International economic activity may result in inflation being even lower than in our main scenario, at the same time as a lastingly weak exchange rate that has no counterpart in poorer economic fundamentals could lead to upward pressure on prices. Increased financial unrest Financial unrest has grown since the September Report was published. It is difficult to foresee to what extent the crisis that began in Thailand almost a year and a half ago will affect the real industrialised economies in the West. The direct real economic effects via foreign trade will probably be relatively small. For economic activity and inflation in Sweden, the effects that could arise from decreased general confidence are more important. Share prices in Sweden have gone on falling since the September Report was published, wiping out not just the gains during 1998 but also a part of last year’s increase. Since the high in July, the Stockholm Exchange1 has dropped nearly 30 per cent, giving a fall of about 8 per cent from the level at the beginning of the year. Since the Inflation Report was published, share prices have fallen nearly 6 per cent. 1  Affärsvärlden’s general index. BIS Review 81/1998  -6Continued unrest and falling asset values would affect the behaviour of firms and consumers. If households and firms postpone investment and consumption decisions, economic activity will be lower.
But this was by no means the only factor. Contributions to the low outcome seem to have been made by this wage round having been conducted both centrally, with efforts to hold wage formation together, if not throughout the labour market then at least in large segments, and decentralised to individual firms. Whether this model can be repeated is another matter. Transitory effects, import prices and rents account for 2 percentage points of the substantial downward revision of inflation in 1998 by a total of 2.2 percentage points between the Inflation Reports in December 1997 and this September. The same factors are responsible for about half of the downward adjustments for 1999 and 2000 between the forecasts in March and June. Monetary policy increasingly understood, but problems last spring BIS Review 81/1998  -4For some years now the Riksbank has been working hard to communicate the line of thought behind its decisions both to the general public and to market players. This is intended to heighten the general understanding of how monetary policy functions and what it can do and also prevent, as far as possible, market disturbances on account of uncertainty. The more clearly the market understands our way of thinking, the smoother should short interest rates adjust to new information about inflation prospects. A comparison of market expectations (as expressed in implied forward interest rates) with the actual repo rate can serve as a indicator of the market’s error in foreseeing the repo rate. This predictive error has, on the whole, decreased.