According to these theories there is some scope for monetary policy to take account of the output gap without necessarily threatening price stability in the slightly longer term. An important condition for this, however, is that there is considerable confidence in the central bank’s aim to focus on long-term price stability. In the long run, monetary policy cannot determine the real interest rate but in the short term the real interest rate can be influenced and deviate from its long-term equilibrium position. An increasing number of central banks have adopted inflation targets during the 1990s. The introduction of statutory price-stability objectives, independent central banks, transparency and - not least - regulations that give long-term sustainability in the public finances have also been important means for increasing credibility for the ability of economic policy to maintain price stability. 1  2  E.g. Woodford, Claridas  BIS Review 40/2004  In Sweden, the Riksbank adopted an inflation target as early as 1993. According to this target, inflation measured in terms of the change in consumer prices should be 2 per cent per year, with a tolerance for deviations of +/- 1 percentage point. As monetary policy does not have an immediate impact, interest rate decisions are normally governed by forecasts of inflation one to two years ahead. To avoid the economic costs of excessively sharp fluctuations in economic activity, the Riksbank many decide not to take account of price effects that are judged to be temporary.
Eva Srejber: What role do asset prices and credit play in monetary policy Speech by Ms Eva Srejber, First Deputy Governor of the Sveriges Riksbank, at The Adam Smith Seminars, Thun, Switzerland, 30 June 2004. The references for the speech can be found on the Sveriges Riksbank’s website. *  *  *  I would like to begin by thanking you for inviting me for the third consecutive year to speak at the Adam Smith Seminars. Today I shall discuss the significance of asset prices and credit for economic stability. For several years now there has been a dramatic rise in many countries in the prices of owner-occupied housing as well as in household debt. In Australia, Spain and England, house prices have more than doubled since 1997. In Sweden, house prices have risen more than 70 per cent over the same period. Before the turn of the millennium it was mainly the sharply rising equity prices and highly indebted firms that were in focus. What has been driving these developments, what role has been played by monetary policy, and what are the possible future effects on the economy? These are questions I shall be discussing today. A strong expansion in credit and increasing asset prices have preceded almost all banking crises and the majority of deep recessions in countries around the world over the past one hundred years or so. In many cases inflation has at the same time been low and stable before the crisis.