Mr Bergström reports on why Sweden has changed its stabilisation policy regime Speech by Mr Villy Bergström, a Deputy Governor of the Sveriges Riksbank, the central bank of Sweden, at the 140th anniversary of the establishment of Norrbärke Sparbank in Smedjebacken, Darlana on 21 May 1999. It is obvious to everyone that we live in a different economic world than we did ten years ago. Ten years ago, registered unemployment was 1.3 per cent and inflation 7 per cent. Now inflation is nonexistent while total registered unemployment is over nine per cent. Why has such a drastic change in the economy taken place? What is characteristic for the new economic conditions? Are there alternatives to the policies now being carried out? Background Since the second war, Sweden, in principle, had a fixed exchange rate. However, in practice, it was not particularly fixed after the mid-1970s. From autumn 1976 to autumn 1982, Sweden devalued five times. I will come back to the sorry history of 1982-92. In autumn 1992, the fixed exchange rate was abandoned and the krona immediately fell by 11.5 per cent. Thereafter the krona declined further so that the total fall in the exchange rate to the lowest position of 13 December 1993, was 31.5 per cent. Note that the starting point for the fall in the value of the krona in November 1992 was a cost level that was 25 per cent lower, measured in common currency, than it had been in 1976. This was a failure for stabilisation policy.
Monetary policy must therefore be elaborated taking into consideration a view of inflation over a one or two year period. Therefore, the Riksbank makes inflation forecasts for this time period at regular intervals. Monetary policy is therefore controlled by an intermediate goal, namely the inflation forecasts. It would be unreasonable to try to immediately bring back inflation to two per cent if inflation was higher. It would require a dramatic reduction of capacity utilisation and a deterioration of the situation on the labour market. 5  BIS Review 59/1999  The Riksbank therefore weighs in the situation on the labour market and the real activity in its assessments. In the short run, there is a trade-off between stability of the inflation rate and stability in the real economy. An unremitting stabilisation of the rate of inflation very narrowly around two per cent would at times lead to real economic instability. Precisely for this reason, the target horizon is set at between one and two years, during which time the Riksbank endeavours to gradually meet the inflation target, by steering inflation towards two per cent, guided by the inflation forecasts, which have been made for this period. In the long run, however, there is no trade-off between inflation and employment. A low, stable inflation provides the prerequisites for fast growth and high employment, according to experiences from earlier periods, such as the first two decades after the war. We are now seeing a development that seems to confirm this hypothesis.