Next, I shall discuss how uncertainty and the degree of credibility with which monetary policy is associated influence policy formulation. These two factors play an important role in practice. The third issue concerns the exchange rate. For small open economies this issue is one of the most important determinants of inflation at the same time as it is also an important measure of how stable economic policy is seen to be. How changes in the exchange rate ought to be handled when monetary policy decisions are taken has been an important monetary policy issue in Sweden in recent years. Finally I shall discuss the issue of how the monetary policy goal has been defined and should be interpreted. The Inflation/Growth Connection The Riksbank’s chief task is the achievement and preservation of price stability, which should be interpreted as keeping the rate of inflation at a low and stable level. Behind this view of the role of monetary policy lies the understanding that growth and employment cannot in the long run be achieved via an inflationary policy. There are other factors that determine growth: technological development, the way in which the economy functions, human resources development, etc. Attempts to stimulate the economy in the short run by allowing higher inflation tend to rebound in the long run. Swedish experience in the last decade, and also experiences in other countries, demonstrate this. Participants in the economy see through the policy, revise wage demands upwards and raise prices.
Heightened volatility in global financial markets can be associated with the presence of very low and even negative rates rather than the underlying macroeconomic and external imbalances. In these circumstances, any change in interest rate differential across countries is likely to create greater impacts than otherwise. If this interest rate change takes place in the largest and the most significant economy in the world, then the impact will expectedly be further magnified. The Fed’s start of interest rate normalization has demonstrated that its impact on the global economy and financial markets indeed has been large, giving rise to significant capital outflows from emerging market (EM) economies, large adjustments and volatility in exchange rates as well as widened EM spreads and interest rates. The adverse effects of the Fed’s interest rate normalization has been on average larger than those occurred in previous two financial turmoil episodes, namely the Eurozone sovereign debt crisis and the US tapering tantrum. However, the disparity between the effected countries has been large too. The plummeted commodity prices as well as other factors led to this outcome as commodity exporters suffered from both the lower commodity revenues and the tightening global financial conditions. Financial markets also differentiated EM countries by policy frameworks and prudent policies. Those having rich and better policy frameworks and prudent policies have withstood the recent global financial turmoil better than the others.