This means that the Riksbank is as anxious that inflation should not be too low as that it should not be too high. In Sweden, the annual CPI inflation rate was negative in February, for the first time since the beginning of 1999. Is there a risk of this development continuing, and what can the Riksbank do if it does? To begin with, it is important to distinguish between whether price trends are governed by developments on the demand side or on the supply side. A period of falling prices is often due to aggregate demand being significantly lower than the total supply of goods and services in the economy. This type of situation can arise for two reasons: One is that demand could fall heavily, for instance, as a result of households for some reason reducing their consumption. The other is that supply could increase significantly, for instance as a result of technological advances leading to increased productivity. While demand-driven deflation is connected with weak production growth, the opposite applies to supply-driven deflation. These are usually termed “bad deflation” and “good deflation” respectively. In practice it is not so easy to distinguish between one sort of deflation and the other. Problems arise when demand is too low in relation to supply.
Over the past twenty years, world trade has increased twice as fast as GDP growth, direct investment has increased three times as much and both foreign exchange and equity trading have increased approximately ten times faster than GDP. There are several explanations for this, including the deregulation of the financial markets during the 1980s. Another contributory factor is that China and India are participating to an increasing degree in the global economy. China is currently the world’s fourth largest trading nation, and its share of global trading has increased from 1.5 to almost 5 per cent since the beginning of the 1990s. At the same time, private consumption in China has increased from a few per cent of US consumption to the equivalent of more than one tenth. What can explain the inflation rate slowing down? Over the past year, lower import prices and higher productivity than expected have contributed to the Riksbank revising down the forecasts for future inflation, particularly in recent months. It was concluded in the Inflation Report published a couple of weeks ago that the unexpectedly low rate of increase in imported inflation (adjusted for oil prices) was partly due to lower international price pressure. Strong productivity growth has also contributed. There appear to be a number of structural changes behind the increase in productivity, which are at least partly connected with globalisation. If one disregards the temporary increases in inflation caused by high prices for energy, for instance, one can observe a gradual decline in inflation over the past decade.