outlook is instead somewhat weaker. for sweden, it seems likely that the economy will experience a rather normal recovery next year. consequently, it is also probable that inflation a couple of years ahead will be close to 2 per cent, roughly as forecast by the riksbank in august, even if inflation in the forthcoming year may be lower. long - term perspective before rounding off, allow me also to touch upon the longer - term perspective. over the last decade, the economic policy debate has largely centred on stabilisation policy. the fact that stabilisation policy was in focus during the first half of the 1990s is easy to understand. following a severe crisis caused largely by mistakes in stabilisation policy, we changed our exchange rate regime and altered the focus of both our monetary policy and fiscal policy. in the emu debate, it has been natural to continue the discussion of monetary policy and exchange rate systems. i, at least, believe that this discussion went a bit too far. it was easy to get the impression that welfare in sweden depended solely on the riksbank's actions. this is not the case of course. the objective of monetary policy over the past ten years has been to ensure price stability. this has proved rather successful - inflation is in line with the riksbank's target and it is important therefore that it lays a solid foundation for growth. but when we alter interest rates, it is mainly with a view to affecting demand around a long - term output trend. while this is important, it must be remembered that we do not affect the trend itself. and it is this trend that determines our welfare! so we must now shift our focus in the public debate from monetary policy and stabilisation policy to issues that determine sweden's ability to create growth and welfare. in fact, this has been important for a long time since sweden suffered a considerable decline in welfare terms relative to almost all other countries, especially during the 1970s and 1980s. but it is particularly significant now in the light of the challenges facing us in the near future, particularly as a result of our ageing population. essentially, economic growth is determined by how much we work and how productive we are. nothing can change this. the number of hours worked is affected by a large number of factors ; e. g. the number of people of working age, the number of these that are employed, absenteeism, etc. labour productivity, measured as gdp per hour worked, is partly dependent on

##ned the broader process of trade and economic convergence. at the same time, capital mobility has been used to postpone fiscal adjustment. capital inflows have fueled credit and asset booms. current account deficits have been financed through fragile sources of funding. the easy access to financing has created insensitivity to current account imbalances which, in turn, have weakened the incentives for preserving or improving competitiveness. an integrated financial system may be efficient, but not necessarily robust. the more complex and interconnected it gets, the more vulnerable it is when exposed to small, and localized, shocks. these may worsen and compromise the stability and integrity of the whole. this is what is now happening in europe, as it happened before with subprime mortgages in the us. in both cases, problems of limited size – the greek public debt in the case of europe – have had a disproportionate impact because amplification mechanisms have occurred inside the financial system. in europe, three separate dynamics have been at work. bis central bankers ’ speeches first, between solvency and liquidity of sovereign debtors. in times of turmoil, sovereigns, like financial institutions, can be either illiquid or insolvent, or both. in many cases, the distinction is blurred. when uncertainty is high, sovereigns face liquidity shortages, and they can only issue new debt at ever higher interest rates. this, in turn, creates doubts about their ultimate solvency, triggering a negative spiral. good fundamentals are an absolute necessity, but not always a sufficient condition. liquidity spirals, when allowed to develop, can lock a country, just like a financial institution, into a bad equilibrium. this process has clearly been at work in peripheral europe, especially spain and italy, since the beginning of august. a second interaction occurs between sovereigns and banks. both are perceived as closely linked by the market. indeed, sovereign cdss act as floors to bank cdss. and, conversely, banks ’ creditworthiness depends on their exposure to sovereign risk. this circularity creates powerful feedback loops which may lead to absolute market freeze. finally, banks form a closely interconnected network. interbank relationships are key to the smooth functioning of financial intermediation. they have been severely disrupted during the current turmoil. it is important to note – and accept – that counterparty risk between financial intermediaries depends as much on perception as on reality. it was enough for