Statement regarding the report "Stabiliseringspolitik i valutaunionen", Stabilisation policy in the monetary union (SOU 2002:16)

On Friday, the Riksbank presented its statement regarding the government report "Stabiliseringspolitik i valutaunionen", Stabilisation policy in the monetary union (SOU 2002:16) to the Ministry of Finance.

The Riksbank shares the Committee's assessment that the European Central Bank's inflation target in the long term comprises a credible objective for inflation expectations in Sweden. However, there is a risk that, for instance, developments in prices and wages in small member states such as Sweden could in the medium-range term deviate from the average level for the monetary union as a whole. This could occur if, for instance, the countries were to suffer some form of country-specific shocks or if those responsible for setting prices and wages became less moderate when they no longer needed to worry that high increases in prices and wages would lead to raises in interest rates. The Riksbank therefore considers it important to create a credible framework for stabilisation policy to reduce the risk of a repeat of the stabilisation policy problems in the 1970s and 1980s, such as rising inflation, which leads to a deterioration in competitiveness.

In the light of the experiences of the stabilisation policy pursued in recent years, the Riksbank considers it necessary to examine whether it would be possible, while taking part in Stage Three of EMU, to retain central elements of the current stabilisation policy framework - a clear target for economic policy, clear institutional guarantees that the proposed stabilisation policy is sustainable in the long term and open, clear decision-making processes aimed at increasing understanding of the policy and enabling an assessment of it.

Clear target for stabilisation policy

The Committee proposes that the production gap, which is a measure of resource utilisation in the economy, should be used as a target for stabilisation policy. The Riksbank's opinion is that consideration should be given to whether or not a national inflation target for fiscal policy might be a better alternative. Normally, a stabilisation of inflation also means that production and employment are stabilised. The difference between the two potential stabilisation policy targets should therefore not be exaggerated. In the case of various types of supply shock, for instance an increase in oil prices that risks leading to requirements for compensation by wage-earners, an inflation target might be preferable. This is because, in this situation, a stabilisation policy based on a production gap target would risk leading to an overly expansionary policy.

In addition, a production gap target could be more difficult to measure and more difficult for the general public to understand than an inflation target, which could help create uncertainty over the direction for the stabilisation policy. One advantage of an inflation target is that it is clear and can be easier to assess than a production gap target.

An inflation target for fiscal policy should be designed to set a limit as to what extent inflation in Sweden can be allowed to deviate from that in the euro area. However, an inflation target must be applied with some flexibility so that the need for necessary changes in the relative price situation (the real exchange rate) can be taken into account during disturbances, for instance, in foreign trade or productivity development.

Institutional reforms to create confidence

A low level of credibility for the stabilisation policy would risk reducing the effectiveness of the measures taken. The challenge here is to find institutional solutions that will contribute to maintaining a high level of confidence in the stabilisation policy, even if Sweden takes part in Stage Three of EMU.

The Riksbank would like to see a broader discussion with reference to the Committee's proposal for a council of experts. There may be reason, for instance, to examine whether stabilisation policy decisions should be taken directly by the government in order to reduce the long decision-making paths and enable measures to be implemented in good time.

Another, more far-reaching measure that is closer to the current system and has also been discussed in academic research, is to delegate certain fiscal policy instruments to an independent authority. The Riksbank also considers that while such a solution is complicated, not least from the point of view of principle, it should not be ruled out in advance.

Continued good budgetary discipline is important to create confidence in economic policy. However, the Riksbank does not consider it self-evident that the net lending target should be raised as proposed by the Committee.

The entire submission is available (in Swedish only) on the Riksbank's website www.riksbank.se.

Any further questions can be answered by Deputy Governor Villy Bergström tel.: +46-8-787 07 10, Jörgen Eklund, Secretariat of the Executive Board, tel.: +46-8-787 01 31 or Robert Boije, Monetary Policy Department, tel.: +46-8-787 05 41.