This volatility in itself argues that a central bank with an inflation target should not focus unduly on exchange rate fluctuations.2 If the central bank were to react to every such fluctuation, monetary policy would also be volatile. This is obviously undesirable as it may mean that the central bank itself becomes a source of unnecessary disruptions in the economy. A volatile exchange rate can be regarded as particularly problematic if the central bank allows the exchange rate to take a very prominent position in its analysis, for example by  2  This is closely linked with Krugman’s (1989) assertion that exchange rates are so volatile because the fluctuations are of so little significance to the economy. This effect is generated by a feedback loop in which increased volatility reduces the exchange rate’s effect on trade, which, in turn, leads to an even more volatile exchange rate. 4  BIS central bankers’ speeches  relying on what is known as a Monetary Conditions Index (MCI). An index of this kind is intended to summarise, in one measurement, the effects of interest rates and the exchange rate on inflation and resource utilisation. Somewhat simplified, the idea behind the MCI can be described as this: all other factors being equal, if the exchange rate is strengthened, the interest rates should be lower, and vice-versa.
Conclusion In summary, I would like to say that, even if there are factors suggesting that the significance of the exchange rate should not be exaggerated, it is my opinion that it should be considered in monetary policy decisions. Recently, the development of the exchange rate has been an important reason for the reservations I have entered against monetary policy decisions. The Swedish economy grew very strongly during 2010, but this should be seen in the light of the very steep fall that started in 2008 and continued in 2009. My assessment is that there are still relatively many unutilised resources in the Swedish economy and that both resource utilisation and inflationary pressures will continue to be lower than normal over large parts of the Riksbank’s forecast period. Contributing to this is the fact that the krona has (nominally) strengthened by about 10 per cent over the last year, which is more than was previously expected. As a stronger krona dampens both inflationary pressures and resource utilisation, I believe that a lower repo rate path than that decided upon would lead to better target fulfilment. References Campa, J. M. and Goldberg, L. S. (2005), “Exchange Rate Pass-through into Import Prices”, Review of Economics and Statistics 87, 679–690. Chinn, M. D. and Meredith, G. (2004), “Monetary Policy and Long-Horizon Uncovered Interest Parity”, IMF Staff Papers 51, 409–430. Ekholm, K. (2010), “Monetary policy and the exchange rate”, speech at HQ Bank, Stockholm 12 January 2010.