12  BIS Review 10/2007  This picture, which is the same picture as the previous one but for a shorter time period, gives an impression that we place less weight on the output gap. The picture becomes even clearer if we travel forward yet another year in time to 2009. Inflation is now very near the target, while the output gap is still clearly positive. It may thus seem as if we are placing more weight on the output gap in the beginning of the period than at the end of the period. This suggests that the reference path in Inflation Report 3/06 is not consistent with a discretionary policy, where you make the best out of the situation in each period. Such a strategy would have involved a higher interest rate in order to provide a better balance between inflation and output towards the end of the projection period. Rather, it seems that the reference path has elements of commitment. Let us therefore assume that we follow the response pattern we have committed ourselves to earlier. In the literature, one such strategy is referred to as commitment under a timeless perspective.5 It is possible to calculate, within the confines of our models, an optimal interest rate path based on such a strategy. 5  See for example Woodford, M. (1999) “Commentary: How should monetary policy be conducted in an era of price stability?”, Paper presented at the Jackson Hole conference, see http://www.columbia.edu/%7Emw2230/jhole.pdf.
Higher potential growth can also influence real interest rates in the long term as households seek to smooth consumption over time. Higher potential growth generates expectations of higher future income. Households may then want to borrow against expected future income and thereby reduce saving already today. Lower saving implies higher real interest rates. The time preference rate can be looked upon as an expression of households’ impatience in consumption. The higher the degree of impatience, the more households will want to consume today at the expense of future consumption, and the higher the real interest rate has to be in order to provide sufficient savings to meet investment demand. It is important to stress the long-term perspective of this analysis. In the really long term, it is potential growth and saving preferences that determine the relationship between desired saving and desired investment and thereby also the real interest rate. In the short- and medium-term, however, the economy is regularly exposed to shocks that influence economic developments, and thereby also the interest rate. It is not unlikely that we might see sizeable deviations of actual rates from the theoretical rates over longer periods. Such deviations may be exactly what are needed to bring the economy back towards a new and sustainable equilibrium. Moreover, uncertainty and risk premia are often disregarded in the theoretical world. In the real world, different types of risk premia exist that can lead to deviations from these stylised theoretical considerations.