Since 1997 we have applied a simple policy rule in order to make our monetary policy even easier to understand: If the forecast shows that inflation will be above target level two years ahead, we usually raise the repo rate, and we lower it if the forecast is below target level. But, as I intend to argue here, the policy rule cannot be applied mechanically. It should instead be regarded as a rule that on average provides a good picture of the policy, but where departures from the rule can and should be made under certain circumstances. The first argument is connected with the time aspect. As there is a time lag before monetary policy has an effect – it takes around 1-2 years before interest rate adjustments achieve full impact on inflation – the Riksbank’s policy must look ahead. Our interest rate decisions are therefore based on forecasts of, for instance, the prospects for inflation and economic activity over the coming two years. It goes without saying that these forecasts, like other assessments of future events, are uncertain. Forecasting errors are often due to genuinely unexpected things, which we have not been able to assess in advance. At the beginning of 1999 the Riksbank made a decision to clarify the principles for monetary policy, as a complement to the simple policy rule. This clarification states that monetary policy is normally aimed at bringing inflation onto the targeted path one to two years ahead.
However, it also identifies two circumstances under which the Riksbank can depart from this aim; namely transient effects on inflation  BIS Review 37/2005  1  and large deviations from target. The main idea behind this is that we do not focus solely on inflation in every situation; we should also be able to regard developments in growth and employment when these do not conflict with the inflation target. Transient effects refers to certain determined factors which affect the inflation forecast one to two years ahead, but which will then subside without having any lasting effect on inflation trends. This was the case, for instance, in 2002-2003, when large fluctuations in oil prices had a significant effect on inflation. We made it clear then that monetary policy should disregard these transient effects. Large deviations from target refers to when inflation deviates so far from the target level that there may be justification for bringing it back to the target level over a longer period of time than the usual two-year horizon. A more rapid return to the target could cause undesirable fluctuations in, for instance, production and employment and thereby lead to large costs for the real economy. Since the decision on the clarification was taken in 1999, it has become increasingly evident, in my opinion, that there are a number of good reasons for allowing deviations from the inflation target during short or long periods of time.