At the same time, the forecast based on the market’s assessment of the future repo rate shows that there didn’t have to be any hurry to begin to hike rates. A repo rate path consistent with implied forward rates led in this example to inflation never reaching the target. Examples like this can of course never give an exact answer to when the repo rate should be adjusted. What they can do is increase our understanding about the consequences of different options. In this case they can help us to narrow down a number of reasonable scenarios for policy a few quarters ahead. And in this particular example an unchanged repo rate was certainly one such reasonable option for a period. Allow me for safety’s sake to emphasise that the conclusions for monetary policy of both the alternative forecasts – the Inflation Report’s usual main scenario and the estimates based on implied forward rates – can generally be expected to be the same. Regardless of whether we reason on the basis of the simple policy rule, which relates the forecast of inflation one to two years ahead – under the assumption that the repo rate is held constant – to the current decision, or whether we study forecasts based on implied forward rates, for example, we can reach the conclusion that it was reasonable to leave the repo rate unchanged in December and that the repo rate sooner or later will need to be raised.
None of these arguments in themselves were the key factor in deciding to leave the repo rate unchanged, but taken together they indicated nevertheless the need for a certain measure of caution. In this kind of situation it can be interesting to consider how different future paths for the interest rate can be expected to affect both the real economy and inflation. Figure 6 shows resource utilisation in two different cases: one based on an unchanged repo rate and another on the implied forward rates that applied during the autumn. At that time the implied forward rates were indicating that the repo rate would be raised very shortly and that it would then rise to levels around 4.5 per cent in the longer term. Resource utilisation picks up in both cases, turning positive after about a year. But if the repo rate is raised according to the implied forward rate at the time, resource utilisation drops, turning negative again during 2007, whereas it remains positive throughout the whole period covered by the example if the rate is held constant. The situation also differs somewhat between the two alternatives when it comes to inflation (see Figure 7). With last autumn’s implied forward rate, inflation never reaches the inflation target, while, with an unchanged repo rate, it can be expected to overshoot the target just beyond the traditional two-year horizon. What this example illustrates is that an unchanged repo rate entailed a continued rise in resource utilisation, which in turn drove up inflationary pressures beyond the two-year horizon.