However, given their distortive effects and collateral damage it brings upon the economy, any introduction of this type of measures will have to be carefully designed to minimize unintended consequences, especially on productive long-term capital inflows that we highly value. As for the case of preventing financial imbalances, it is sometimes proposed that for policy rate to have sufficient traction in addressing risks to financial stability, the adjustments may need to be so large as to have a significant adverse impact on economic activity, a price too dear to pay. Thus, with an additional objective of managing credit growth and asset prices in order to avoid financial instability, one really needs another instrument that acts more directly on the source of the problem. That is what “macro-prudential policy” is supposed to achieve. 2. Imperfect foresight  The second limitation of monetary policy lies with the notion that all policymakers have limited capacity to measure economic performance very precisely even in real time, not to mention to forecast the future. Monetary policy is always conducted in an uncertain environment. Unforeseen macroeconomic shocks, imprecisely estimated effects of policy on macroeconomic variables, and noisy measurement render monetary policy design and implementation a challenging task. Our state of knowledge is also far from a perfect understanding of people’s decision making that determine the future evolution of the economy.
However, the Riksbank’s ambition is to formulate monetary policy so that inflation returns to the target level in a few years’ time. But why in a few years’ time? Why not the next quarter? The reason is that the Riksbank also strives to stabilise production and employment around long-run sustainable levels. Sometimes an overly rapid return to the inflation target could lead to excessive fluctuations in production and employment. The Riksbank then tries to bring inflation back on target at a somewhat slower pace so production and employment develop in a stable manner. It is also possible that inflation will approach the target for reasons that risk slowing down production and employment. One example of this is when substantial wage increases lie behind an inflation rate that is below target beginning to rise. The inflation target and Industrial Agreement have contributed to higher real wages So what significance has the inflation target had? Let me start by reviewing what has happened to the rate of inflation. Figure 1 shows how high inflation in Sweden has been from 1970 until today. Inflation here is measured in terms of the annual percentage change in the consumer price index (CPI). 1 The average annual rate of inflation during the period 1971–1992 was 8.4 per cent. The inflation  1  2  Statistics Sweden has adjusted the methods for calculating the consumer price index, for instance in 2005. BIS central bankers’ speeches  target has led to a severe slowdown in the rate of inflation.