International developments will be weak this year The world economy was in a slowdown phase even before September 2008. Since then the deterioration in the world economy has been rapid. All of the large, developed economies are now in recession. During the fourth quarter of last year GDP growth in the United States and the euro area fell by around 6 per cent calculated on an annual rate. In Japan the fall was even greater, more than 12 per cent calculated on an annual rate. In the wake of the weak development households and companies have become more pessimistic about the future. Confidence indicators have been in free fall and are now at alltime lows in many countries. For example, the purchasing managers index has never before been so low. Share prices have largely halved since the top levels in 2007. The great uncertainty is also reflected in the large fluctuations in stock market rates. For the world as a whole we are now expecting more or less zero growth this year. Growth and developing economies appeared for a long time to be coping relatively well. But they have now also been affected by the crisis. In China, growth slowed down significantly during the final quarter of last year. The oil-producing countries in the Middle East and Russia have  BIS Review 25/2009  3  also experienced a sharp slowdown in economic activity. A few years ago GDP growth in the growth and developing economies was on average around 7 per cent a year.
If the central bank has cut the nominal policy rate to zero, one may find oneself in a situation where the real interest rate is too high to be able to stimulate the economy. The central bank must then bring up inflation expectations and thereby bring down the real interest rate. According to Lars, one means of creating expectations of higher inflation and escaping from this liquidity trap could be to introduce a temporary price level target, for instance in the form of an average inflation target where inflation must remain around the target over a five-year period. The central bank would then have the possibility to compensate for low inflation or deflation through a correspondingly higher inflation rate further ahead. The idea is that if the target is credible, inflation expectations will rise and the real interest rate will fall. My opinion is that we should not change the inflation target. We have invested so much in the credibility of the current inflation target and it has functioned very well. Inflation has on average been close to 2 per cent during the 14 years we have had an inflation target, and in the longer term inflation expectations are firmly anchored close to 2 per cent. Nor does Lars suggest that we should change the inflation target. He discusses a hypothetical situation where the policy rate is zero and inflation expectations are no longer firmly anchored around the inflation target, but are much lower.