Within that first section there are two points I’ll try and get across. One is the distinction between the price of what we buy (consumer prices) and the price of what we sell (mainly wages). For the moment it’s the first that’s fallen not the second: the drop in inflation has been driven largely by something that has significantly boosted real incomes (the sharp decline in commodity prices). It is what some have termed “good” deflation and, while it is unlikely to go on for that long, it is positive, not negative, for demand and output. There is a risk that the fall in prices becomes more generalised and more sustained. If so – and this is the second point about the economics – what matters is not deflation per se but the capacity of monetary policy to respond to it. There are circumstances, in particular when the appropriate or “neutral” real interest rate is clearly positive, and when it’s not entirely unexpected, in which mild deflation wouldn’t pose a problem. I think Britain was in precisely that position for much of the classical gold standard period, during the second half of the 19th century (you can see from Chart 1 that periods of deflation were common at that time; as we shall see, they didn’t appear especially damaging for output growth). Deflation becomes a problem if, in conjunction with the zero lower bound on nominal interest rates, it prevents the monetary authority from setting a real short rate that’s sufficiently low to ensure stable growth.
Although the interbank rates, that is, the rates banks pay when borrowing from one another, have fallen they are still much higher than the average rate in recent years. The TED spread in the United States and the euro area is for example three times higher than the average. The housing market in the United States has not yet bottomed out. If new large loan losses arise in the financial system again this may shake market confidence once again. Over the past few days a large amount of new information has been received regarding the situation in the US economy. Inflation in the United States remains high. This is largely due to the increasingly high food prices, as well as high energy prices. However, the rate of wage increase has slackened. Inflation in the euro area is also affected by the higher energy and food prices. However, growth appears to have been stronger than we had expected for the United States in the most recent quarter, as well as in the euro area, particularly Germany. At the same time, there are indicators for both the United States and the euro area pointing to a slowdown in the second quarter. International developments affect us all, both you as entrepreneurs and Sweden as a whole. We have assumed that foreign trade will slow down in the future, as world growth is expected to continue slackening. Orders from the export market have so far declined in 2008.