With today’s integrated capital markets, we will have a global trend with lower real interest rates. An individual country with a floating exchange rate may deviate from this trend in the short term, partly for cyclical reasons and partly  5  Ingves (2019), and Frohm and Ingves (2020). 6 See Lundvall (2020). 5 [25]  because global investors may demand a time-varying risk premium to invest there, but in the longer run the real interest rate in a small open economy will follow the global trend downwards. The challenge for monetary policy is that the low real interest rate limits the monetary policy scope to manage a severe recession by cutting the repo rate. The nominal interest rate cannot continue to be cut indefinitely – a negative repo rate makes it increasingly attractive to hold cash. Even if frictions in the banking system make it possible to have a weakly negative repo rate, it is not possible in practice to cut the repo rate indefinitely. The average repo rate is the total of the average real interest rate and the inflation target – the lower the real interest rate is, the lower the average repo rate is and thus there is less scope for interest rate cuts in a recession. Figure 3: Global real interest rates have fallen in the past 25 years  Note. Per cent. Source: Lundvall (2020). Increased indebtedness Parallel with the fall in real interest rates, indebtedness has increased in Sweden and in many other countries (see Figure 4).
Weak inflationary pressures and low 2 Over the period 1946-1971, this system, in practice, was very reminiscent of the gold standard, as many  countries had fixed exchange rates against the US dollar under the so-called Bretton Woods system and the United States had a link between the dollar and gold; see Jonung (2000). 3 See, for instance, Rogoff (1985). 4 It is difficult to obtain an overall picture of the actual development of the foreign currency reserves, as the Riksbank used different forward transactions as part of its management and these positions are not visible on the balance sheet. 3 [25]  resource utilisation led to interest rate cuts and vice versa. Even the reserve requirements that many other central banks around the world still use were set at zero way back in 1994, and have remained unchanged since then. Figure 1: Assets on the Riksbank’s balance sheet 1980-2019  Note. SEK billion. Annual data where the final observation is 2019. The broken line indicates corona-related measures. Source: The Riksbank  Figure 2: Liabilities on the Riksbank's balance sheet 1980-2019  Note. SEK billion. Annual data where the final observation is 2019. The broken line indicates corona-related measures. Source: The Riksbank  The communication when the inflation target was introduced was clear and successful – inflation expectations were gradually adapted down to the target of 2 per cent and wage formation functioned well when both employer and employee could assume that average inflation would be close to the target.