lars heikensten : introduction on monetary policy speech by mr lars heikensten, governor of the sveriges riksbank, at the riksdag committee on finance, stockholm, 20 october 2005. * * * let me begin by thanking you for your invitation to the committee on finance. we have now been working with inflation targeting for just over ten years in sweden. we have had open hearings in their current form since 1994. the hearings are one of the cornerstones of the riksbank ’ s strategy regarding openness and are an important instrument with which to win democratic legitimacy for monetary policy. today is the last time i will have the opportunity to appear before the committee in my capacity as riksbank governor. against that background i thought i would begin with a look back at the last ten years. what have we achieved during these years? what has gone well and less well? i also intend to discuss a couple of issues concerning the formulation of the inflation targeting policy ; what expectations are reasonable to have? how is policy being conducted and how can it be developed? these are relevant questions, not least given the discussion that we have seen recently. finally, i intend to speak about the outlook for the economy and inflation that is presented in the inflation report and my own view on future monetary policy. developments in the past ten years as i ’ m sure you all remember, our country was hit hard by a deep economic crisis at the start of the 1990s. this crisis could generally be described as a dramatic end to almost twenty years of stabilisation policy problems. the swedish economy had been characterised by an unsustainable rise in costs, which had originated in price and wage increases that constantly came on a collision course with the fixed exchange rate. the result was repeated devaluations, modest economic growth, poor productivity growth and more or less stagnant growth in real wages. the performance was markedly weak both compared with earlier periods and in relation to other countries. during the crisis years the situation was aggravated further. unemployment increased fourfold in the course of a few years and the central government finances deteriorated dramatically. interest rates rose unchecked and the interest rate differential vis - a - vis germany occasionally came to several percentage points. favourable results today, a little more than ten years after the crisis, the situation is completely different. the new focus of stabilisation policy – which involved crucial changes in the framework for both fiscal and monetary policy – has meant that

may also be problematic for several reasons. the riksbank ’ s repo rate is and should preferably be a blunt instrument that affects the entire economy, that is the households, the companies and the financial markets. it is not desirable for monetary policy to have a disproportionally large impact on a limited part of the economy, in this case on the indebted households. one should not expect that monetary policy will always be designed so that it is well balanced for just this particular part of the economy. this is exemplified by the monetary policy of recent years in which the repo rate has been set lower than justified by developments on the mortgage market. in the future, we may well end up in the opposite situation with the repo rate being set higher than justified by this particular part of the economy. longer fixed - rate periods desirable it is difficult to determine how large a proportion of variable interest rates is desirable in an economy, but i suspect that we have gone too far in that direction in sweden. and by this i mean from the point of view of systemic risk. for an individual household there may be good reasons for choosing a variable interest rate, but for the economy as a whole it would probably be good if we could limit the proportion of variable rates. this can be achieved in different ways. in some countries, regulations have been used to either limit how large a proportion of the mortgage may have a variable interest rate or how much a variable interest rate may increase during the maturity of a mortgage. in other countries, long fixed - rate periods have become the norm without the need for regulations. the fact that this has not happened in sweden indicates that the financial markets are not working well enough for some reason. this may, for example, be due to the lack of a market for mortgage bonds at really long maturities, or of regulations concerning how mortgages with long fixed - rate periods can be paid off prematurely. limit the build - up of debt despite the need to stimulate the economy i would also like to say something about the interplay between current monetary policy and measures to mitigate the risk factors i have mentioned. is it really justified to introduce measures that may dampen household consumption or activity on the housing market when the riksbank is at the same time trying to stimulate the economy in order to increase several studies based on household data from the financial crisis of recent years show that highly - indebted households reduced their consumption more than households with low debts (