inflation is incompatible with a permanent improvement in standards of living. a commitment to price stability is therefore one of the foundation stones of any economic policy that aims for rising prosperity and high employment. the years since the policy realignment have been successful. but this is not only because stabilisation policy is now being conducted differently, with a clear focus on price stability and a balanced budget. it is also a result of all the measures that were introduced around the turn of the 1980s to improve the workings of the economy. these included the deregulation of capital markets, “ the tax reform of the century ”, a realignment of housing policy and so on. since the upturn in 1993, annual gdp growth has averaged 3 – 4 per cent, while inflation has stopped at 1 per cent. this is impressive, not least compared with the 1970s and 1980s, when growth averaged little more than 2 per cent and inflation over 8 per cent. moreover, open unemployment has fallen in just four years from 9 to less than 4 per cent. today, when sweden again faces an economic downturn, the initial position is considerably better than earlier. inflation is low. there is no sign of large financial imbalances. foreign trade is generating surpluses. the government budget is also in surplus and government debt has been reduced from about 80 per cent of gdp to 50 – 55 per cent. an economic policy synthesis this brief review clearly illustrates the interaction of theory and practice over the years. new features in economic development raise new questions. new theories provide answers that are sometimes incorporated in practical politics. this influences developments and raises new questions. in view of this, there is every reason to be humble. we are no doubt as far from the end of history in this field as in others. perhaps one can discern the outlines of a synthesis between the classical approaches and the ideas of keynes. as i see it, such a synthesis can rest on three pillars : • the basic condition for a good economic development is markets that function properly, with rules that are clear and firm. • a stable value of money combined with sustainable public finances makes an essential contribution to an economic development that is favourable and stable. • a policy with this direction that is implemented consistently can, with the aid of certain direct cyclical measures, help to stabilise economic activity. as i have chosen to focus today on issues to do with cyclical activity and stabilisation policy, i have not said much about the first of these pillars but that

lars heikensten : stabilisation policy - experiences and challenges speech by mr lars heikensten, first deputy governor of the sveriges riksbank, at the swedish taxpayers association, 80th anniversary, stockholm international fair, 4 october 2001. * * * first of all, congratulations on your anniversary. for an 80 - year - old you look relatively fresh. the organisation i represent first saw the light of day 333 years ago, though despite appearances i haven ’ t been there from the start. today i shall be dwelling a good deal on the past to see what lessons we can draw from 80 years of stabilisation policy. economic developments impose new policy requirements. over the years, the instruments and objectives of economic policy have been put to the test and renewed in the light of experience. i shall be taking you on a conducted tour of the business cycles to see what they can teach us about the current situation. strong belief in spontaneous recovery let me start in 1921, the year in which marcus wallenberg senior initiated what subsequently became the swedish taxpayers association. that was in a period when both economic growth and inflation were fluctuating widely. not counting wars and bad harvests, the crisis sweden went through was the deepest in modern times. when trade picked up after world war one and demand grew, prices had risen sharply. the strong economic upswing led in time to overheating, with shortages of fuel, raw materials and labour. the high demand for labour brought unemployment down to 4 – 5 per cent of trade union membership. in the period from 1917 to 1920 the annual rate of wage increases averaged about 25 per cent. in 1919 and 1920 the balance of trade showed massive deficits of about 5 – 6 per cent of gdp. sweden ’ s inflationary economy elicited mounting criticism. knut wicksell, one of our best - known political economists, took an active part in pointing to the grave injustices that rising inflation caused by skewing contracts that had been concluded earlier. something ought to be done, he said, but no serious efforts to stabilise the economy were actually made. the subsequent adjustment occurred suddenly and unexpectedly. when the international boom came to an end, demand slumped. from 1920 to 1922, manufacturing output in sweden dropped about 40 per cent and gdp about 35 per cent. unemployment shot up to 25 per cent. the swedish economy went into a deflationary spiral. the price level fell about 35 per cent from 1920 to