The high-inflation economy with recurring cost crises and high interest rates is a thing of the past. Inflation has instead been low and stable. GDP growth has on average been higher and also more stable than in the 1970s and 1980s. Real wage growth has also been considerably more favourable. Productivity growth has been surprisingly strong – stronger than in almost all of the other EU countries. Most people seem to be in agreement now that the potential growth in the economy has been increased. Employment has not developed as well, but the situation today is much better than it was in the mid1990s. It is also interesting to study inflation expectations. Although inflation has on average remained fairly close to 2 per cent, there have been both shorter and longer periods when inflation has deviated significantly from the target. The past few years are such an example. Inflation has been below target, which is largely due to productivity having developed much more strongly than we had expected. How has confidence in monetary policy been affected by the deviations we have experienced? Even though inflation expectations can be measured in different ways, I think that the overall picture is clear. From around 1996-97 expectations have been in line with the target a couple of years ahead. This is of course pleasing, and a much better development than many people expected when the new monetary policy regime was introduced in the early 1990s. However, the stabilization policy change in regime was not only about monetary policy.
4  BIS Review 8/2007  This rule was easy to understand and in that respect it was a good educational tool. However, there were also disadvantages. In normal cases it is not, for instance, particularly realistic that the policy rate would remain unchanged a couple of years ahead. The assumption made it difficult to assess our forecasts and to compare them with those of other forecasters. The latter usually base their assessments on the policy rate being changed. It was also difficult to apply the assumption in a consistent manner in the forecasting process. These problems would have become worse when we extended our forecast horizon. Moreover, it gradually became clear that this rule could sometimes be an obstacle in our communication. It created an exaggerated focus on the current interest rate decision and on the inflation forecast exactly two years ahead. The gradual shift towards more flexible monetary policy led to a greater need to illustrate the fact that it is the entire expected sequence of events for inflation and the real economy a few years ahead that is important in monetary policy decisions, and not only the levels we foresee two years ahead. And the focus should not only be on current interest rates, but also on expectations of future interest rate changes. 5 We left most of these problems behind us when we changed over in October 2005 to making forecasts based on market expectations of the future development of the policy rate.