The period during which inflation undershot the target thereby became gradually more prolonged. In mid-2014, inflation had been continuously below target since 2010, and periodically quite far below (see Figure 1). Once inflation had undershot the target for a while, inflation expectations also began to fall, including long-term expectations. Thus, economic agents did not expect inflation to meet the target even five years ahead (see Figure 2). In wage formation as well, there were signs that the inflation target was beginning to be of less significance. In other words, a risk began to build up that the role of the inflation target as benchmark for price-setting and wage formation would begin to weaken – that the nominal anchor that has been an important part of the favourable developments in Sweden since the early-1990s crisis would begin to slip. As the basic premise of inflation targeting policy is to anchor long-term inflation expectations at the target, this development made it urgent to bring inflation back up towards 2 per cent fairly rapidly. It was therefore clear that the Riksbank needed to focus entirely on the task of maintaining confidence in the inflation target. Consequently, there was no longer any scope for conducting a policy that “leans against the wind”. As a result, the Riksbank cut the policy rate quite rapidly down to –0.50 per cent and also began to purchase substantial volumes of government bonds, particularly in relation to the size of the sovereign debt.
It is unlikely that the regime would have been adopted without these developments and so as and when the MPC starts to “normalise” the level of Bank Rate, the Bank is likely to review whether to retain the current “floor” system indefinitely or whether it should move to a different medium-term operating framework. One obvious option would be to return to the framework used before the introduction of QE – which was known as “reserves averaging”. That operating regime was introduced after a careful review of alternative regimes open to the Bank in the mid-2000s. But the world has changed markedly since that review was undertaken. Banks have structurally higher demand for central bank reserves than they did before the crisis, reflecting in part liquidity regulations, and as I noted earlier, a far wider range of institutions can directly access our balance sheet than was the case a decade ago. Moreover, the structure of money markets has evolved considerably over this period as banks have responded to lessons learned during the crisis and the impact of post-crisis regulation. These changes have been sufficiently profound that the Bank no longer maintains a presumption that it will return to a version of reserves averaging that existed prior to 2009. 2  See 3.1-3.4 of the September 2014 MMLG Minutes http://www.bankofengland.co.uk/markets/Documents/money/mmlgsep14.pdf.