This seems especially germane in the current environment in which very low longterm government bond yields in Europe and Japan appear to have been an important factor in pulling U.S. long-term yields lower over the past year or so. •  Given the uncertainties about the current and future levels of the equilibrium real short-term rate, an inertial policy rule may lead to better outcomes. As a consequence, the process of normalization of monetary policy should proceed cautiously, with short-term interest rates more likely to rise only gradually toward the equilibrium real short-term rate. BIS central bankers’ speeches  1  That said, I think the paper leaves some open questions worthy of further exploration. First, although the equilibrium real short-term interest rate, which I will refer to as r*, is only loosely related to real potential GDP growth, could we do better if we were to decompose real potential GDP into its components – such as the growth rates of labor input and productivity – and examine the relationship between r* and each component separately? Second, accepting the principle that an inertial monetary policy rule performs better as uncertainty about the level of the equilibrium real short-term rate increases, what does this imply for monetary policy under current circumstances? Third, in light of the evidence on the volatility of the equilibrium real short-term rate, what are the implications of adopting a Taylor-type rule as a benchmark for monetary policy evaluation?
As the Riksbank’s reporate changes have a major impact on inflation measured in terms of the CPI, it is in this context most relevant to look at inflation measured in terms of the CPIF, that is the CPI with a fixed mortgage rate (see Figure 3). As can be seen in the figure, CPIF inflation was around 3 per cent when the Swedish economy was hit by the fall in demand at the end of 2008. It is now down to levels of around 1 per cent. The fact that Sweden has a substantial surplus on its current account, as shown in Figure 4, also indicates that domestic demand is relatively low. BIS central bankers’ speeches  3  Figure 4. Current account as a percentage of GDP Per cent 10  10  8  8  6  6  4  4  2  2  0  0  -2  -2  -4  -4 Spain  -6  -6  Ireland USA  -8  -8  Sweden  -10  -10 90  94  98  02  06  10  Source: IMF WEO, October 2012. The current account reflects the difference between the value of what is produced and the value of what is absorbed in the economy through consumption and investments. It also shows the difference between total saving and total investment in the economy.