Monetary policy only affects employment indirectly in the long run When setting a policy target, it is important that whoever is to meet the target can do so on a lasting basis. A natural target for a central bank is to keep inflation at a particular level over time. The central bank’s ability to govern inflation ultimately depends, somewhat simplified, on its ability to affect the amount of money in the economy. It cannot steer inflation with a high amount of precision, but still well enough to ensure that it is on average close to the target over time.10 But when it comes to targets for employment, monetary policy does not have the same power. The best way for monetary policy to promote a good long-run development of employment is to “keep the house in order”. By this I mean keeping inflation low and stable – supplying a nominal anchor – and in addition holding the economy in balance by dampening fluctuations in economic activity. This creates a good macroeconomic environment where companies dare to invest and hire. The possibility of monetary policy to influence the long-run employment rate, the equilibrium level, is thus in all essentials indirect. Employment target not meaningful and potentially counter-productive The long-run employment rate is essentially determined by factors beyond the control of monetary policy, such as demography and, above all, the functioning of the labour market.
To be even more explicit; when we formulate our policy we have on several occasions deliberately chosen to allow deviations from the inflation target for short or long periods of time. When the consequences of the deviations have been lower interest rates than would have been the case with a stricter interpretation, there has been practically no criticism. However, it has been rather different with regard to deviations in the other direction. Neither the Riksbank nor any other central bank using inflation targeting can be described as an “inflation nutter”, to borrow a famous phrase from Mervyn King, now Governor of the Bank of England. That is, we do not focus solely on stabilising inflation; we also take into consideration the real economy – conducting what is usually termed flexible rather than strict inflation targeting policy. This is also entirely in line with our task as laid down in law. There are also other types of consideration that need to be made in monetary policy. One that is immediately apparent is how financial stability will be affected by the interest rate decisions. Over the past year, and also on a few earlier occasions, there has been extensive discussion of developments in the credit market at our monetary policy meetings. We have relatively short experience of how credit cycles affect the economy; up until the 1980s the financial markets were strictly regulated. Our knowledge of the risks entailed in a rapid increase in indebtedness and asset prices is thus limited.