mr heikensten talks about the interaction between monetary and fiscal policy and labour market developments speech by lars heikensten, first deputy governor of the sveriges riksbank, the swedish central bank, to the landskrona municipality in landskrona, sweden on 16 june 1999. for more than six years now, monetary policy in sweden has been conducted with an inflation target. sweden was one of the first countries, together with canada, new zealand and the united kingdom, for example, to adopt an inflation targeting strategy. other countries have recently displayed an interest in targeting inflation directly as the guideline for monetary policy. examples are countries with strong economic growth in asia, south america and eastern europe. in many respects, sweden ’ s period with an inflation target has been one of good economic results. inflation and interest rates have come down to levels that are historically low and growth since the crisis in the early 1990s has been relatively high and stable. part of the explanation is, of course, that the recession left us with plenty of unutilised resources. but new production capacity has also been created at a rapid rate. moreover, inflation expectations have been lowered, which gives a new and better environment for price and wage formation. international inflation has also been low. the picture of unemployment is more disappointing, though here too the recent trend points in the right direction. growth and inflation in oecd and sweden 1999 and 2000 forecast percentage annual change growth oecd - 1 - 1 sweden - 2 - 2 - 3 - 3 8 0 8 2 8 4 8 6 8 8 1 5 9 0 9 2 9 4 9 6 9 8 0 0 1 5 inflation 1 2 1 2 sweden oecd * 8 0 8 2 8 4 8 6 8 8 * excluding hihginflation countries 9 0 9 2 9 4 9 6 9 8 source : oecd monetary policy, however, is just one of the factors that are important for economic development. two crucial matters for economic development in general and thereby for the conditions underlying monetary policy are the situation in the labour market and fiscal policy. in recent years it is not least the construction of fiscal policy that has contributed to the good economic performance. the interaction of fiscal and monetary policy has been debated a good deal of late. income tax cuts have been discussed, for instance. now that sweden ’ s economy seems to be moving into a stronger phase, in large measure as a result of higher domestic activity, it is of the

the trade union confederation, for example, has acknowledged. their wage negotiations in 1997 started, in fact, from the 2 per cent inflation target. in the assessment of future inflationary pressure, monetary policy in turn must take the labour market situation into account. wages are of major economic importance : in that the wage bill accounts for almost 70 per cent of value added, the development of wages has a large impact on costs and thus on price formation. moreover, wage settlements are liable to influence inflation expectations. wage tendencies are therefore one of the principal variables in any assessment of inflation. however, the difficulties in forecasting wage trends are considerable. the riksbank does, of course, follow data on wages and unit labour costs ; other important indicators include labour shortages in particular industries, wage drift, registered and total unemployment in relation to job vacancies. a central concept in this context is equilibrium unemployment, often referred to by the english acronym nairu — the level of unemployment that can be combined with stable inflation. attempts to push unemployment down below the nairu with monetary stimuli are liable to have the sole effect of boosting inflation. in other words, the nairu is not responsive to an expansionary stabilisation policy. it depends instead on the workings of the labour market, together with demographic changes and technology. thus, lastingly higher employment cannot be generated by continuously implementing an expansionary monetary policy. this is a basic tenet of economics, yet to judge from the public debate it still seems to be misunderstood. various attempts have been made to estimate the nairu for sweden. if this could be done with some certainty, it would obviously be of interest. insights into when a reduction of unemployment risks boosting inflation would be a useful guide for monetary policy. the matter is unfortunately not that simple, mainly because equilibrium unemployment is something that cannot be observed directly. registered and structural unemployment per cent registered unemployment structural unemployment source : the riksbank assessing the level of the nairu for sweden is presumably particularly difficult at present. we still do not know all that much about the long - term consequences of all that has happened in the past decade. after fluctuating around a low level for decades, possibly with a slight upward trend, with the crisis in the early 1990s, unemployment shot up in just a few years. moreover, policy has been realigned and focused successfully on low inflation. this is likely to influence wage formation and hence the nairu. it is notable that problems have also been