The only effect is liable to be increased uncertainty about the future. The criticism, which presupposed that economic agents are rational, also concerned the labour market. In that the Phillips curve disregards a central explanatory variable – inflation expectations – it is not stable over time. A demand stimulus that pushes inflation up erodes real wage levels. Employees will therefore demand compensation for the price increases and the attendant loss of purchasing power. That means that the additional employment which the stimulus was designed to generate will never materialise. Moreover, Keynesian economic policy had already been criticised in the 1930s on the grounds that stimulating demand in a downturn is considerably easier than tightening policy in an upswing. Economic developments in Sweden from the 1970s onwards provided plenty of support for Keynesianism’s critics. Inflation rose at the same time as keeping total unemployment down proved increasingly difficult. Public spending expanded continuously and particularly in downward phases. Government debt grew even though tax pressure rose. A fundamental loss of competitiveness was countered with repeated devaluations. Back to price stability In a number of industrialised countries, economic policy was realigned in the years around 1980. The aim was to provide a good foundation for stable growth by keeping inflation low. In Sweden the corresponding realignment did not occur until the turn of the 1980s. After almost two decades of high inflation, the costs were considerable. The financial excesses that had characterised the late 1980s in particular were ruthlessly exposed when the inflation bubble burst.
Lars Heikensten: Stabilisation policy - experiences and challenges Speech by Mr Lars Heikensten, First Deputy Governor of the Sveriges Riksbank, at the Swedish Taxpayers Association, 80th anniversary, Stockholm International Fair, 4 October 2001. *  *  *  First of all, congratulations on your anniversary. For an 80-year-old you look relatively fresh. The organisation I represent first saw the light of day 333 years ago, though despite appearances I haven’t been there from the start. Today I shall be dwelling a good deal on the past to see what lessons we can draw from 80 years of stabilisation policy. Economic developments impose new policy requirements. Over the years, the instruments and objectives of economic policy have been put to the test and renewed in the light of experience. I shall be taking you on a conducted tour of the business cycles to see what they can teach us about the current situation. Strong belief in spontaneous recovery Let me start in 1921, the year in which Marcus Wallenberg Senior initiated what subsequently became the Swedish Taxpayers Association. That was in a period when both economic growth and inflation were fluctuating widely. Not counting wars and bad harvests, the crisis Sweden went through was the deepest in modern times. When trade picked up after World War One and demand grew, prices had risen sharply. The strong economic upswing led in time to overheating, with shortages of fuel, raw materials and labour.