kristina persson : monetary policy and labour supply speech by ms kristina persson, deputy governor of sveriges riksbank, at a meeting arranged by the municipality of orebro, orebro castle, 2 april 2003. * * * thank you for the invitation to participate in this conference and for the opportunity to inform you about current monetary policy and the riksbank ’ s objectives. i shall also take up one of the major challenges facing the swedish economy over the coming years, namely labour supply and what consequences this may have for future growth and welfare in sweden. monetary policy focuses on inflation the monetary policy objectives are clearly stated in the sveriges riksbank act - to maintain price stability and to promote a safe and efficient payment system. the riksbank has specified the first of these objectives in an inflation target. the annual rate of change in consumer prices shall be 2 per cent, with a tolerated deviation interval of ± 1 percentage point. monetary policy is normally directed at fulfilling this target one to two years ahead. to achieve our objective, we therefore make forecasts of price trends. if the forecasts indicate that inflation will be higher than the target level one to two years ahead, monetary policy must normally be tightened and the interest rate raised. the reverse applies if the forecast shows a lower inflation rate than the target level. although monetary policy is aimed at an inflation target, developments in the real economy and the labour market have considerable significance for the shaping of monetary policy. for one thing, total demand is one of the most important determining factors behind the inflation rate, and for another thing, taking the real economy into account can in certain cases mean that exceptions are made to the fundamental monetary policy rule. this applies in particular in the case of supply shocks : firstly, inflation can be allowed to be higher or lower one to two years ahead, when due to factors that are not considered to have a lasting effect on inflation, and secondly, the real economic costs of a rapid return to the target level are considered to be excessively high. for example, we had particular reason to observe certain temporary changes at the time of our most recent repo rate decision. the riksbank believes that energy prices will fall back from their present high levels without the rise spreading to other prices. another circumstance that affected our forecast was the crisis in iraq, which has now become a war. the geopolitical situation overshadows the more normal inflationary risks that we usually observe. i shall return in

interest expenditure on government debt has been reduced as a consequence of lower interest rates and debt repayment. this has been accompanied by comparatively high tax payments from households as well as the corporate sector. for 1998 the financial surplus – measured as public sector revenue less expenditure – was almost sek 40 billion, which is equivalent to over 2 % of gdp. in recent years the central government budget process has been changed with a view to tightening the control of government spending. the new budget process includes a spending ceiling that sets the maximum level for central government expenditures. in addition to the new budget process, the goal has been established of achieving a general government financial surplus equivalent to 2 % of gdp over the business cycle. thus, the goal is formulated in terms of the average over the business cycle, not as an annual target. these rules do not owe their existence to happenstance. both the expenditure ceiling and the goal of a government financial surplus over the business cycle serve to promote greater confidence in economic policy. the direction of budget policy, like the monetary stance, is highly important for economic developments. the observance of these rules is important. stable fundamental rules encourage economic agents to make long - term decisions. the international situation favourable conditions in the rest of the world are of course of major importance for economic growth in sweden. in the euro area there are now also increasing signs that activity is picking up. incoming statistics on confidence indicators, for instance from italy, france and germany, show that households as well as firms foresee a brighter future than before. moreover, the japanese economy seems to be recovering from its poor performance in recent years. still, the latest statistics suggest that the trend for manufacturing output remains weak, making it advisable to wait for further statistics before taking a japanese upswing as given. the us economy remains strong. gdp growth in the first quarter this year was over 4 % and over 2 % in the second quarter. household expenditure on consumption has gone on rising more rapidly than current income, so saving has fallen and is now at a record low. this has been accompanied by a weak price trend for a majority of goods. nevertheless, the us federal reserve now considers that inflationary pressure is building up. at the two most recent meetings the federal reserve has raised interest rates in order to forestall an unduly rapid increase in consumer prices. new economic relationships? the prolonged strength displayed by the us economy has been unexpected. in the past five years us economic growth has averaged an annual rate