But the deficit that would be permissible – without endangering long-term confidence in fiscal policy – if activity were to go on weakening is an open question that we should be reluctant to put to the test. Budget policy’s other foundation stone, in addition to the targeted surplus, is the spending ceiling. This has been observed to date but the safety margins have shrunk. Additional savings will therefore be needed if activity weakens as much as now seems likely. To exceed the spending ceiling the first time it is exposed to serious strains would harm confidence in the budget system that has been established. For monetary policy the situation is also relatively good. Inflation has been low for a number of years, frequently lower in fact than the Riksbank’s 2 per cent target. Now that it has crept up above 2 per cent in recent months and thus exceeds our target, I am not aware that anyone has taken this as a sign that we do not take the target seriously. Inflation expectations, as measured by a variety of indicators, have also been well in line with our target. This is the fruit of the policy we have followed. Had we continually stretched the limits in the past, there would have been less room in which to take prompt action, as we did a fortnight ago, for instance. As you are all probably aware, the interest rate hike of 0.25 percentage points in July, to 4.25 per cent, was controversial.
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.