to say, how much that can be produced in, for example, one hour of work or use of the machinery. it is important to emphasise that potential output is not an estimate of a ceiling for production. it is therefore not a measure of the level of output that would apply if the entire labour force were employed and all physical capital was used to the maximum. by potential output and potential growth we mean instead the output and growth that is possible without serious imbalances arising in the economy ; the level of output at which supply and demand correspond and actual and expected inflation are in line with the central bank ’ s inflation target ( assuming that there is one ). the potential output level is not constant over time ; it usually shows a growth trend, which is illustrated in figure 1. this is mainly because technological developments mean that higher output can be achieved with the same amount of factors of production. another reason could be long - term changes in the factors of production. the change in potential output from year to year is equal to the potential growth of the economy, which thus is the growth rate that is sustainable in the long term. figure 1 shows the potential output level according to a simple statistical method where the trend, and thereby also the potential growth rate, is allowed to vary over time. the difference between actual and potential output is known as the output gap, and this reflects the cyclical variations in the economy. a negative output gap, that is to say, when actual output is lower than potential output, is usually connected with a recession. the demand pressure for goods, services and the factors of production is then small and there are ample unutilised resources in the economy. price and wage increases are small and inflation is usually below the central bank ’ s target level. when there is a positive output gap, the circumstances are normally the reverse. then, actual output is higher than potential output, resources are strained, unemployment is lower than normal and inflation is higher than the target level. when the economy is in balance, the output gap is closed, that is to say, equal to zero. in practice, both actual and potential output is affected by various shocks which mean that the output gap is rarely zero. if there is a situation with a negative output to begin with, the economy can grow more rapidly than its potential output rate for a short period. the fact is that this is necessary in such a situation in order to close the gap and bring the economy back into balance. however

mr. heikensten looks at the prospects for the swedish economy against the background of the central bank ’ s monetary policy speech by the deputy governor of the bank of sweden, mr. lars heikensten, given at the centre party ’ s economic seminar in haparanda on 15 / 6 / 97. i should like to begin with a word of thanks for the invitation to talk to you here. in these introductory remarks i shall be discussing the economic situation. sweden ’ s economy presents many positive aspects : the outlook for growth is good, the general government deficit is estimated to be eliminated next year and the low inflation policy is becoming more and more established. but there are also persistent economic problems to solve, not least in the labour market. before considering the economic situation, however, i thought i would say something about monetary policy, the role of the riksbank and the changes in the status of the riksbank that recently gained the support of five of the political parties in sweden ’ s parliament, including the centre party. 1. monetary policy and the role of the riksbank why low inflation? in the past decade there has been a growing awareness of low inflation ’ s importance as a central condition for the proper workings of an economy. this has been the case not just in sweden but virtually throughout the western world. the significance of price stability is clearly demonstrated by sweden ’ s experience in earlier decades. the economic climate in the 1950s and 1960s, with low inflation, high and stable growth and low unemployment makes a sharp contrast with the 1970s and 1980s, when attempts to keep the price rise on a par with the rest of the world failed and a series of devaluations had negative effects on wage formation, productivity and economic growth. there is reason to believe that the high and fluctuating inflation in the 1970s and 1980s contributed to the weak state of investment and productivity. the recurrent crises over wage costs generated uncertainty about business profits and thereby about the conditions for investment. and although the devaluations did lead to a temporary improvement of profitability in the sector exposed to foreign competition, they also eased the pressure for structural adjustments. by concealing important economic signals, high and fluctuating inflation impairs the workings of the economy. households and firms are less able to make rational consumption and investment decisions and planning for the longer term is more difficult. the risks are greater and the required return, including compensation for the risks, rises. decision - making therefore