Heikensten: Low-inflation environment has underpinned growth: four examples

First Deputy Governor Lars Heikensten spoke about "Monetary Policy and Economic Growth" at a seminar on growth arranged by the Swedish Confederation of Professional Associations (SACO). His speech will be published in full on the Riksbank's website at a later date.

"Since the crisis in the early 1990s we in Sweden have successfully combined low inflation and relatively high growth. Many different changes for the better in the conditions for economic activities have contributed to this. They include the major tax reform, changes in social security and pension systems, and various deregulations. But it has also been a matter of establishing a stable economic environment with low inflation," Mr Heikensten said.

"The existence of a strong link between low inflation and economic growth has not been all that easy to establish in academic studies. I still believe, however, that the combination of low inflation and clear macroeconomic rules has played a significant part in our favourable economic development in recent years. In the light of my own experience, here are four fields where I have seen distinct changes that have favoured growth compared with the situation in the 1970s and '80s:

- The composition of investment. In the 1980s a large proportion of investment in Sweden went into housing and other real estate. The picture in the past decade has been different, with investment in machinery playing a leading role. The sectoral pattern has also changed, with considerably more investment in advanced technology. There are, of course, many explanations for these differences, such as the structure of the tax system and the introduction of new technologies. But it seems to me that the more stable macroeconomic environment has played a major part. Many investment decisions in the 1980s, not least in real estate, were based on false premises. Moreover, the high level of costs in the wake of inflation hit industrial investment.

- Productivity. An important explanation for the acute economic crisis in the early 1990s was the weak productivity in the preceding years. In this respect there seems to have been a change for the better, though it is still too early to tell how permanent it will be. The change is presumably attributable in part to the clearer framework which the inflation targeting regime has created for business operations. The short-cuts to profits that were available in the 1970s and '80s, when problems with competitiveness were repeatedly resolved with devaluations, do not exist today. Both the motives for and the acceptance of continuous rationalisation and heightened efficiency have been strengthened.

- Wage formation. Here, too, there have been appreciable improvements. Nominal wage increases have come down in the 1990s. This has been accompanied by comparatively favourable real wage increases. The picture in the 1970s and '80s was different. When fiscal policy failed to secure low inflation and we had a series of devaluations, wage formation more or less collapsed. Wages and prices chased each other in an upward spiral. Nowadays the labour market organisations have a specific inflation target to start from; it is admittedly over- or under-shot at times but it does serve as a clear and useable benchmark.

- Structural policy. The new environment, with a precise target for inflation, has also improved the conditions for generating changes that strengthen competition and heighten efficiency in the Swedish economy. The chief argument in favour of such measures is, of course, that they help to promote prosperity. That was also our argument in the Ministry of Finance in the late 1980s, for instance when we were working on the deregulation of agriculture and the housing sector. But it was not always an argument that made an impression on strong producer interests. Today there is an additional argument: increased competition can help to keep inflationary pressure down and that in turn - at least for a time - can pave the way for somewhat lower interest rates and thereby higher growth," Mr Heikensten continued.

"Monetary policy accordingly play an important role by helping to make general economic developments more stable. That in turn provides a good foundation for growth and employment. But there is more to high economic growth than that: a sound educational system, a suitable climate for business and investment, tax and social security systems that function properly and so on. Even more is required to face competition from an outside world that is changing rapidly, with high ambitions to raise prosperity. In my opinion, both the media and discussions among economists should pay considerably more attention to questions of this type. For our prosperity in the longer run they are much more important than whether the repo rate is raised or lowered 25 basis points," Mr Heikensten concluded.