But the interest rates households and companies could borrow at did not fall as much, as risk and liquidity premiums increased at the same time. However, these observations do not mean that the effects of changes in the repo rate have altered. A more reasonable interpretation is that the cuts in the repo rate have been counteracted by, and perhaps sometimes drowned  BIS central bankers’ speeches  11  in, other effects.22 If the repo rate had not been cut as aggressively, households and companies would most probably have had to pay higher interest rates. Misinterpreted: Monetary policy in small economies is determined internationally A traditional textbook account would say that a country that has a floating exchange rate and allows the free mobility of capital across national borders can formulate its monetary policy to attain a domestic inflation target. But Rey (2013) claimed recently in a widely-read paper that this conclusion is no longer valid. She argued that globalisation and the increasing international flows of capital meant that monetary policy around the world must adapt to monetary policy in the dominant economies, primarily the United States. Rey’s theory is that large amounts of capital will flow into a country that tries to conduct a tighter monetary policy. The capital inflow will either lead to an undesired appreciation of the country’s currency or to asset prices in the country rising too quickly.
Import prices have been falling since the middle of 2012. One contributory factor was the rapid strengthening of the krona in the summer of 2012. During 2013, the krona fluctuated somewhat, but on average it was stronger than in 2012. This, together with the fact that global export prices have in principle remained unchanged, has continued to dampen import prices although these are no longer falling to any great extent.7 Sometimes the impact of developments in international economic activity and prices on domestic inflation is regarded as unrelated to monetary policy in Sweden. I consider this to be a mistaken point of view. But before I return to this question, I would like to explain why I am worried about inflation being so low. 7  Figure A4 in the appendix shows developments for global market prices (global export prices), the nominal exchange rate and import prices. BIS central bankers’ speeches  5  Why should we worry about low inflation? We have thus noted that inflation has been below the two per cent target in recent years, and also lower than the Riksbank and other analysts had expected. But is the low inflation really something we need to worry about? My answer is yes. I shall explain why. Surprisingly low inflation leads to arbitrary reallocation Some of the problems with low inflation arise if inflation is surprisingly low. For example, this leads to arbitrary reallocations from borrowers to lenders.