lars heikensten : economic recovery with low inflationary pressure speech by mr lars heikensten, governor of the sveriges riksbank, at a meeting at residenset harnosand, 15 march 2004. * * * allow me to begin by thanking you for your invitation to today ’ s meeting. in order to get an idea of economic developments in different areas of sweden and to explain how the riksbank works, i pay regular visits to various parts of the country. the items on the agenda for today ’ s visit include a talk at mid sweden university on how the riksbank works, a visit to sca and a discussion with county representatives about developments in business and the labour market in vasternorrland. at this lunch, i intend to give my views on the economic situation and monetary policy. before going into the economic assessment itself, however, i would like to say a few words about the riksbank ’ s work methods. one of the riksbank ’ s objectives is to maintain price stability. we have decided to define this as 2 per cent inflation as measured by the consumer price index, with a tolerance range of plus / minus 1 percentage point. monetary policy is conducted on the basis of a forecast of inflation over primarily the coming two years. if the forecast in this perspective indicates that inflation will be lower than 2 per cent, the repo rate should normally be cut and vice versa. the reason we focus on inflation 1 - 2 years ahead is because monetary policy affects the economy and inflation with a certain time lag. this approach has served us well over the decade during which we have conducted monetary policy with an inflation target. since the target was adopted, inflation has by and large averaged 2 per cent. at the same time, we have experienced better general economic progress than during the two preceding decades. the clear target coupled with our mode of action has also helped to make the riksbank ’ s policy accessible to both the public and the financial markets. inflation expectations have been anchored fairly stably around our target and it has been possible to predict our actions rather well. nevertheless, there is cause to underline that we do not run on autopilot and mechanically change the repo rate in relation to our inflation forecasts. there may be reasons for us to wait before taking a decision in order to be able to perform more in - depth analysis or obtain more information. there may also be reason to take into account additional

middle of autumn 2003, new data has gradually been received that has warranted changes in our view of the inflation situation. these relate to the labour market, which has been weaker than expected with consequences for our assessments of wage developments, to productivity, which has risen more than anticipated, with lower cost pressure as a result, and finally to actual inflation, which has been lower than expected, with effects also on inflation expectations, which have declined somewhat. employment growth has therefore been weaker than expected, particularly at the end of last year. the same applies to the number of hours worked. the weak employment growth coupled with a lower number of labour market policy measures has resulted in higher unemployment. this rose from 4. 5 per cent in february last year to 6. 0 per cent in february this year. business tendency data and other indicators currently suggest that employment growth in the private sector will be relatively weak in 2004. there are some signs that the labour market may be about to turn, but these are weak. very recently, for example, the number of new job vacancies has increased slightly and redundancy notices have declined. at the same time, the strained financial situation in the public sector points to weak employment growth in local governments in the period ahead as well. thus, employment growth is likely to be somewhat weaker during the year compared with our december forecast. as early as february, we changed somewhat our outlook for the rate of wage increases as a result of the situation in the labour market. there is reason to expect total rises in wage costs to average around 3. 5 per cent in 2004 and 2005, which in terms of average collectively agreed levels leaves little room for more than about 2 per cent on average in the years ahead. the wage bargaining round appears so far to have gone relatively well, but the historical experiences of swedish wage formation suggest that one should be cautious about assuming that we are home and dry. the parties appear to be far from agreement on a number of issues, and there are risks of conflicts arising. as long as the agreements are reached at moderate levels from an inflation perspective, longer agreement periods are preferable. this would alleviate some future uncertainty and should thereby contribute to a better economic situation. so while employment, measured by the number of hours worked, in the business sector was weaker than expected last year, gdp growth was roughly in line with the riksbank ’ s expectations. this means that productivity was higher than anticipated. this picture has been confirmed by the latest national accounts