10 We used to think that the output gap, as a proxy for marginal cost, is what affects inflation, but the Chilean experience was more of a large swing in the growth of domestic demand rather than output. However, the connection from domestic demand to inflation is less clear than that of the output gap. Finally, the degree of openness and competition in the Chilean economy may increase the sensitivity of prices to demand conditions. More work would have to be done to fully understand the dynamics of inflation, but still the inflation targeting framework has been very useful to conduct monetary policy and to stabilize inflationary expectations. 6. Concluding remarks  Although more often than not, central banks have an explicit financial stability objective, for many years, and within a context of strong GDP growth and sound balance sheets of banks and firms, this was a second-class issue. Now things have changed dramatically. As of last year, financial stability became the protagonist in monetary policy management in developed countries. 11 Central banks need to oversee price stability and financial stability. To pursue two objectives, one instrument, namely the interest rate, is not enough. Indeed, a well functioning financial system strengthens the transmission mechanism of monetary policy. There may be exceptional occasions in which both objectives may collide, for example when monetary policy requires an increase in the interest rate, while financial stability calls for a reduction. Another example could be a bubble in the exchange rate with high inflation.
Here we can see that while sovereign debts have increased considerably in the United States and the euro area in recent years, Sweden’s sovereign debt has decreased more or less continuously over the last 15 years. 4  BIS central bankers’ speeches  This indicates that the economic-policy framework in Sweden has worked well. The framework reflects the lessons we have learned from our own problems in the past, not least during the 1970 and 1980s, and we should build on this. The framework largely addresses three areas: fiscal policy, wage formation and monetary policy. The first area, fiscal policy, had to be changed following the crisis of the 1990s as the problems with Sweden’s public finances became acute. At the same time as austerity packages were implemented, great importance was attached to not ending up in the same situation again. The introduction of surplus targets, expenditure ceilings and the stipulation that municipalities should have balanced budgets also contributed to increased stability in public finances. A number of important reforms were also implemented that significantly improved the budget process. Figure 14 clearly shows the positive effects of all this on the budget. The second area is wage formation, which has also improved considerably since the mid1990s. The Industrial Agreement and the setting up of the National Mediation Office are two important factors behind this improvement. Nominal wage increases have been significantly lower over the last 15 years than in the 1980s.