We assumed therefore that growth in the world economy would be somewhat weaker in 2008 and 2009. In Sweden on the other hand, economic activity was somewhat stronger than expected. Nevertheless, it was assumed that the weaker prospects for economic activity internationally would lead to a slowing down of growth in Sweden as well later this year and early next year. Signs of this slowdown were already beginning to appear, for example in the data in the National Institute of Economic Research’s Economic Tendency Survey and in the statistics on retail sales and new job vacancies. Our assessment, however, was that the slowdown in Sweden would be relatively moderate. GDP growth remained good, and the potential for future growth was still relatively favourable. The level of saving among households and in the public sector was high. Property prices were fairly stable and the direct effects of the financial turmoil were expected to be relatively slight. BIS Review 68/2008  1  At the same time, inflation was high both in Sweden and abroad. This related above all to higher energy and food prices on the world market. Inflation expectations in Sweden also remained high, and were also way above the inflation target even in the longer term. We thus had to take various counteracting factors into account. On the one hand, growth in the Swedish economy was still good and both inflation and inflation expectations were high.
Monetary policy cannot respond to temporary upswings in inflation that can be expected to subside quickly, as monetary policy acts with a time lag. Raising the interest rate to counteract temporary inflationary impulses could cause unnecessary costs. And here I mean costs in the form of production and employment falling too much. However, monetary policy should react to price impulses that would otherwise risk having lasting effects on inflation. As I have mentioned earlier, monetary policy both in Sweden and abroad is facing a severe challenge. On the one hand, the fact that oil and food prices have recently shown a rapid upturn, both in the world market and in Sweden, means that inflationary pressures have increased substantially. This implies that the interest rate should be raised. On the other hand, our most recent growth forecasts indicate that international growth will be weaker, or at least in the United States and the euro area. There is a risk that this will also subdue growth in the rest of the world. In addition, the upswing in oil and food prices risks further dampening world growth. Domestic demand is a strong driving force for growth in many developing countries and it may be weakened by the large rises in food prices. But US growth is also highly dependent on domestic consumption, which can be negatively affected by the high oil price. All of these factors would instead indicate that the interest rate should be cut. 2  International perspective, no. 15 2008, LRF, the Federation of Swedish Farmers.