchange rate,
and a fiscal policy that could not withstand inflationary pressures. All in all, this led to repeated crises
and finally to economic collapse. This leads me in to the next three episodes.
The reform of wage formation
Before I get into the changeover in exchange rate and monetary policy at the beginning of the 1990s, I
want to mention two episodes that have contributed to making the changeover in exchange rate and
monetary policy successful with regard to bringing down inflation to a level comparable with other
countries. These are the reform in wage formation and the budget consolidation in the 1990s.
At the end of the 1980s it had become increasingly evident that Swedish wage formation did not
function in a manner compatible with macroeconomic balance. It was common for central wage
agreements signed during the 1980s to contain price trend guarantees, wage development
guarantees, earnings guarantees, checkpoints etc., which led to prices and wages pushing one
another upwards in an increasing spiral.
On 1 March 1990, the Government appointed the Rehnberg Commission to follow negotiations of new
central wage agreements in the labour market and to act to achieve new agreements that would
contain price clauses to replace the agreements for 1990 and new agreements for 1991 and lead to a
radical reduction in total wage increases, including wage drift, during 1991. Based on the
Commission's proposals, stabilisation agreements were signed for the period 1 January 1991 - 31
March 1993 for just over 75 per cent of the labour market, which contributed to the rate of wage
increasing falling from around 10 per cent in 1990 to 3 - 4 per cent a year during 1992 - 1993. After
that, however, the rate of wage increase rose again to around 6 per cent in 1996.
In April 1997 I was given the task by Deputy Labour Minister Ulrika Messing of making an inquiry into
wage formation and mediation. When I was given this task, the social partners in the industrial sector
had recently (in March 1997) signed a new cooperation agreement, known as the Industrial
Agreement, whereby the parties took joint responsibility for wage formation in their part of the labour
market and had agreed on a regulatory framework for negotiating wage agreements. The agreement
was followed up by similar, but not as far-reaching, agreements in other sectors. At the same time,
there were substantial parts of the labour market that had no such type of agreement.
The inquiry led to a new National Mediation Office being established, with the tasks of mediating in
labour disputes and acting to promote an efficient wage formation process. The most important
change was in my opinion that a third, independent, party was established in the labour market to
promote efficient wage formation. The National Mediation Office has the task of keeping up-to-date
with the situation in central wage negotiations and acting to ensure that macroeconomic
considerations are taken into account in wage negotiations. The Office was also given increased
powers of authority to act in connection with central agreement negotiations, for instance, the
possibility to call the parties to talks, to provide mediation even if one party was opposed to mediation
and to postpone industrial action. The wage statistics improved. The National Institute of Economic
Research was given the task of annually producing reports on the economic conditions for wage
formation.
Over the past 10 years wage formation has functioned much more efficiently. Nominal wage increases
have been around 4 per cent a year on average, compared with 8 per cent a year in the 1980s. The
agreements no longer contain clauses regarding inflation and so on and wage drift is much more
limited. Real wage increases have been on average 3 per cent a year on average, compared with 0
per cent a year in the 1980s.
Of course, one can discuss how much regulatory frameworks and institutional conditions surrounding
wage negotiations have meant for this development in relation to the general conditions and the
increased understanding of the inflation target and of the importance of low, stable inflation. My belief
is that they improve the conditions for succeeding in monetary policy's objective of maintaining price
stability.
Budget consolidation
Following the change of government in October 1994, I returned to the Ministry of Finance after a
couple of years as adviser at the International Monetary Fund in Washington to become
UnderSecretary of State to Göran Persson. There was basically one task on the agenda; to eliminate the
very large budget deficit. The deficit in public sector finances amounted to around 11 per cent of GDP
in 1993.
After a majority of the Swedish population had expressed their support for Sweden joining the
European Union at a referendum held in autumn 1994, this became an additional task, as well as
financing Sweden's membership of the EU, which cost in the order of SEK 20 billion a year.
The timing for dealing with the deficit was ideal from both a political and an economic viewpoint.
Studies made by the OECD indicate that powerful budget consolidation processes have only been
carried out in connection with serious crises, and the 1990s began with the most serious recession in
Sweden since the Depression of the 1930s. GDP fell three years in a row, 1991-1993, and
employment fell by more than 500,000 persons during these three years. At the same time, letting the
krona float free in 1992 had led to a depreciation of the krona of around 20-25 per cent and a large
increase in exports. There was thus a strong growth in demand from abroad that made it easier to
constrict domestic demand.
