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

consideration for monetary policy in that it affects the demand situation in the economy. an illustration of this is provided, for example, by the recent years ’ changes in household disposable income. although household wage income rose strongly from 1994 to 1997, the sector ’ s disposable income hardly changed. household income has been held back by increased taxes and decreased transfers ; but for the negative effects of changes in public systems, the annual level of household income would have been 3 to 4 per cent higher. the burden on household income was probably greatest in 1996 but even in the coming two years the fiscal stance measured in this way will be tight. it is accordingly helping to lower inflationary pressure. if, in the current situation with good prospects for growth, unexpected budget improvements were to be used to give fiscal policy a more expansionary turn, the result might be an earlier need to tighten monetary policy in order to secure the objective of price stability. it is then by no means certain that the overall effect on demand would be what was intended. secondly, the fiscal trend in a longer context of “ sustainability ” is also important for monetary policy. if the government deficit appears to be growing uncontrollably, as was the case for some years in the early 1990s, uncertainty may arise as to whether the problems can be tackled at all. this can have negative consequences for monetary policy ; the exchange rate may weaken sharply, for instance, with an increased risk of inflation. the budget consolidation has naturally been important in this respect, too. it is the main single explanation for the krona ’ s appreciation since the crisis years, as well as for the riksbank being in a position to lower interest rates so markedly. as a result of the years with massive general government deficits, however, from 1990 to 1996 public sector debt has grown from 44 per cent of gdp to 78 per cent. this restricts the future freedom of action in economic policy and means that there is a risk of fiscal policy in practice having a destabilising effect. this is particularly the case in that, with high revenue and spending ratios, the swedish budget is sensitive to cyclical factors. seen from this angle the government ’ s target of a 2 per cent budget surplus over the economic cycle appears reasonable, though there is no academic foundation for a quantified level of ambition. there may be grounds for strategic tax cuts to improve the long - term growth potential. but in the light of the experience with government