A point worth noting is that, if they continue, today’s higher market interest rates will have a direct impact on inflation from household interest expenditure, just as the recent years’ steeply falling interest rates had a sharp downward effect on inflation. In that case, the higher interest expenditure would pull CPI inflation upwards fairly rapidly towards the targeted rate and above inflation’s underlying rate (UNDIX). Monetary policy would then face the same situation, albeit in reverse, as on so many occasions in the recent past. An attempt to counter the tendency by tightening the monetary stance would accentuate the direct impact and add to the increase in CPI inflation. That is why it is inflation excluding transitory factors that is the focal point for monetary policy. Central issues for monetary policy in an upward phase About a fortnight ago the Executive Board of the Riksbank confirmed that the stronger growth can lead to increased price pressure. Monetary policy may accordingly need to be conducted in a less expansionary direction in the future. But the Board also emphasised that the Swedish economy is not yet in such a situation. The trade-off between inflation and growth is uncertain and earlier relationships therefore have to be tested in the light of new information. I consider that this conclusion still holds. When the Riksbank begins to talk of a less expansionary monetary stance, I can imagine it raises a number of questions. I should like to take this opportunity of discussing some of them.
We have also made very real progress on the liquidity framework for banks, though I do not propose to go into that today. But as we have reinforced regulatory standards for the regulated banking sector, there is considerable concern that we have simply moved the risks beyond the regulatory perimeter. In short, that bank-like activities, carrying bank-like risks are taking place without bank-like regulation and supervision. Many of these concerns find expression in the term “shadow banking”. I think “shadow banking”, like “backstops” and “frontstops”, is an unhelpful and misleading description. To be clear, we want to see more diversity in the way credit is provided in the economy – more players in the banking sector and more non-bank market-based finance. Because another lesson of the crisis for many countries was that the risks from a credit “banking monoculture” could be very serious – when banks were badly damaged, it led to a credit crunch that left the economy without other forms of credit intermediation. I suspect one of the reasons the US recovered more quickly from the crisis was because it had greater diversity of credit channels in the economy. It is for this reason that the Bank is working with the ECB and others to encourage the revival of a robust, simple and transparent securitisation market in Europe. But – and this is an important “but” – it is important that bank-like activity does not migrate outside of the regular banking system in an uncontrolled manner that presents equally important systemic risks.