An outline: trade-off between target fulfilment in the short and long term Last year the Riksbank published an article with an outline for how financial imbalances can be included in the monetary policy deliberations.10 The point of departure was that a central bank now needs to have a more long-run focus than was traditionally the case. The reasoning leads to the conclusion that monetary policy should be regarded as a trade-off between target attainment in the coming years, that is, the period for which central banks normally make forecasts, and target attainment in the longer run, beyond the forecast horizon.11 The idea is that a monetary policy that solely focuses on target attainment a couple of years ahead could miss the fact that financial imbalances are building up, which risk leading to very poor macroeconomic outcomes in the longer run. So according to this outline, central banks need to balance target attainment in the shorter run against target attainment in the longer run.12 Inflation target still the foundation, but may take longer to attain The first important thing to note is that this trade-off does not mean throwing away the inflation target. Attaining the inflation target thus remains the foundation for monetary policy.13 However, one consequence of conducting a policy that tries to counteract financial 10  Sveriges Riksbank (2013).
This is an idea I have considerable sympathy for in principle, and I shall try to explain why in my speech today. Lessons from the crisis: price stability is not enough to prevent financial imbalances The foundation for the monetary policy strategy we use today is the changeover in monetary policy in the early 1990s, when some central banks began to switch to explicit inflation targets. This turned out to be an effective way of anchoring inflation expectations and in this way attaining price stability. Inflation targeting became the standard for central banks. The way the policy was implemented could differ slightly, but on the whole there was agreement on the fundamental principles. A credible inflation target also creates some scope for monetary policy to stabilise the real economy. Monetary policy could therefore be flexible and focus on attaining a good balance between on the one hand price stability and on the other hand the stability of the real economy, a couple of years ahead. There was also a consensus – sometimes referred to as the “Jackson Hole consensus” – that monetary policy would not try to counteract rapid increases in asset prices or credit growth.2 I shall return to this shortly. The long period of relatively stable inflation and robust growth – “the Great Moderation” – that preceded the financial crisis was considered to be proof that the chosen monetary policy strategy functioned well.