Countries with growing current-account and budget deficits were now able to obtain finance in the emerging international capital markets. Economic policy in many Western countries, Sweden included, drifted further and further away from Keynes’s basic tenets. Inflation, which in the Bretton Woods era had averaged around 4 per cent, soon rose to twice that. When unemployment began to increase in connection with the oil crises in the 1970s it was evident that Keynesianism faced a crisis. It offered no solution to the problem of stagflation. Earlier ideas were now revived and new approaches were developed. The difficulties decision-makers face over adjusting imbalances in good time had already been highlighted by economists, above all in the United States, in the late 1960s. There is a considerable risk, for example, that a demand stimulus when activity is low will not have time to act before an upturn has occurred. Policy is therefore liable to accentuate cyclical fluctuations instead of smoothing them. Perhaps the most pungent criticism came from those who argued that in practice, firms and households act in the light of their economic policy expectations. If, for example, the government tries to stimulate demand by increasing transfer payments and thereby the budget deficit, households will simply save the additional benefits because they expect that, sooner or later, the public sector deficit will have to be financed and this entails either increased taxes or decreased transfers. There would be no increment to demand because households strive to keep consumption stable over time.

The Finance Minister, Felix Hamrin, declared that monetary policy’s objective would be to “use all the available instruments to maintain the Swedish krona’s domestic purchasing power”. Deflation was to be combated just as vigorously as inflation. So the Riksbank seems to have been the world’s first 2 central bank to base its policy on price stability. Our work today with an inflation target is accordingly set in a proud tradition. When Sweden came off the gold standard the krona rapidly depreciated by about 30 per cent. Export producers found this particularly welcome as it immediately improved their competitive position. The increased unemployment in the early 1930s elicited a debate about economic policy. Ernst Wigforss, the Social Democrat Finance Minister, saw unemployment as a function of insufficient purchasing power in the economy. To rectify this, he proposed public work projects with market wages, financed with short-term government borrowing. This was a departure from the earlier concentration on monetary policy as perhaps the only effective instrument for stabilisation policy. Wigforss’ proposal also differed from the previous policy of keeping unemployment benefits at a low level so as not to compete with regular wages. Another innovation was the focus on domestic demand instead of on a need to stimulate employment by adjusting prices and wages. The new direction of policy was nurtured with ideas from the Stockholm school of economics, which included Erik Lindahl, Bertil Olin, Gunnar Myrdal and Erik Lundberg. Their ideas had been developed concurrently with those of John Maynard Keynes.