Inflation and the transitory effects The CPI is used by the Riksbank to target inflation mainly because it is familiar, published monthly with a short time lag and seldom has to be revised. However, using the CPI as a target variable is liable to face monetary policy with explanatory problems. The past year is a case in point. The low rate of inflation stemmed mainly from transitory effects; the consolidation of government finance and increased confidence in economic policy helped to strengthen the exchange rate. During 1996 it proved possible to lower the instrumental rates almost 5 percentage points. Altogether, in 1996 decreased interest costs and the stronger exchange rate had a downward effect on the CPI of around 1 percentage point. In some countries the inflation target is assessed in terms of the CPI with various components excluded, for example indirect taxes and subsidies or mortgage interest costs. It may then be asked whether the CPI is the most appropriate target variable and whether some measurement of underlying inflation might be preferable. An advantage of focusing on a single underlying indicator is that it might help the Riksbank in its contacts with the general public and make monetary policy more transparent. Analysis and debate would be concentrated on factors that monetary policy influences. BIS Review 32/1997  -2-  This, however, presupposes the existence of an underlying yardstick that can take every conceivable transitory effect into account. Such measurements are difficult to construct.
Such decisions can be made after an exchange of information with the government but in the final analysis it should be up to the Riksbank to determine whether or not they are compatible with price stability. With a flexible exchange rate, policy should operate, as today, with an inflation target, and the government should have no possibility of influencing the construction of exchange rate policy. Democratic control is important. But it should be exercised via the Riksbank’s principal, the Riksdag, on whose behalf monetary policy is conducted. It should be noted that in exceptional situations, when the price stability objective may have to be suspended for the time being (e.g. a major oil price shock), both the government and the Riksbank may call on the Riksdag to amend the Riksbank’s statutory objective. In that way the democratic control of monetary policy can be clearly ensured. BIS Review 32/1997