The second cost is due to the fact that deflation, if it is unexpected, results in a redistribution of wealth from borrowers to lenders. The third cost stems from the real interest rate becoming too high in relation to demand. The IMF’s report on deflation last year pointed out these costs and emphasised that monetary policy must be preventive, vigorous and forward-looking with the aim of avoiding deflation. If deflation should nevertheless arise, what tools do we have to deal with the situation? If the scope for interest rate cuts has been exhausted, central banks must resort to other measures. These include, for instance, trying to influence interest rates on securities with a long time to maturity and creating confidence in a higher inflation rate in future. In addition, fiscal policy can be more expansionary. A boxed article in the October 2003 Inflation Report described the Riksbank’s views on the deflation problem. The risk of deflation was portrayed as slight, given the targeted monetary policy and improved economic activity. However, there are analysts, such as the American economist Paul Krugman, who see parallels between the situation in Japan ten years ago and the American situation now, for instance with regard to the low level of resource utilisation and the aftermath of large share price bubbles.
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