Conclusion and the current situation Let me now briefly comment on our most recent interest rate decision. It may appear strange that the Riksbank chooses to raise the repo rate in a situation where inflation is very low. To understand this, it is important to remember that monetary policy must be conducted on the basis of expectations of the future, i.e. forecasts. It is therefore not the present inflation rate we intend to influence, but the expected inflation rate a couple of years ahead. Back in December we envisaged an inflation rate in line with the target towards the end of the forecast period, given a gradual rise in the repo rate during 2006. Information we have received since December indicates that developments will be slightly stronger in Sweden and abroad than we had assumed. As is often the case when making decisions, there are also arguments against raising the interest rate; productivity growth and import prices are continuing to dampen inflation, and inflation is expected to remain low for a large part of the forecast period. One thing that must be remembered when considering our decision to raise the repo rate, is that monetary policy is still expansionary even after this decision, both from a historical perspective and compared with other countries. An interest rate increase of 0.25 percentage points does not mean that monetary policy has been tightened; it is merely the first step towards less expansionary monetary  6  BIS Review 8/2006  policy.
If there is no conflict with the price stability target, the Riksbank should as an authority under the Riksdag (parliament) support the general economic policy objectives of sustainable growth and high employment. At the same time, of course, it is not possible to accept large deviations if the inflation target is to retain credibility. In an attempt to clarify further, monetary policy is guided by a principle that when there is a deviation from the target, the aim is normally to bring inflation back to the target level within two years. This also gives the Riksbank some scope to take into consideration other factors than the path of inflation when setting interest rates, such as growth and employment, while the principle is based on the idea that the deviations will only be temporary. We thus endeavour in normal situations to meet the inflation target within a two-year perspective. We have chosen this because we would otherwise be forced into substantial interest rate adjustments to keep inflation exactly at target level in the short term, which could subject the economy to considerable strain. In certain cases, however, we may need to have greater flexibility than the two-year perspective allows. If the economy were to suffer a very large supply shock – for instance, in the form of soaring energy prices, or during extreme situations such as wars or natural disasters – the adjustment of inflation could need to be even more prolonged. Otherwise, the strain on the real economy could become unacceptable.