This means that the central bank must get people to believe that it will knowingly and deliberately strive to exceed the inflation target. How can a central bank that normally strives to create low inflation expectations and meet the inflation target promise, with any credibility, that it will exceed the inflation target in the future? 6 When we discuss and evaluate various policy alternatives for monetary policy in a liquidity trap, we should thus start from the most important criteria for assessing their effectiveness – how effective alternatives will be in affecting inflation expectations. The solution: affect inflation expectations A credible inflation target An established and credible inflation target above zero and a transparent monetary policy will help to ensure that inflation expectations do not fall too low and to reduce the risk of expectations of deflation arising. The Riksbank has a major advantage in this respect in that we already have a well-established inflation target. By publishing well-founded forecasts for  4  The appendix to this speech shows, in a simple so-called new-Keynesian model, how the output gap depends on expectations regarding the repo rate path, the spreads, the future price level and the path for the natural interest rate; see equations (6) and (7). 5  See Bernanke, Ben (2009), “The crisis and the policy response”, speech at the Stamp Lecture, London School of Economics, January 13, 2009, www.federalreserve.gov. 6  As Paul Krugman put it in his insightful Brookings essay – how will the central bank "credibly promise to be irresponsible”.
But the figures collected by the HKMA for the local banks’ Hong Kong offices show that, in aggregate, their pre-tax operating profits rose by about 15% in 1999. This compares with the decline of 33% that we saw in 1998. This improvement has been supported by renewed growth in net interest income. Moreover, the aggregate bad debt charge of the local banks showed little change in 1999, having increased by 335% in the previous year. It is true that some banks were obliged to increase their provisions against Mainland related companies during the course of the year. But the general trend in the latter part of 1999 was that the growth in new problem loans began to slow down as the economy improved. This is supported by the figures for problem loans in the final quarter of 1999 which we published recently. These show that the ratio of loans classified as “substandard”, “doubtful” or “loss” to total loans fell to 9.8% at the end of December, compared with the 1999 peak of 10.3% at the end of September. At the risk of tempting fate it does seem that the worst of the bad debt problems for Hong Kong banks is over. Certainly all the local banks are expecting a significant reduction in the bad debt charge in 2000, which will give a boost to profitability. Can we say therefore that life for the local banks is getting back to where it was prior to the crisis? The answer unfortunately has to be “no”.