mr backstrom reports on the swedish economy and monetary policy speech given by mr urban backstrom, governor of the sveriges riksbank and chairman of the board of directors and president of the bank for international settlements, to the foreningssparbanken, in malmo on 16 february 2000. * * * the repo rate increases in order to understand why the riksbank has raised the repo rate in two steps from 2. 90 % last november to 3. 75 % less than a fortnight ago, it is necessary to consider the situation in 1998. the mood at that time, in the global economy as well as in sweden, was coloured by the asian crisis, the suspension of russian payments, the problems with the hedge fund long term capital management and falling stock - market prices. it was considered that in addition to direct problems, the financial crisis in the autumn of 1998 would have negative effects on real economic activity. forecasters altered their assessments and the prospects for global output and inflation were revised downwards. central banks around the world did likewise and the riksbank was no exception. instrumental rates were reduced in many countries. between the early summer of 1998 and the spring of 1999 the riksbank cut the repo rate by a total of 150 basis points, bringing it down from 4. 40 to 2. 90 %. the actions of central banks probably mitigated effects of the various shocks. they helped to check the signs of panicky behaviour in the market and then to restore a more optimistic assessment of the future. at the same time, the process displayed some ability to heal itself. all this has contributed to a rapid recovery in the global economy as well as in sweden. the current picture of many economies is thus very different from the uneasy situation that prevailed during 1998 and the early part of 1999. global growth prospects are appreciably better and the risks connected with inflation have changed. that is also why instrumental rates were adjusted upwards by many central banks last autumn and early this year. in principle it can be said that inflationary pressure follows a cyclical pattern. when economic activity is strong, demand growth tends to exceed the expansion of capacity and this normally leads in time to an accelerating rate of price and wage increases. conversely, weak demand may lead to the prospect of inflation being below the target one to two years ahead. as a rule, the repo rate should be raised in the former case and lowered in the latter. in this way, the rep

picture is thus that the new information technology seems to be having knock - on effects in the form of enhanced productivity in other segments of the us economy. many observers therefore consider that the american economy is now capable of expanding at a rate of 3 - 3. 5 % without encountering shortages and an acceleration of inflation. a similar change could well occur in other countries that reap the new information technology ’ s potential benefits. but it cannot yet be said that productivity growth in the swedish economy has improved to the same extent. neither have we registered a similar growth of investment, which could then be a leading indicator that the new technology is being introduced on a wide front. in the 1990s the stock of corporate capital, for example, grew twice as fast in the united states as it did in sweden. it is certainly conceivable that the high level of the stockholm stock exchange represents expectations that productivity growth will also move up in sweden. the sum of the values of individual companies can serve as a yardstick of what is expected of the stock market as a whole and this presumably reflects expectations of how the total economy will develop. and if current share prices are regarded as reasonable, there will clearly have to be an appreciable increase in future profits. this can then be interpreted as expectations of an overall improvement in productivity growth and thus of a higher potential output. an alternative interpretation could be that the stock market is at least partially over - valued. a third possibility is, of course, that the development of share prices is explained by a combination of these two factors. it still seems too hazardous, however, to assume that potential growth in sweden has moved up towards the level in the united states. it is possible - perhaps even probable - that similar supply factors will emerge in the future and the riksbank must be alert to this. but it seems safest at present to count on a potential annual gdp growth rate of between 2 and 2. 5 %. growth can be temporarily higher when the labour force is not being fully utilised, the increase in employment can exceed the trend rate of about 0. 5 %. in a transitional period the economy can then grow faster than its potential rate in the longer run. unemployment in sweden is still historically high. that might suggest that the labour market has plenty of unutilised resources at its disposal. some bottleneck problems are already showing up, see lu 1999 / 2000 bilaga 1 ( medium term survey 1999 / 2000, annex 1,