Such low real interest rates would normally lead to GDP and inflation abroad being unreasonably high. If reality and models differ, it is in my opinion reality that applies. In the current abnormal times, models and historical patterns do not work so well and should to a great extent be replaced by judgement. In my opinion, the forecasts for inflation and GDP abroad under the current abnormal circumstances are compatible with the low interest rates abroad. Monetary policy alternatives in October I would thus claim that the assumption in the main scenario that policy rates abroad will be high is unrealistic, and that it is more reasonable to assume a forecast for policy rates abroad that is compatible with market expectations of interest rates abroad. This also means assuming the prevailing actual long interest rates abroad with regard to the effect on the exchange rate. Figure 9 shows monetary policy alternatives, all under the assumption of a forecast for policy rates abroad in line with market expectations, that is, a forecast for policy rates abroad that follows the grey curve in Figure 7. Figure 9a shows different interest rate paths. The red broken curve, called “Main scenario repo rate path”, is the main scenario’s repo rate path. The blue broken curve, called “Riksbank’s reaction function”, shows the repo rate path arising from the Riksbank’s historical reaction function when policy rates abroad are compatible with the prevailing market expectations. The yellow broken curve, called “Market repo rate path”, shows the prevailing market expectations for the repo rate.
However the unexpected referendum result in favour of leaving the EU has impinged strongly on the financial markets and it is still too early to gauge how the stability and recovery of the euro area will be affected. The global Great Recession and sovereign crisis combined to make the past decade that of the lowest growth of the euro area since the Second World War. It is what the International Monetary Fund has so graphically summarised with the expression “too slow for too long”. At the same time, inflation has remained far from the medium-term monetary policy target. The exceptionality and nature of the imbalances built up, particularly the high private and public indebtedness, not only hinder the ability of economies to grow and reduce their unemployment levels, but also limit the room for manoeuvre of countercyclical economic policies, at least within their conventional framework. This has led the European Central Bank to assume leadership in the response to the crisis. The magnitude of the structural challenges facing the euro area is notable. Some are due to design failures in the current operational framework of the Monetary Union and of the European Union itself, and others to the absence of a sufficient will to press for reform, all failures and absences that have eroded European citizens’ confidence in the integration process. Against this background, I would like to focus my comments on the difficulties facing economic policy as it attempts to put the euro area recovery on a firm footing.