Structural improvements in the labour market are, however, unlikely to explain the full improvement in the stability of inflation and output. They cannot explain the low and stable level of inflation expectations. Changes in the yields on government bonds indicate that investors’ expectations of inflation over the medium-term – and the premium they require to compensate them for the risk of future inflation – have also fallen significantly. Chart 5 shows the sharp fall in expected inflation that resulted from the actual announcement of independence for the Bank of England in 1997. It seems to me likely that the new framework for monetary policy has been a key, though not the only, driver in moving the frontier inwards. By eliminating uncertainty about the inflation target and ensuring that the objective of low and stable inflation is well understood and credible, the change in the framework in 1997 helped to anchor expectations of inflation in the medium term. By doing so, it has made it possible for the MPC to keep inflation closer to target with smaller changes in monetary policy, and hence fluctuations in output, than would otherwise have been the case. The anchoring of inflation expectations has changed the way businesses respond to unexpected shocks. Faced with changes in their costs stemming from, for example, changes in import or energy prices, businesses can respond in two ways, each consistent with the necessary change in employees’ real take-home pay. They can pass those cost changes forwards to prices or backwards to money wages.
These are important function with regard to cash management in the economy. At the end of the 1990s, the Riksbank began work on achieving greater efficiency in cash management. We observed in the surveys made then that there were deficiencies in the system. This was partly due to the way the Riksbank organised its work. By offering a service to the banks without charging in full for it, the Riksbank had contributed to the preservation of an outdated cash management structure and inefficient methods of working, which included extensive cash-in-transit transports to and from the Riksbank for the sole purpose of avoiding interest costs overnight. This system was very costly, while it led to unnecessary risks for cash-in-transit companies. The Riksbank therefore wanted to make the cost of cash management more visible and allow the banks and other participants to bear the costs, which would give them a clear motive to make operations more efficient. The aim was to stimulate greater competition and increased product development for services all along the cash management chain, even outside of the banks. However, there were not merely economic reasons for reviewing the cash management system. The Riksbank’s own office network, its depots and working methods were considered too costly, for instance having overly large premises and surplus capacity. By allowing the banks to take greater responsibility for cash depots, for instance, the Riksbank can focus on its own core activities: maintaining low and stable inflation and promoting a safe and efficient payment system.