ms hessius speaks about the monetary policy and growth conditions for sweden ’ s economy speech given by ms kerstin hessius, deputy governor of the sveriges riksbank at the chairmens ’ conference of the vastmanland ’ s local authorities association on 27 august 1999. * * * the whole speech the bright picture of the swedish economy that has been coming to the fore in recent years now seems to be becoming increasingly distinct. growth is stable and employment is rising, accompanied by price increases that are moderate. it is important now that this bright picture can become permanent and that the work of creating good conditions for long - term economic development continues. today i shall be considering the economic situation in sweden and the rest of the world, with some discussion of the conditions for consolidating the favourable trend. functions of the riksbank ever since sweden abandoned the fixed exchange rate regime in november 1992, monetary policy has been conducted with its sights on inflation. sweden was one of the first countries to adopt an inflation targeting strategy. in many respects, the period with the inflation target has been characterised by good results in the swedish economy. interest rates and inflation have fallen to levels that are historically low and, after the crisis in the early 1990s, growth has been comparatively high and stable. the general public ’ s expectations of inflation two years ahead are below 2 %, which suggests that the inflation targeting policy has achieved credibility – a matter that is crucial for monetary policy ’ s ability to produce good results. the foundation for monetary policy credibility has been strengthened in that the new legislation in force from the beginning of this year has created a more independent central bank. maintaining price stability is now the riksbank ’ s statutory function. the riksbank has defined its target as being to keep annual inflation, expressed as the change in the consumer price index ( cpi ), at 2 %. the ambition to keep inflation low stems from the insights about inflation ’ s harmful effects on the economy – that higher growth and employment cannot be generated in the longer run by means of higher inflation. it is other matters, such as how the economy functions, achievements in technology and the educational system, that determine those factors. the best way for monetary policy to contribute to high growth and employment is therefore to improve the long - term growth potential via low inflation. to achieve its objective, the riksbank uses its instrumental rate, the repo rate. if the riksbank ’ s monetary stance is unduly

expansionary, that is, if the repo rate is too low to ensure macroeconomic balance, in time the economy will be liable to overheat. demand then grows more rapidly than production capacity and this generates inflationary pressures. if, instead, the riksbank ’ s monetary stance is unduly restrictive, that is, if the repo rate is set too high, the result may be declining demand, a weaker price trend and unsatisfactory growth. the full effect of an interest rate adjustment takes between twelve and twenty - four months to materialise. this means that the interest rate has to be set on the basis of the riksbank ’ s assessment of the macroeconomic trend and inflation prospects in that period. however, the inflation assessments are subject to uncertainty and this risk spectrum has to be considered too. since december 1997 the riksbank ’ s inflation forecast includes what is known as an uncertainty interval. this interval represents the riksbank ’ s assessment of the uncertainties in the forecast. targeting cpi inflation, however, has certain drawbacks. at the beginning of this year the executive board of the riksbank therefore clarified the inflation target in some respects, stating that, under certain specific circumstances, the riksbank may have grounds for interpreting the cpi target more flexibly. price formation in the past three years, for example, has been affected by some clearly identifiable price movements that monetary policy neither can nor shall aim to counter in full. this applies mainly to decreased indirect taxes and the direct effects that the riksbank ’ s own interest rate adjustments exert on interest expenditure and thereby on cpi inflation. the economic situation in sweden labour market as i mentioned earlier, monetary policy ’ s primary contribution to the development of employment lies in creating conditions for a stable economic trend. a predictable monetary policy, focused on a clearly defined inflation target, provides good guidance for wage negotiations. one of the main reasons why wage formation did not function satisfactorily during most of the 1980s was probably that stabilisation policy did not work. inflation exceeded the official target on several occasions in that period and the labour market organisations had difficulty in discerning the rules of the game. one example of this is the government ambition of bringing inflation down in the mid - 1980s : a crisis package was presented in 1983, aimed at inflation rates of 4 % in 1994 and 3 % in 1995 ; when inflation exceeded these targets, the employee organisations considered that a 5 % ceiling on