It is about establishing an incentive-based approach to risk management and capital adequacy, within a framework of the three mutually-supporting pillars The new comprehensive framework provides at least four transmission channels for influencing financial stability and the overall economy: first, by setting more risk-sensitive minimum regulatory capital requirements, so that regulatory capital is both adequate and closer to economic capital; second, by providing incentives to encourage improvements in banks’ internal risk management processes; third, the enhanced mechanisms to encourage the marketplace to exert external discipline on banks and the banking sector; and fourth, the necessary greater co-operation among supervisors across jurisdictions. The effects of each of these channels will be different in terms of time and in terms of final influence, some of them having the capacity to bring significant long-term positive changes to the financial markets. In my view, perhaps too much attention is placed on the minimum capital rules of Pillar 1 and not enough on the effects of the other three channels. 3. Implications of Basel II for monetary policy  Let me therefore turn to the issue of how the main elements of Basel II may affect the ability of the monetary authority to fulfil its objectives. I believe that the achievement of price stability as a desirable medium to long-term target is, by now, a non-controversial objective of primary importance whose foundations are well known. On one hand, the proposition that labels inflation largely as a pure monetary phenomenon within long time-horizons can hardly be contested either conceptually or empirically.
Let me now consider the implementation of monetary policy in the course of 1999. 1  As an indicator of inflation, UNDINHX has merits as well as drawbacks, as I have pointed out on many occasions. Besides excluding imported goods, the index has a tendency to eliminate prices for domestic goods and thereby disregard inflation effects from important structural factors. But it does serve to illustrate the extent to which domestic demand pressure contributes to inflation’s path. BIS Review 28/2000  2  Monetary policy in the past year The early months of 1999 were marked by continued effects of the Asian crisis on the world economy, with weaker international demand. In order to prevent this from leading to a weaker economic trend in Sweden and thereby a lower path for inflation, the Riksbank reduced the repo rate twice, in February and March, bringing it down to 2.90%. The situation stabilised during the late spring and summer. The relatively relaxed monetary policy that had been implemented for a number of years - both in Sweden and in many other parts of the world economy - played an important part in the improvement that occurred during 1999 and contributed to more positive economic forecasts. It was then important for the Riksbank to take timely action so as not to have to implement a more pronounced monetary tightening and economic retardation to cope with rising inflationary pressure at a later stage.