The inflation target is worded as the annual CPI inflation being two per cent, with a tolerated deviation interval of plus/minus one percentage point. Monetary policy shall thus be conducted to ensure that the purchasing power of the krona remains stable with regard to the basket of goods bought by the average Swedish household. Low inflation is important for many reasons. When a central bank’s target is to avoid high inflation and large fluctuations in the rate of price increase, it also contributes to stabilising economic activity. Practically all of the industrial nations that have changed over to an inflation target of the type we have in Sweden have seen a reduction in variations in inflation. When a central bank stabilises the rate of price increase, it can also contribute to reducing the risk of financial crises, which is especially important because bank crises, as the experiences of for example Sweden, Finland Norway and Japan show, are often linked to a rise in unemployment and a prolonged period of poor growth. Sweden’s experiences of inflation targeting are positive. Growth in the Swedish economy has been at an average of 3.0 per cent a year since 1994, while inflation has been low over several years. At the same time, open unemployment has declined from around 8 per cent in 1993 to less than 4 per cent in 2002.
Both production and investment are determined by fundamental factors such as demography, households’ preferences and institutions, as well as regulatory systems. These factors in turn determine the development of production factors such as labour, capital and production techniques. The long-term sustainable growth rate is also very important to households’ and companies’ expectations of future growth in income and profits. Willingness to consume and to produce - both supply and demand - are in the long term determined by the same fundamental factors. It is reasonable to assume that the variations in factors such as demography and institutional conditions are relatively limited in the short term. However, demography is likely to become a constraint on economic growth to an increasing extent throughout Europe. Deviations between actual and potential production can arise. When consumption or production exceeds the long-term sustainable growth rate, the level of resource utilisation rises, which may exert inflationary pressure in the economy. The fact that deviations can arise between actual and potential production is due to a number of slowmoving factors in the economy. Market imperfections, such as a lack of competition and transaction costs make both prices and production factors slow-moving, and mean that it takes time for actual production and consumption to adapt to changes in supply and demand in the economy. When adapting to changes in the fundamentals that determine growth or to disturbances, the rate of price increase often increases or declines during a period of time.