Well-judged adjustments in the interest rate can ensure a stable development of inflation in the long term. In addition, monetary policy can, at best, contribute to alleviating cyclical fluctuations in production and unemployment. However, the interest rate is much too blunt an instrument to be able to fine-tune the economy to any great extent. Secondly, a production target or employment target would only be purposeful if we were fairly sure how large the growth potential of the economy was and what level of employment represented some form of equilibrium. In practice, it is not possible to determine this with any great precision. Both potential growth and employment vary over time with structural changes in the economy in ways that are difficult to quantify. BIS Review 17/2007  3  Thirdly, an extra difficulty in this context is that the picture of how the economy develops changes over time as statistics are revised. This applies in particular to GDP statistics. It becomes particularly clear how difficult it would be for the Riksbank to have a target for productivity growth if one looks at how the statistics were revised at the end of 2004 and beginning of 2005. The information available at the beginning of 2005 indicated a fairly clear slowdown in production growth. Later on in 2005 the picture of a slowdown in the growth of the economy was confirmed, but it then appeared to have a more prolonged course of events.
Furthermore, some areas of the financial system are still not yet adequately covered by regulation, for example leverage in the non-bank financial sector. In my remarks today, I would like to elaborate on the interaction between monetary policy and macroprudential policy. I will first review the conceptual framework for monetary policy and financial stability and then look at how, at this stage of the cycle, macroprudential policy and monetary policy can best complement each other in the pursuit of their respective objectives. Monetary policy and financial stability Price stability and financial stability are tightly interconnected and mutually reinforcing; in the longer-term, each is a necessary – but not sufficient – condition for the other. Price stability contributes to the efficient allocation of resources in the real economy, thereby supporting longterm growth. A stronger and more stable macroeconomic environment contributes to healthy household and business balance sheets, thereby fostering financial stability. However, history abounds with cases where financial vulnerabilities were built up in good times, while market participants overly discounted the likelihood of adverse shocks. Financial instability is basically the result of market failures, which should be addressed by regulation (covering the time and cross-section dimensions of financial stability). Deficient regulation can lead to excessive leverage and maturity transformation, which may in turn result in funding fragilities and systemic vulnerability.