Reputation costs in the sense that it is more damaging to good will to be among the first to raise prices, than to be one of many during a wave of price increases. This means that once some companies have started raising prices, many others soon follow. For this reason, if the central bank misunderstands the situation and allows a positive inflationary pressure to prevail as long as the  2  BIS Review 13/2002  inflation rate remains low, the general public’s image of the central bank’s behaviour will change. This in turn will affect pricing behaviour and once the increases have started, more will follow in the shadow of the first. This is why inflation often comes at a late stage during an economic upturn and it can mean that inflation remains too high during a period when economic activity is declining, despite falling demand and production. It is something of a paradox that a credible central bank can have greater difficulty seeing the signs of price pressure in time. In my opinion, there is a risk that Swedish inflation has been held down through deregulation and increased competition in such a way that we have been lulled into thinking that the inflationary tendencies in the economy are lower than they actually are.
For instance, the interest rate influences the general public’s decisions regarding investment and consumption. A higher interest rate normally means that growth in demand is slightly subdued, which is assumed to entail that the amount of free resources in the economy increases slightly in the long term. The effects on demand often come after a few quarters and thus also subdue price increases at an even later stage. A change in the interest rate also affects the exchange rate. An increase means that the return on assets in the home country’s currency is slightly higher. This also means that expectations of growth and inflation are subdued somewhat relative to developments in the rest of the world, which according to the textbook can contribute to a slightly stronger exchange rate. If the krona appreciates, it becomes slightly cheaper to import to Sweden, which can be assumed to lead to import prices on input and consumer goods increasing at a slower rate. A stronger krona also subdues global demand for Swedish export goods, which helps subdue growth in demand. On the other hand, if there is little confidence in the country’s economic policy, an increase in the interest rate risks resulting in a weaker exchange rate rather than the reverse, because confidence in growth is low. Monetary policy can also affect price developments via households’ and companies’ expectations of future inflation. In this context it is important to point out that there are a number of different measures  BIS Review 13/2002  1  of inflation expectations.