It became increasingly obvious that the trade-off between inflation and unemployment that had previously been taken for granted did not apply, that each new attempt to raise employment by expanding demand only resulted eventually in increasingly higher inflation (see Chart 1). It is easy to understand why. When inflation rises, it affects the wage demands in the next round of wage negotiations. Wage-earners are interested in the actual purchasing power of their wage and structure their wage demands accordingly. Inflation thus increases without any effect on employment. The conclusion is that in the long run there is no trade-off between inflation and unemployment. But even though inflation does not have any long-term impact on employment, it does affect economic growth and welfare. High inflation disrupts the mechanism by which goods’ relative values are signalled via prices, and distorts the reasons to save. This problem is perhaps especially significant for investment when the return is expected to be yielded over a long period in the future. In such cases, uncertainty over price developments can have a curbing effect. Furthermore, there is an increase in uncertainty about future developments in wages and costs, making it more difficult for agents in an economy to make economic decisions. Lenders may decide to set a higher rate of interest to compensate for any rise in inflation, and firms may decide not to invest in new machinery or to hire employees.
The fact that employment depends on a number of other factors than monetary policy decisions and cyclical variations is illustrated, among other things, by the miscalculations of the National Labour Market Board just prior to 2004. In November last year the Board estimated that Swedish economic growth would be 1.4 per cent in 2003 and 1.9 per cent this year, while unemployment was forecast to be 5.1 per cent this year. Moreover, the Board believed that the repo rate should be cut from 2.75 to 2.25-2.5 per cent. These forecasts were roughly in line with those of the Riksbank at that time, with the exception that we, as usual, based our forecasts on the assumption that the repo rate would be kept unchanged. A year later we can say that economic growth has exceeded both the National Labour Market Board’s and our expectations at the same time as the monetary stance has become looser. Nevertheless, labour market growth has been weaker. This shows both that forecasters can be surprised by unexpected developments in the economy and that unemployment at present is not chiefly due to insufficient demand for goods and services owing to low growth and tight monetary policy.