The budget consolidation succeeded beyond expectation. Public finances were improved from a
deficit of around 11 per cent of GDP in 1993 to a surplus of around 2 per cent of GDP in 1998. The
target had been aimed at achieving a balance in public finances in 1998. The major part of the budget
consolidation was achieved by reducing the public expenditure as a percentage of GDP.
There are considerable similarities between the problems at the beginning of the 1980s and the
1990s. In both cases, Sweden's international competitiveness had deteriorated and we had large
deficits in both the current account and public finances. However, the major difference between
developments in the 1980s and developments in the 1990s was that fiscal policy was much stricter in
the 1990s and inflation was brought down to a level comparable with other countries.
I have since had reason to go through what happened when confidence was restored in the Swedish
economy and economic policy. Despite the decision on budget consolidation essentially being taken
by the Government and Parliament in autumn 1994, it took some time before various figures believed
it would succeed.
The first international recognition of our policy came from the European Commission in spring 1995. I
accompanied Göran Persson to Brussels and gave an account of Sweden's convergence programme
to Giovanni Ravasio, who was one of the leading economists at the Commission. Each member state
of the EU was to draw up a convergence programme that would show what policy they intended to
conduct to achieve stable public finances, low inflation and low interest rates. The Swedish
convergence programme was aimed at achieving balance in public finances in 1998, and had the
broad support of all of the parties in Parliament with the exception of the Left Party. Ravasio was
convinced that the programme was sustainable.
It was possible to see in the financial markets that the interest rate differential between Swedish and
German long-term bonds began to decline in spring 1995 when the Swedish convergence programme
had been decided and even more so in autumn 1995, when it had been approved by the EU's finance
ministers. For the Riksbank it took until the beginning of 1996 before short-term interest rates began to
be cut. The krona was still weak during 1995 and inflation was close to 3 per cent.
I have also had reason to go over how fiscal policy has been managed, since leaving the Ministry of
Finance in 1997 to become head of the National Institute of Economic Research and later General
Director of Statistics Sweden in 1999. In June 1999, Finance Minister Bo Ringholm appointed me to
assess the reformed budget process. The budget process had been reformed in stages since the end
of the 1980s. Following the assessment and with broad political agreement, a Budget Act came into
force on 1 January 1997. It contained regulations on, for instance, an expenditure ceiling and
guidelines for public expenditure.
The main conclusion of the assessment was that the new budget process had functioned well. It had
contributed to public expenditure as a percentage of GDP being reduced significantly and to public
sector financial saving being turned around from a large deficit to a surplus. Of course, there had been
some creative accounting to bring public expenditure under the ceiling, but this was on a relatively
small scale.
The changeover in exchange rate and monetary policy
In 1992, when the fixed exchange rate for the krona could no longer be defended, and we changed
over to a floating exchange rate, Sweden found itself in a situation where it had not been since the
1930s. The krona was floating and the fixed exchange rate could no longer function as a nominal
anchor for monetary policy.
In 1993, the Riksbank specified the objective of monetary policy as being that inflation as measured by
the Consumer Price Index (CPI) with effect from 1995 should be 2 per cent a year, with a tolerated
deviation of one percentage point above and below this. The exchange rate and monetary policy
regime had thereby changed over from a fixed exchange rate regime with monetary policy aimed at
maintaining the fixed exchange rate to a floating exchange rate where monetary policy was aimed at
keeping inflation low. The inflation target had become the new nominal anchor. However, it was
necessary to build up credibility around the new monetary policy and the inflation target.
Part of the work of strengthening confidence in monetary policy was to make the Riksbank
independent. At the beginning of the 1990s, the Riksbank had begun to be more independent. In 1990
there was a change in the principle that the Under-Secretary at the Ministry of Finance would be
chairman of the Riksbank's General Council. During the changes in government in 1991 and 1994 the
Riksbank Governor was not replaced, which had previously been the accepted rule. Membership of
the EU in 1995 carried the requirement of adapting Swedish legislation to the EU's regulatory
framework. During the years 1996-97 there was a commission of inquiry that investigated granting the
Riksbank formal independence and in 1998 there was a broad political agreement that this would be
granted. In 1999 the Riksbank formally received independence, with an Executive Board that makes
monetary policy decisions and a statutory inflation target.
The changeover in exchange rate and monetary policy and the Riksbank's increased independence
have been important conditions for bringing down inflation to a level that corresponds to other
countries. This development has been supported by the budget consolidation and the wage formation
reform.
Sweden is now once again a low inflation economy, after cost crises and overheating. Over the past
10 years, inflation has varied between just below zero and just over three per cent on an annual rate
and inflation expectations have stabilised at around 2 per cent a year. International inflation is also
lower now. Both in the EU and the OECD area, inflation is close to 2 per cent a year. The major
distinction from before is that the difference in inflation between Sweden and other countries has
declined. We once again have an inflation rate comparable with that in Germany.
