Stefan Ingves: The inflation target and monetary policy Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, to the Swedish Economics Association, Stockholm, 4 April 2006. *  *  *  Introduction Discussing monetary policy at the Swedish Economics Association has become something of a tradition. I very much appreciate being invited to initiate this evening’s debate and I hope you will find the discussion stimulating. I would like to take the opportunity to discuss the general foundations for monetary policy. I will mainly focus on how a policy of inflation targeting can and should take into account developments in the real economy. From time to time it is claimed in the general debate that the Riksbank's inflation target needs to be supplemented by various targets for the real economy, such as capacity utilisation or employment. Those who advocate this appear to argue that our inflation target means that the Riksbank focuses solely on price developments. This was true to some extent when the inflation target was still a fairly new concept. The primary objective of monetary policy was then to establish confidence that inflation would really be kept at a low level. The fact that there is a discussion of these issues now, may be because we have not always discussed the various considerations we make as directly as we do now. There has been a gradual development in our reasoning on monetary policy. Monetary policy is no exact science and the Riksbank is a learning organisation.
The gradual shift in the policy towards – within the framework of the price stability objective – also taking into account fluctuations in economic activity meant that this focus on inflation at a particular point in time could be overinterpreted. It is the entire path for inflation and the real economy that is actually important in the monetary policy decisions, not merely the levels at the two-year horizon. Nor is it possible to ignore what happens beyond this horizon. The world will not come to an end in two years’ time. Interest rate and inflation forecasts can be interpreted in the same way as before to the extent that if the forecast for inflation two years ahead is above the target, it will normally mean that the repo rate will need to be adjusted at a faster rate than market expectations assume. The reverse applies, of  3  More exactly, it is assumed that the repo rate will follow implied forward rates, which can be gathered from the yield curve for debt securities with different durations. Implied forward rates do not exactly reflect market expectations of future repo rates as a result of the existence of term premiums and other forms of risk adjustment, but they provide a good approximation. For a more detailed description, see the box “Longer-term forecasts under the assumption that the repo rate evolves in line with implied forward rates” in Inflation Report 2005:2 and Alsterlind, J. & Dillén, H., “Monetary policy expectations and forward premia”, Sveriges Riksbank Economic Review, 2005:2.