rather on a series of potential outcomes and the possible effects of alternative policies, including judgments of the consequences of taking a policy action that might, in the end, have turned out to be less than optimal. i viewed our small increase in the federal funds rate on march 25 as taken not so much as a consequence of a change in the most probable forecast of moderate growth and low inflation for later this year and next, but rather to address the probability that being wrong had materially increased. in the same sense that it would be folly not to endure the small immediate discomfort of a vaccination against the possibility of getting a serious disease, it would have been folly not to take this small prudent step last march to reduce the probabilities that destabilizing inflation would re - emerge. the risk to the economy from inaction came to outweigh the risk from action. to be sure, 1997 is not 1994 when the fed was forced to tighten monetary conditions very substantially to avoid accommodating rising inflation. current financial conditions are much less accommodative than they were in 1994. yet we must be wary. while there is scant evidence of any imminent resurgence of inflation at the moment, there also appears to be little slack in our capacity to produce. should the expected slowing in the growth of demand fail to materialize, we would need to address any emerging pressures in product and credit markets. to understand the problems of capacity restraint, i should like to spend a few moments on what we have learned over the years about economic growth and the conditions necessary to foster it. first it is useful to distinguish between two quite different types of economic growth. one is true, sustainable growth, the other is not. true growth reflects the capacity of the economic system to produce goods and services and is based on the growth in productivity and in the labor force. that growth contrasts with the second type, what i would call transitory growth. an economy producing near capacity can expand faster for a short time through excess credit creation. but this is not growth in any meaningful sense of promoting lasting increases in standards of living for our nation. indeed, it will detract from achieving our long - term goals. temporary fluctuations in output owing to say, inventory adjustments, but not financed through excess credit, will quickly adjust on their own and need not concern us as much, provided policy is appropriately positioned to foster sustainable growth. when excessive credit fostered by the central bank finances excess demand,

the deterioration in public finances that we have seen during this crisis will keep gdp growth and inflation down in many regions for some time to come, as the weak finances will enforce fiscal policy contraction and / or may lead to higher interest rates. a tighter fiscal policy is inevitable to make public finances stable in the long term. restoring the deficit to the level that prevailed prior to the crisis, and one might ask whether this will be sufficient, is not simply a case of replacing the fiscal policy stimulus measures implemented during the crisis with corresponding tightening measures after the crisis. in addition, expenditures have to be replaced as potential gdp and thus potential tax revenue have fallen due to the crisis. the oecd estimates that potential gdp in the oecd area will decline by around 4 per cent as a result of the crisis. all in all, this means that public finances in the oecd area require a structural strengthening of around 5 – 6 per cent of gdp over the coming years. at the same time, several factors indicate that interest rates will rise, which will lead to increased interest expenditure and thus put even greater pressure on public finances. monetary policy is expected to become less expansionary in the years immediately ahead, which means that short - term interest rates will rise. the large general government deficits and thus rising borrowing requirements will probably lead to higher government bond rates. in addition, there is the premium that the market participants require as compensation for the risk that the debt may become unsustainable. meanwhile, stricter financial regulations will probably also lead to higher interest rates. in the past, there have been periods when the debts of the public sector as a percentage of gdp have been reduced as a result of high inflation. but as experiences of the harmful effects of inflation have led to more or less explicit inflation targets for central bank activities see reinhart and rogoff ( 2009 ). and as interest rates tend to adapt very quickly to inflation expectations, it is not probable that higher inflation will reduce public - sector debt as a percentage of gdp. our own experience from the swedish budget consolidation process of the 1990s shows that it is important for the credibility of fiscal policy not just to make general statements about what needs to be done to achieve a balance, but also to make concrete decisions on the spending cuts and / or tax increases that are considered necessary. experience also shows that it is important to base forecasts regarding improvements in public finances on cautious assumptions about economic growth. it may also be worth recalling that there is