Continued growth at a rate around 3 to 4 per cent was not reasonable. Observers usually consider that the Swedish economy is capable of long-term growth at an annual rate of about 2 to 2.5 per cent. A similar situation had been faced for a time by other central banks around the world. In the United States, for example, the Federal Reserve had raised its instrumental rate successively during 1999 and 2000 to 6.5 per cent. In Europe, the ECB tightened its rate last year to 4.75 per cent, while the Bank of England’s rate was raised to 6.0 per cent. The same type of reaction was also evident in other countries. I recall that in the course of last year many observers counted on relatively large interest rate hikes in Sweden, too. They thought they saw clear signs that the Swedish economy was on the way to becoming overheated and argued fairly strongly that the Riksbank should therefore act quickly to increase its instrumental rate in keeping with other central banks around the world. But the Riksbank arrived at a different assessment and chose instead to proceed more cautiously with interest rate increases. In our opinion, the relatively favourable inflation prospects last year simply did not warrant a tighter monetary stance. We kept to the level of 3.75 per cent for practically the whole of 2000. In December, however, we did raise the repo rate 0.25 per cent points, from 3.75 to 4.0 per cent.
This is partly explained by cyclical factors. By this I mean the plentiful supply of unutilised resources - not least all those who had lost their jobs during the economic crisis that ravaged Sweden in the early 1990s. That lessened the risk of the upswing in production soon leading to the economy reaching its potential output. But as far as we can judge at present, the more favourable trend also has to do with an economy that is functioning more efficiently. Sooner or later, however, demand growth that is unduly strong and persistent will generate economic imbalances, whereupon price and wage increases usually tend to accelerate. In time, such a development is liable to turn into a recession, with falling output and rising unemployment. Rapidly rising inflation is often - though not always - an indication that the economy has been expanding too rapidly and that economic policy has not been sufficiently tight. Economic overheating and rising inflation were in fact a recurrent problem in the 1970s and ’80s. Restricting economic activity when times are good has often proved difficult. But sooner or later it has had to be done in ways that were then more dramatic. Production and employment have then fallen and unemployment has risen. BIS Review 72/2001  1  Towards the end of last year we judged that it was time for economic activity in Sweden to start slowing down to the growth rate that is commensurate with a stable long-term trend.