In the meantime, inflation is uncomfortably high, and an absolute precondition for maintaining our support to demand is the credibility of monetary policy. Over the next few quarters, the Committee’s most important judgment call will be put to the test. We will all discover whether inflation declines rapidly from 5% towards 3% as the effects of the price level shocks wane. Finally, let me stress that the gloom should not be overdone. The record is that flexible economies with sound macroeconomic regimes recover from almost any crisis. The UK will recover. Meanwhile the MPC will continue to underpin demand, consistent with getting back to the 2% inflation target and so with sound money. BIS central bankers’ speeches  3
“A desirable monetary policy is characterised by inflation under normal circumstances being close to the inflation target in a two-year time perspective while at the same time the paths for inflation and the real economy do not exhibit excessively large fluctuations.” Given this reasoning, I think it is possible to identify some important characteristics of a good interest rate path. Firstly, the interest rate should be set so that inflation remains close to the 2 per cent target. If inflation were to deviate from target from the start, we should normally choose a path for the repo rate that brings inflation back on target within two years. Moreover, this path should be chosen so that inflation is close to target even beyond the two-year horizon. This way of conducting monetary policy helps reduce uncertainty and anchor inflation expectations around the target. The interest rate should also be set to achieve as far as possible a stable, sustainable development in the real economy, as long as this is compatible with the price stability target. Let us say that the  11  See, for instance, Giavazzi, F., and F. S. Mishkin (2006). 12  See also Rudebusch, G.D. and J.C. Williams (2006). 13  See the box ”Uncertainty regarding future interest rate movements” in Inflation Report 2006:1 for some examples of how to produce such uncertainty intervals. 14  See the memorandum "Monetary policy in Sweden” which can be downloaded from the Riksbank’s website, www.riksbank.se or ordered as a printed document.