lars e o svensson : flexible inflation targeting – lessons from the financial crisis speech by mr lars e o svensson, deputy governor of the sveriges riksbank, at the workshop “ towards a new framework for monetary policy? lessons from the crisis ”, organized by the netherlands bank, amsterdam, 21 september 2009. i am grateful to claes berg, ylva heden, jonas niemeyer, virginia queijo von heideken, annika svensson, ulf soderstrom, staffan viotti, anders vredin, karl walentin and, especially, bjorn lagerwall, for comments and help with the speech. the views presented here are my own and not necessarily those of other members of the riksbank ’ s executive board or staff. * 1. * * introduction the financial crisis has raised some questions regarding monetary policy and how it should be conducted in relation to financial conditions such as credit growth, asset prices, imbalances, the risk of creating bubbles and so on. i will discuss two particular questions : has monetary policy contributed to the conditions for the crisis? do the lessons from the crisis justify any changes in the way best - practice monetary policy should be conducted? i will lay out my pre - crisis view of best - practice monetary policy – flexible inflation targeting – and its relation to financial stability and asset prices, discuss the role of monetary policy in possibly contributing to the current financial crisis and, finally, present my conclusions on whether flexible inflation targeting needs to be modified in the light of the crisis. 2. flexible inflation targeting the riksbank and all the other inflation - targeting central banks conduct flexible inflation targeting rather than strict inflation targeting. flexible inflation targeting means that monetary policy aims at stabilizing both inflation around the inflation target and the real economy, whereas strict inflation targeting aims at stabilizing inflation only, without regard to the stability of the real economy, what mervyn king ( 1997 ) has described as being an “ inflation nutter ”. by stabilizing the real economy i mean stabilizing resource utilization around a normal level, keeping in mind that monetary policy cannot affect the long - term level of resource utilization. because of the time lags between monetary - policy actions and their effect on inflation and the real economy, effective flexible inflation targeting has to rely on forecasts of inflation and the real economy. flexible inflation targeting can be described as “ forecast targeting ” : the central bank chooses a policy - rate

which was broken recently both due to economic activity and to more structural causes. several factors lie behind this development. once again it is natural to go back to the crisis years in the early 1990s. at that point the number of hours worked declined significantly as a result of the large fall in demand that took place. parallel with this, structural changes were implemented. young people on the verge of working life chose to continue studying, partly because of the lack of jobs, partly because developments on the labour market meant that higher educational demands were made. another explanation could be that the number of older persons in the labour force also declined considerably during the same period. the labour supply in the age group 60 - 64 years fell by approximately 40, 000 persons during the 1990s, despite the fact that this group's percentage of the population did not change significantly. in addition, the number of people taking early retirement increased at an alarming rate. recently, as we are all aware, the amount of sick leave has increased. another factor that appears to have had some significance is that the swedish labour market has not been able to make adequate use of the labour reserve comprised of inhabitants who were born abroad. the employment frequency among these people has been much lower than the employment frequency among people born in sweden. this applies in particular to those who have arrived here quite recently. the efficiency in matching on the labour market also appears to be lower for these people. one indication of this is that many with a university education are either unemployed or have jobs below their competence levels. contrary to what many people believe, however, demographic developments have been relatively favourable during the 1990s, from a labour force perspective. the population growth in the age group 20 - 64 years developed weakly during the entire 1970s and most of the years up to the 1980s ( figure 7 ). however, towards the end of the 1980s the rate of increase began to accelerate. since then it has been relatively high, with the exception of a few individual years in the mid - 1990s. the fact that growth in the number of hours worked at the end of the 1990s began to take off was mainly due to the rapid expansion in the private, and to some extent also the public, services sector. i mentioned earlier the discussions of the significance of the " new economy " for productivity increases during the 1990s and as i said productivity growth fell heavily at the beginning of the new millennium. the same applies to the number of hours worked. this raises the question, similar to the case of