When the Riksbank alters the repo rate, there is an effect on total demand and ultimately also inflation through various channels within the economy. These channels are the cost of borrowing, incentives to save and wealth, as well as exchange rate fluctuations that affect imported inflation, exports, imports and capital flows. In addition, there is an effect on inflation expectations. It takes some time for an interest rate change to have an effect through these channels. The monetary policy decisions must therefore be based on an assessment of future inflation. Flexibility thanks to credibility Conducting monetary policy is not the same as flying a familiar, well-tuned aircraft. The repo rate is unfortunately a blunt instrument with regard to steering inflation, even a couple of years ahead. What monetary policy can do is to ensure an inflation rate that is over a number of years in line with the target and to contribute to reducing fluctuations in the real and financial economy. When the inflation target was announced in January 1993, the Riksbank formulated a tolerance interval around the target of ± 1 percentage point. The purpose of this was to explain that it is not within the power of monetary policy to exactly meet the target all of the time. In addition, the tolerance interval provides scope for temporary deviations from the target which may be justified by taking growth and employment into consideration.
Recurring financial crises have made it clear that there will always be problems that need to be tackled and that the authorities can therefore benefit from a structured approach to financial stability. What can the Riksbank do if it considers that financial stability is threatened? There is no direct steering instrument or lever to pull in the same way as for price stability. Moreover, the Riksbank cannot intervene in the banks’ operations at a microeconomic level. The work is instead largely concerned with preventing crises. This is achieved partly by regulations that establish the framework within which financial companies can operate, and partly by regular monitoring of the system. There must also be an emergency system so the central government can manage any crises that may nevertheless arise. With regard to the first part of the stability work, the responsibility for regulations in the financial markets lies mainly with the Ministry of Finance and Finansinspektionen (the Swedish Financial Supervisory Authority). However, the Riksbank can affect financial market legislation by responding to consultation documents, participating in commissions of inquiry and in the international work on  BIS Review 8/2006  5  developing regulations. On the basis of my own earlier experiences of the management of bank crises in different countries, I consider it particularly important to complete the Swedish legislatory work on how banks in distress should be managed.