The differences in the interest rate affect the currency flows which, in turn, puts pressure on the exchange rate. In Sweden, for 20 years, we have had free capital movements, a variable exchange rate and an independent monetary policy aimed at meeting the inflation target. However, recent years’ experiences have shown that it can be difficult to conduct an independent monetary policy when capital movements are free, even with a variable exchange rate. The exchange rate has not always acted as the stabilising factor that many economists have counted on. One example of this is the ECB’s highly expansionary monetary policy from the start of 2015, which risked entailing an excessively rapid appreciation of the krona. One hypothesis put forth is that monetary policy’s trilemma may, in fact, be a dilemma: It is not possible to fully unite an independent monetary policy with free capital movements. New studies based in what is usually known as the financial cycle provide a certain amount of support for this. 15 No widely-accepted definition of the financial cycle exists, but, as a rule, it is usually constructed on the basis of time series of various financial variables such as indebtedness, asset prices and so on. What distinguishes this cycle is that it lasts for longer and fluctuates more than a normal economic cycle. According to the new studies, there exists a global financial cycle that is mainly steered by monetary policy in the United States. For smaller economies, it can be difficult to deviate from this global cycle in practice.
This is very much the theme of my speech here at the Swedish Economics Association – weighing the effects of monetary policy today against the effects tomorrow and what challenges this creates. But I thought I’d start by discussing the downward trend in global interest rates and what this means for monetary policy, as it is important to realise that the problems we are grappling with in Sweden are very much influenced, and shared, by the world around us. 3 [23]  Downward trend in global interest rates The financial crisis that broke out in the autumn of 2008 was preceded by a seemingly calm and stable period of low inflation and good economic growth. The period is normally referred to as The Great Moderation. This positive development can be attributed to a number of factors. Ever-faster globalisation led to greater movement of goods, services, labour and capital among countries. This, in combination with various deregulations increased competition on labour and goods markets, contributing to higher economic growth. Increasingly independent central banks focused on achieving low and stable inflation are also considered to have contributed to the positive development. In retrospect, we can now see that major financial imbalances had built up in what appeared to be a stable macroeconomic environment. Central bank monetary policy had successfully stabilised inflation. But this did not prevent the break-out of the more serious economic crisis since the 1930s.