although it has the great advantage of being known and spread among the general public. “ inflation ” is understood by the general public as a slow rise in cpi. the disadvantages with cpi are that the measure itself is affected by the policy carried out by the riksbank. if inflation is low and risks turning into deflation, the economy needs to be stimulated. the riksbank then reduces the instrumental rate to increase activity and capacity utilisation in the economy. however, the first thing that happens is that inflation is further reduced or even becomes deflation as interest rates fall and housing costs become lower. these are namely included in cpi. only after some delay is there an effect on the level of activity and inflation in the right direction. this can lead to misjudged policies. another example of problems with cpi is as follows : if the government tightens fiscal policy with a vat increase, cpi rises, as vat has a direct effect on inflation measured in this way. the effects of such measures, interest rate changes and tax changes are temporary. these normally result in one - off effects on the price level. however, it cannot always be right to tighten monetary policy and increase the interest rate because inflation has been increased by a vat increase which in time will dampen demand and lower the level of activity and capacity utilisation. in time, inflation will be dampened by the vat increase, although this takes place by means of an increase in prices – bear in mind though that this depends on inflationary expectations not being affected. a different situation arises then. this shows that cpi movements must be interpreted and analysed when deciding on monetary policy. temporary effects on the price level should not initiate changes in monetary policy. the riksbank is therefore studying a number of other indexes that do not have the weaknesses of cpi in the aspects taken up here. a harmonised index, hicp, is being designed for the entire eu area. this is used by the european central bank, ecb, and this measure does not include interest rate changes, although it does include indirect taxes and subsidies. another index, undix, measures the “ underlying ” inflation by excluding the direct effects of indirect taxes, as well as interest effects. by studying such indexes and comparing with cpi, the riksbank can obtain a view of the temporary effects of economic policy that should not lead to monetary policy changes. however, this means that the riksbank should be able

will be fully centralised. the treaty explicitly states that the ecb is not to be swayed by political considerations ; its task is to concentrate on monetary policy. but naturally a dialogue will be needed with the governments in the eu and euro areas, in the first place with the ministers of finance and economy. the treaty actually provides for this in that the ecofin president may participate in meetings of the ecb governing council and even submit motions. moreover, representatives of the ncbs and finance ministries will continue to meet in the economic and financial committee. monetary union raises many other institutional questions that i will not be taking up today. not the least of these is relations with countries and organisations outside the european union. where, for instance, does the primary responsibility for the exchange rate lie in europe and what about relations between euro area countries and the international monetary fund? i now want to hark back to the issues i touched on earlier : fiscal policy in relation to the business cycle, and how the labour market functions. how will these matters be handled in the system for economic policy decisions? cyclical disparities and fiscal policy the past year has seen a general strengthening of economic activity in the eu area. this has helped improve government finances and provided better conditions in other respects for the start of monetary union. but it has been accompanied by increased cyclical disparities between the future euro countries. this is clear from a look at how observers have revised their growth predictions as compiled, for example, in “ consensus forecasts ”. a look at the euro countries divided into two groups with higher and lower predicted gdp growth, respectively, shows that in the past year the gap between these groups has widened. the same applies in terms of predicted inflation. one should not make too much of this ; the differences have grown but are still small and assessments for 1999 suggest that they will narrow again. but the picture does illustrate a problem that will have to be addressed. the single monetary policy is incapable of both stimulating the economy in some countries and curbing it in others. pressure on fiscal policy will accordingly vary across countries. for one thing, differences in automatic stabilisers and thus in cyclical sensitivity will automatically lead to country differences in budget trends. for another, different degrees of active fiscal policy will be needed to manage tensions that may arise from a single interest rate throughout the monetary union. this question has been deliberated informally for some time by economic policy decision - makers in the european union. it also underlies