The forces behind all this are complex and not well understood, and this complicates any judgment of how enduring they will prove to be. The main candidates in terms of fundamental explanations involve change in economic conditions and in the structure of financial markets. There has been a marked improvement in global economic performance, with strong growth, relatively low inflation, and less volatility in both growth and inflation. This seems to have reduced concern about future fundamental risk, in terms of the potential damage of future shocks and in the ability of governments and central banks to both avoid the policy errors of the past and to competently manage some daunting longer-term policy challenges. The global trend toward independent central banks with clearer mandates for price stability has contributed to this confidence, as has the improvement in national balance sheets in emerging markets, with stronger fiscal positions, higher reserves, and less exposure to foreign-currency denominated debt. Changes in financial markets, including those that are the subject of your conference, have improved the efficiency of financial intermediation and improved our confidence in the ability of markets to absorb stress. In financial systems around the world, the capital positions of banks have improved and capital markets are becoming deeper and playing a larger role in financial intermediation. Financial innovation has improved the capacity to measure and manage risk. Risk is spread more broadly across countries and institutions. Technological change and the relaxation of controls have made it possible for capital to move more freely across national borders.
One such question could be: Why must the Riksbank spoil the party? The Swedish economy has finally begun a period of good growth, rising employment and decreased unemployment, while inflation is low. So why do central bank representatives have to talk about the need to raise the interest rate in such a situation? May it not lead to a renewed increase in unemployment? Another question is how strongly the Swedish economy can expand without risks for inflation. Can it be the case that even the Swedish economy is displaying new tendencies, as certain observers argue has happened in the United States, that is, that growth can be higher without inflation taking off? If so, why is the Riksbank talking of a need to raise interest rates? Let me begin with the first question. Why spoil the party? History teaches that when the growth of demand outpaces the economy’s long-term output trend, this leads in time to risks of capacity shortages and bottlenecks that result in turn in rising prices and wages. At the same time, as it takes one to two years for an adjustment of the instrumental rate to affect the economy, the central bank’s monetary policy decisions have to be based on assessments of the future. Faced with the risk of a situation of this type occurring, it is therefore better to try to slow BIS Review 92/1999  2  things down with a small interest rate increase at an early stage.