In the fall and in early winter, the market also felt the weight of rapidly deteriorating global lending terms, which will undeniably support the Central Bank’s tightening measures and will reduce domestic demand and inflationary pressure, as was mentioned in the Board of Governors’ announcement of 14 February. It is possible that there will be a rapid drop in domestic demand as a result of high interest rates and a tightening credit supply. At this point, however, it is impossible to assert that this will be the case. Exactly when it will be possible to lower the policy rate will be determined by economic developments and outlook. Precipitate interest rate reductions would push inflation upward and standards of living downward. The suggestion that it is necessary to lower interest rates in order to control inflation is absurd. Indeed, it is astounding how carelessly many people seem to view inflation. Furthermore, it is appropriate to stress that the Central Bank believes it is impossible to choose between price stability and financial stability. If we were to relax our stance on price  BIS Review 25/2008  1  stability, it would surely undermine the credibility of monetary policy. Inflation – and no less important – inflation expectations would increase drastically, which could lead, in short order, to an upward spiral of prices and wages and falling exchange rate.
In the most recently published inflation assessments, it was assumed that the price stability target was not threatened during the forecast period despite the growth of demand being so strong that use of capacity was under strain at the end of the period. The majority view of the Executive Board was therefore that there was no reason to increase the repo rate. This assessment was based on free resources in the initial situation, good productivity growth, low price increases on certain recently deregulated areas, low import prices and finally low inflation expectations. It is not per se strange that GDP can increase as much as 3-4% for a couple of years without inflation sharply accelerating, if the use of resources is low initially. If the pattern from previous cyclical upswings was to be repeated, price pressure should now increase. However, it has proven difficult to identify any exact and very stable correlation. As I mentioned earlier great changes have taken place in the Swedish economy. While there are still considerable deficiencies in competition in many areas, it is nevertheless not probable that inflation will accelerate strongly in the next few years. An important reason for this is that the price stability target has now  BIS Review 48/2000  4  obtained such strong support that inflation expectations are not increasing despite a cyclical upswing that is stronger than for a very long time.