Exchange rate movements are not to be considered as isolated events, neither should monetary policy’s reactions to them be mechanical. If a depreciation stems from an international slowdown, for example, the consequences for monetary policy will differ from a case where the roots lie in a lack of confidence in Sweden’s economic policy. The situation at the beginning of June can serve as an illustration. The problem was not simply that the krona was under-valued. That had been the case, though not so dramatically, for a long time. What led us to conclude that the situation was sufficiently serious to warrant action was a conjunction of several factors. The depreciation occurred very rapidly and we had not received any new information that justified such a marked movement. That meant that the future, relatively optimistic path for the krona on which monetary policy had been formulated now appeared less realistic. The depreciation was, moreover, particularly troublesome in that it coincided with a substantial price rise and accordingly heightened the risk of inflation expectations shifting to a rate of price increases that exceeded the Riksbank’s target. The increase in inflation stemmed both from transitory factors and from persistently high resource utilisation. BIS Review 75/2001  1  Forecasting exchange rates is difficult As I said, it is the exchange rate’s path in the coming two years that is important for monetary policy. So how can one arrive at a picture of the exchange rate several years ahead?
We now have the same policy commitment to price stability as the rest of the world. That leaves around 40 per cent of the depreciation to account for. Our work at the Riksbank suggests that in the 1970s and ’80s, the major part of the real exchange rate’s weakening can be attributed to deteriorating terms of trade, low GDP and productivity growth compared with the rest of the world and growing external debt. One of the models we have used indicates that about three-quarters of the depreciation stemmed from relatively poorer growth in Sweden and about a quarter to worsening terms of trade. The picture in the 1990s looks different. As far as we can tell at present, in the past decade neither productivity nor GDP growth has been poorer than in the rest of the world (Fig. 1). So in this respect, too, there seems to have been a change for the better. It is partly against this background that the krona’s persistently weak average path in the latter part of the 1990s is surprising. BIS Review 75/2001  3  Fig 1.