Things also look better in other regards than they did in the 1970s and 1980s. During the 1960s and
up to the mid-1970s, Sweden enjoyed high growth, with the exception of a few individual years. This
was followed by a period up to the early 1990s when growth was lower and varied considerably. Some
years it was even negative. Over the past ten years we have once again enjoyed good and relatively
stable growth. If we compare the period 1970-1993 with the past twelve years, we can observe that
growth was much higher during the latter period of low inflation (almost 3 per cent a year) than during
the earlier period of high inflation (almost 2 per cent a year).
Real wages have also developed better over the past ten years than during the interim period with
higher inflation, despite the fact that nominal wage increases have been lower. During the 1960s and
up to the mid-1970s, real wages rose every year, i.e. wage were rising more rapidly than prices. Then
followed a period of 20 years when real wages did not rise at all on average. Since the mid-1990s, we
have once again enjoyed a period of rising real wages. Higher productivity growth has contributed to
this.
The current account is showing a very large surplus. Public finances are also showing a surplus,
although this does not reach the target of 2 per cent over an economic cycle.
On the other hand, unemployment is now higher than before. During a very long period up to the
beginning of the 1990s, unemployment was very low in Sweden. Open unemployment varied between
1 and 4 per cent. In recent years, it has varied between 4 and 6 per cent, following a peak of 9 per
cent in 1997.
When I studied economics at university, we were taught that lower inflation was linked to higher
unemployment. This relationship was illustrated by the Phillips curve. However, later research has
shown that in the longer term there is no connection between inflation and unemployment. At the
same time, I believe that the problems in the 1970s and 1980s could partly be explained by the
Swedish economy being unable to manage the low unemployment we had then without excessive
price and wage increases ensuing. For me, one of the most important tasks of economic policy over
the coming years is to bring down unemployment. However, the Riksbank is unable to do very much
about this. The Riksbank's contribution is to safeguard the inflation target and in this way create
favourable conditions for growth and employment.
All in all, my picture is still that the Swedish economy has functioned much better over the past ten
years than in the 1970s and 1980s. Things are better now.
Current monetary policy
The other part of my presentation is concerned with economic developments and current monetary
policy and the reasons why the Executive Board of the Riksbank decided at its most recent monetary
policy meeting on 22 February 2006 to raise the repo rate by 0.25 percentage points to 2 per cent.
The Riksbank's view of economic developments over the coming years is presented in the Inflation
Report, which was published at the same time as the interest rate decision. This part of my
presentation does not contain any new information or new assessments in relation to the February
Inflation Report and the separate minutes of the Executive Board meeting.
In the light of the picture of economic developments outlined in the February Inflation Report, the
Riksbank concluded that there was reason for gradually moving towards a more neutral monetary
policy. Although inflation is currently low, developments in the real economy are strong and as
capacity utilisation increases, inflation is expected to approach the target of 2 per cent. Raising the
repo rate by 0.25 percentage points therefore appeared reasonable. The rate for the continued
adjustment of monetary policy will depend as usual on the information received.
To understand the aim of monetary policy, it is necessary to be aware that monetary policy normally
has an impact with a relatively long time lag. It is not aimed at the current low inflation rate, but at the
expected inflation rate a couple of years ahead. One must also take into account the fact that even
after raising the repo rate to 2 per cent, monetary policy is still expansionary. During the entire forecast
period, the repo rate is expected to be lower than what can be considered an average key rate in the
long term, and lending is expected to continue to increase relatively strongly, even after an interest
rate rise.
In my opinion, the information received recently does not significantly change the picture outlined in
the Inflation Report. The National Accounts for the fourth quarter of last year were slightly weaker than
expected, but at the same time, the outcome for previous quarters was revised up, so that GDP
growth for the year 2005 as a whole was as expected. Inflation was slightly lower than expected in
January, but in February inflation was slightly higher than expected. The moving three-month
averages in the Labour Force Surveys in February showed largely the same picture of labour market
developments as that on which our interest rate decision was based.
Conclusion
In conclusion, I would like to return to my theme for this talk, namely that things are better now. Of
course there are problems now, and of course one can discuss whether monetary policy should
provide a little more or less stimulation. However, with the long-term perspective I have tried to provide
here today, I believe that Sweden has a much better economic situation now than during the problem
years between the mid-1970s and the mid-1990s. We have a regulatory framework for exchange rate
and monetary policy, as for fiscal policy, which promotes macroeconomic stability and good economic
growth. It is important that we safeguard these regulations.