At the same time, tax financing may be politically difficult to implement.4 In the short term, the politically easiest way of financing war, but in the longer term perhaps the most harmful, is through the printing of money, as this almost inevitably results in higher inflation. A fairly large share of the literature on the effects of war on inflation is about the financing of war. A review of the effects on inflation of the United States’ wars from the American Revolution to the First Gulf War shows that when the US has been involved in more limited wars, they have usually been financed through higher taxes or increased borrowing or a combination of these. However, in the case of major wars, the point where these two methods of financing have been considered exhausted has often been reached, and the government therefore turned to the printing press. The result has often been a considerably higher inflation rate.5 The two world wars are examples of this. After a war, sovereign debt has often increased considerably. At the same time, it may be difficult to raise tax revenue in the same way as before the war. This may be because the political situation has become more unstable or the economy's production capacity has declined. In such a situation, there may be a great temptation for a government to try to alleviate the situation by using the printing press to finance current expenditure and pay off the loans.
To be a little drastic, one can say that the task facing the central banks is to avoid ‘The Great Inflation 2.0’, and to do so at the lowest possible cost in terms of lower production and higher unemployment. The conditions are better than before I intend to stick my neck out a bit here and say that the conditions for coping with this balancing act are quite good for Sweden and at least considerably better than they were when inflation began to rise in the mid-1970s. There are several reasons for this. None of these are news, but it is still worth reminding ourselves of them. Firstly, since 1993, we have had an inflation target in the Swedish economy. During the most recent period of lastingly high inflation, the idea was that inflation would be kept down by means of the fixed exchange rate. The fixed exchange rate was expected to have a disciplinary effect on price-setting and wage-formation, as excessive inflation in relation to the rest of the world would lead to difficulties for the export industry and increased unemployment. However, as I have pointed out, this did not work very well. Expressed in economist terms, there was no credible nominal anchor in the economy, that is, a clear, quantified benchmark for price-setting and wage-formation. Today, we have one in the form of the inflation target. During the period of inflation targeting, long-term inflation expectations, in the way we can measure them, have remained fairly stable at around 2 per cent.