If not even this, contrary to expectations, were to prove sufficient and inflation expectations were to remain low and impossible to influence, or were to change to lasting expectations of deflation, then a possible last resort is my suggestion of a foolproof way of getting out of a liquidity trap. This method entails a price level target where the currency is depreciated and the exchange rate held at a temporary exchange rate target until the price level target has been attained. This dramatic method is most efficient in creating expectations of a higher  BIS Review 19/2009  9  future price level and could provide sufficient stimulation to the real economy. I consider it very unlikely that this method would be needed in Sweden, but I believe it is good that it is available as a last resort. On the other hand, “quantitative easing” in the form used in Japan, that is, a temporary targeted increase in the banks’ reserves with the central bank, would probably be completely ineffective. There are probably many in the central bank world who are hesitant about openly discussing the advantages and disadvantages of monetary policy in a zero interest rate situation and the unconventional methods that are available. Many would perhaps even prefer to exclude some of the alternatives without any particular justification. With a zero lower bound for the interest rate the central bank’s credibility and its possibilities to affect inflation expectations are even more important than usual.
Lars E O Svensson: Monetary policy with a zero interest rate Speech by Mr Lars E O Svensson, Deputy Governor of the Sveriges Riksbank, at SNS – Centre for Business and Policy Studies, Stockholm, 17 February 2009. The original speech, which contains various links to the documents mentioned, can be found on the Sveriges Riksbank’s website. *  *  *  The Riksbank conducts a policy of flexible inflation targeting, which aims to stabilise inflation around the inflation target and also to stabilise the real economy. To achieve this, the Riksbank sets the repo rate and publishes a forecast for the repo rate in the years ahead. The repo rate and the expectations of future repo rates that arise from the repo rate path affect market interest rates, which in turn affect aggregate demand and inflation. During the financial crisis, the functioning of the financial markets has deteriorated and the transmission mechanism from the repo rate path to inflation and the real economy has weakened. In order to improve the functioning of the financial markets and strengthen the link between the repo rate path, market rates, inflation and the real economy, the Riksbank has taken a number of special measures. 1 Although the discussion of monetary policy often focuses on the repo rate and the repo rate path, it is important to realise that it is the real interest rate and the real repo rate path that mainly affect aggregate demand, not nominal interest rates.