The long-term inflation expectations then play an important role. Here we can mainly have an effect by conducting a credible monetary policy. Long-term interest rates are also affected by the economic outlook and by long-term growth. The level of the repo rate is set so that inflation will be close to the target within a couple of years at the same time as inflation and the real economy should not show excessive fluctuations. What is known as the transmission mechanism is often described in terms of the different channels through which the repo rate has an effect on the real economy and inflation; the interest rate channel, the credit channel and the exchange rate channel. According to the “interest rate channel”, higher interest rates normally make it more attractive to save. A higher interest rate also means that it becomes more expensive for companies to finance investments, and for households to borrow for consumption. The “credit channel” describes how monetary policy’s impact on the economy can be reinforced by companies’ and households’ credit ratings declining when interest rates are higher. Households and companies find it more difficult to borrow money. All in all, a higher repo rate dampens household consumption and corporate investment and thereby also total demand in the economy. This in turn means that production growth slackens and resource utilisation is lower. Prices and wages then rise at a slower rate. The “exchange rate channel” describes how monetary policy affects the value of the currency.
Nor has there been reason to take any measures on the basis of our other task, safeguarding financial stability. Swedish banks are profitable and financially strong, and therefore have good opportunities to manage unexpected negative events. The role of central banks in times of financial turmoil The role of central banks is to safeguard economic stability. We can do this best by focussing on achieving our objectives, that is, price stability and financial stability. However, the recent developments in the financial markets have illustrated the importance of increased cooperation both with other Swedish financial authorities and among countries’ central banks. One important challenge is to manage financial crises which risk spreading across national borders. In December 2007 and March 2008 the Federal Reserve, the Bank of England and the ECB coordinated measures to meet the banks’ needs of short-term financing. The Riksbank expressed its support for this action, although we did not consider it necessary to take corresponding measures in the Swedish financial system. BIS Review 51/2008  7  It is not self-evident what the role of the central bank should be when uncertainty and financial turmoil create problems in certain parts of the financial markets. The fact that central banks take measures to ensure the targeted interest rate is at the right level may appear reasonable. Similarly, we can observe that several central banks see arguments in favour of also influencing interest rates with a slightly longer duration.