In such a situation, the mean squared gap in Figure 3 would lie in a north-west to south-west direction and determining monetary policy would entail weighing up whether to stabilise one more or less than the other. BIS Review 60/2010  7  Figure 4. The mean squared gap for CPIF inflation and output and hours worked respectively. Source: The Riksbank  Figure 5: The decision-making situation for Norges Bank in 2005 Figure 5 shows the policy decision facing Norges Bank in March 2005, which is an example of a case where there was a conflict between stabilising inflation and stabilising resource utilisation. 5 The problem at that time was that the inflation forecast was under the inflation target of 2.5 per cent, so that the gap between the forecast and the target was negative, while the forecast for the output gap was positive. In such a situation, a lower repo-rate path stabilises inflation around the target better but the output gap less well, and vice versa for a higher repo-rate path. The mean squared gap then lies in a north-west to south-west direction. This case is discussed in more detail in my Umeå speech and in my chapter “Inflation targeting” to be published in a new North-Holland Handbook of Monetary Economics. 6  5  Norges Bank (2005). 6  Svensson (2010b). 8  BIS Review 60/2010  Figure 5. Monetary policy alternatives for Norges Bank, March 2005  Source: Norges Bank  Are there any arguments against an extended repo-rate path?
It is therefore of course desirable that the extended repo-rate path is perceived as credible. As I mentioned earlier, it is possible that the extended repo-rate path with an unchanged repo rate further ahead would be perceived as less credible than a lower repo-rate path with a reduced repo rate now. In this case the effects are shown by the curves marked “Unexpected”. However, as the extended repo-rate path can be justified by the fact that it provides better outcomes for inflation and resource utilisation than the main scenario it may perhaps be perceived as being more credible, in which case the effects are shown by the curves marked “Expected”. 4  4  The effects of deviations from the repo-rate path of the main scenario on inflation, output and hours worked are calculated using the Riksbank's model Ramses with the methods described in Laséen and Svensson (2009) for expected deviations and Leeper and Zha (2003) for unexpected deviations. They are discussed in more detail in Svensson (2010c). The lower repo-rate path gives as an expected deviation (unexpected deviation in parenthesis) a largest increase in CPIF inflation of 0.42 (0.22) percentage points, in output of 0.33 (0.21) per cent and in hours worked of 0.35 (0.22) per cent. The extended repo-rate path gives as an expected deviation (unexpected in parenthesis) a largest increase in CPIF inflation of 0.48 (0.25) percentage  BIS Review 60/2010  5  Figure 2.