Lars Heikensten: Risk management and financial stability Speech by Mr Lars Heikensten, Governor of the Sveriges Riksbank, at the Risk Management Forum, Stockholm, 17 February 2004. *  *  *  Why is the Riksbank interested in risk issues? Firstly, I should like to thank you for the invitation to come and speak at the Risk Management Forum. The Riksbank’s objectives are not limited to price stability; the Sveriges Riksbank Act also requires that we promote a safe and efficient payment system. We therefore have a natural interest in monitoring risks in the financial sector and that these are handled in a responsible, but also efficient, manner. As you know, this has not always been the case. At the end of the 1980s, risks built up in the Swedish banking system that were much greater than most people realised. The Riksbank was as unaware of the situation as others. However, when the crisis was over, we decided that we needed to improve our knowledge of the risks in the financial system and to closely follow their development. Later, we began to publish a twice-yearly report on financial stability, which focuses on the development of risks in the financial system. We were actually pioneers in this work and several central banks have since followed our example. Naturally, our endeavour has not been to ensure that the risks are as small as possible in every aspect.
2  BIS Review 121/2007  inflation expectations from becoming entrenched below the operational target of 2.5 per cent was one of the main reasons the interest rate was lowered to a very low level in 2003 and 2004, when inflation receded and approached zero. Low interest rates have stimulated demand and output and gradually led to the prospect of higher inflation, which we are addressing by increasing the interest rate. Consumer price inflation is still fairly low, but capacity utilisation is now at such a high level that inflation is projected to move up gradually to 2.5 per cent. Higher interest rates will contribute to a gradual decline in capacity utilisation, thereby preventing inflation from becoming too high. In the long term, monetary policy cannot influence real economic variables such as output and employment; it can only influence nominal variables such as inflation, the nominal interest rate and the nominal exchange rate. When monetary policy serves as an anchor for inflation expectations, it allows the interplay between monetary policy and other components of the economy to function. A good result can be achieved if the social partners take the role of "leader" and the central bank the role of "follower". Wage growth can then be determined in the knowledge of the monetary policy response. Flexible inflation targeting provides a fixed framework for monetary policy and gives a clear indication of how the central bank is to respond in different situations.