Leif Pagrotsky on the Swedish Banking Crisis

Question: What provoked the banking crisis of 1992?

Pagrotsky: It had very, very little to do with the construction of the welfare state economic model. That was one element of the economic model that was fundamentally flawed. We had to fix the exchange rate policy, and that was [unattainable]. We tried to defend the existing exchange rate with interest rates up to 500%. That was ridiculous. It was a failure, but we were so indoctrinated, we have lived with a fixed exchange rate regime all our lives, since the early ‘30s, and we could not imagine that there’s something wrong with a fundamental element of our economic policy. When that was abolished, the economy took off and we have had much more flexible situations since then. And today it is one of the fundamental assets of our economy, that we are flexible enough to set interest rates according to our own needs, high interest rates if we have [overheating] and inflation and we can stimulate by low interest rates when a recession is threatening, and I think that was one of the main elements of the shocks that we experienced in the late ‘80s. We had a shock from the financial market, and, as you know, financial markets destabilize. They don’t stabilize. They destabilize economies. They destabilized our economy. We could not do anything about it because we did not have in our possession the interest rate weapon because we had a fixed exchange rate regime, and I think that was a much more important explanation.

Leif Pagrotsky on the Swedish banking crisis of the early 1990s.

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