•  A stable value of money combined with sustainable public finances makes an essential contribution to an economic development that is favourable and stable. •  A policy with this direction that is implemented consistently can, with the aid of certain direct cyclical measures, help to stabilise economic activity. As I have chosen to focus today on issues to do with cyclical activity and stabilisation policy, I have not said much about the first of these pillars but that does not imply a value judgement. On the contrary, the reforms of taxation, regulations and so on have presumably played a crucial part in the good development in the 1990s, both in Sweden and elsewhere. At the same time, recent developments bring out some of the problems we now face. Markets are evidently liable to malfunction in the sense that prices deviate markedly from what is reasonable in the long term. Stock markets have provided evidence of this in recent years and it is also very much the case with the krona’s exchange rate. The result can be considerable fluctuations not just in financial markets but in the real economy, too. It is here that I believe the major challenges lie today, both for economic theory and for us more practical decision-makers. I have already discussed the other two pillars. Attempts to raise demand and employment in the short term entail considerable risks, as we saw in the three decades before 1990.
One underlying cause is the low labour force, which limits the supply of workers. The total size of workforce may further decline with the secular demographic trend, an important issue I will come back to in a moment. But the low degree of cyclicality of unemployment suggests that there may be factors keeping the labour market tight other than demand pressure. Through our business contact and recent surveys, the labour shortage has repeatedly come up as one of the top concerns, alongside competitiveness and production costs among others, yet pressure on wages is largely absent. What labour market imperfections are responsible for the structural shortage of labour supply, or equivalently, persistent excess demand for labour? A long standing issue is that of education and skills mismatch. The manufacturing industry, for example, often reports difficulties in hiring workers with vocational training, which is in shorter supply relative to university graduates. There are also reports of under-supply of graduates in science, relative to social science. One reason may be the firms’ reluctance to adjust wage upwards, resulting in shortage of supply at the going wage. This reluctance, in turn, may be caused by low marginal productivity of labour, which is a consequence of subdued capital formation over the years, resulting in low capital-to-labour ratio. Escaping this vicious cycle of low wage and labour shortage, involves an improvement in labour productivity via higher investment in physical capital. Several strategies have been proposed.