Markets are also questioning the overall solidity of bank balance sheets in the aftermath of the financial crisis. Therefore, last Thursday the heads of governments of the EU member states agreed that the results of stress tests on their respective banks will be published in the second half of July. This decision can play an important role in fostering market confidence. In the event that these stress tests reveal cases where additional capital is necessary, recapitalization efforts will have to be undertaken swiftly. Institutional investors appear to be underweight in their exposure to European banks. This should prove helpful in lending support to potential capital raising efforts following a credible and transparent stress test exercise. Indeed, one of the reasons investors currently appear to underweight European banking stocks may very well  3  See IMF (2010): World Economic Outlook, April, chapter 1, p. 9. 4  ECB press release, 10 May 2010. BIS Review 87/2010  3  be related to the fact that there is insufficient transparency about bank balance sheet conditions in Europe. Credible stress tests can remedy this problem. Contrary to what some commentators suggest, financial markets also look beyond the shortterm. As a result, Europe’s authorities had to recognize that decisive and comprehensive longer-term fiscal programs are needed to put the EU as a whole on a sound fiscal basis. Equally, individual countries can’t forever live beyond their means.
As long as inflation expectations are unaffected, there is no reason to suppose that the effects on inflation will be permanent. Transitory effects account for inflation target deviations An explicit inflation target has the advantage of enabling us to evaluate how monetary policy is conducted. Consequently the Riksbank cannot implement an asymmetric approach to the inflation target without this being detected. Two curves are presented in the diagram below. One represents CPI inflation and the other is one of the various indicators of underlying inflation, in this case the CPI excluding transitory effects from house mortgage interest costs, changes in indirect taxes and subsidies, and prices of imported goods.1  Actual and underlying inflation 1995 – 1997 12-month change figures, per cent 4  3 CPI 2 "Underlying" inflation 1  0 95  96  97  98  Source: Statistics Sweden and the Riksbank. Note. Underlying inflation is represented here by one of the indicators (UNDINH) used by the Riksbank; it shows the CPI excl. changes in indirect taxes and subsidies, house mortgage interest costs and prices of goods and services that are mainly imported. 1The use of this indicator in the present context does not signify that it is particularly significant or the best approximation of underlying inflation in every case; instead, it happens to be the indicator where all the excluded items had a marked influence on price movements in the period 1995–97.