If wage formation places a lot of focus on the current level of CPI inflation, I see a risk that this could create instability in the wage formation system. A situation similar to the one in the 1970s and 80s could then ultimately occur, whereby wage developments varied substantially from year to year depending on the current inflation rate, which also varied extensively. It would therefore be better if wage formation were based on a less volatile inflation measure than CPI inflation.13 A new monetary policy target variable could hopefully take on that role. A band surrounding the target When the General Council of the Riksbank decided to introduce an inflation target of 2 per cent in January 1993, it also decided that there should be a tolerance band surrounding this target of 1 percentage point both above and below.14 The aim was to clarify that the Riksbank does not have the ability to control inflation exactly in the short term, but that it also aims to limit deviations from the target – that it does not intend to “tolerate” deviations greater than 1 percentage point. The size of the interval was determined by what intuitively appeared to be reasonable. It was not possible to rely on any past experience as the monetary policy regime was entirely new and inflation had varied considerably during the old regime which had a fixed exchange rate. The Riksbank expected that inflation would now vary less, but was unsure as to how much.
The fact that the effects of monetary policy are surrounded by major uncertainty and cannot be calculated with good precision is something we probably need to remind people of more or less constantly, and in that case an interval can be useful. The most obvious approach in this case would perhaps be to reintroduce a tolerance band around the inflation target. If this route is chosen, it is important of course that it is given a practical significance and fulfils some kind of function, in contrast to the interval removed in 2010. One possibility could be that the Riksbank undertakes to explain in a special report why inflation has ended up outside the interval whenever this occurs – in roughly the same way as the Bank of England writes an open letter to the Chancellor of the Exchequer. On the one hand, this could lead to deviations outside the band being seen as slightly dramatic, but on the other hand it could also make deviations within the interval less dramatic. I believe the latter would be an advantage seen against the background of what I have just said about monetary policy not being able to fine-tune inflation. Naturally it is also important that the breadth of any band matches the variations in inflation in a meaningful way. It could be questioned whether this was the case for the previous tolerance  17  One possibility could be that long-term inflation expectations would have been anchored better if there had been an interval.