In the long run monetary policy is only capable of influencing inflation; a systematically higher rate of inflation, however, would not lead to higher long-term growth. The level of long-term growth is determined instead by real economic factors such as demographic changes, technology, education and the efficiency of markets. In so far as a long-term relationship between inflation and growth does exist, most of the evidence suggests that, if anything, higher inflation impairs the workings of the economy and thereby weakens output. Today there is widespread - though not yet complete - agreement on this. What monetary policy can do, on the other hand, is influence the economy’s fluctuations around the long-term trend, albeit without any lasting effects on growth. This means that if resource utilisation is low or high, monetary policy can be used to stimulate or dampen activity temporarily, but not to fine-tune the economy. With an inflation target which applies downwards as well as upwards, so that deflation as well as inflation are avoided, monetary policy can then exercise a stabilising influence and help to smooth economic fluctuations around the long-term trend. Problems arise if resource utilisation becomes so high that inflation starts to accelerate and the central bank has not intervened. People may then begin to count on inflation remaining high in the longer run. A higher level of inflation may then be established, whereas the effects on production and employment will be only temporary.
This is a reason why the central bank should act with foresight and be alert to the development of inflation expectations. BIS Review 8/1997  -2-  The potential for influencing fluctuations in activity around the trend is dependent on people’s appraisal of the central bank’s determination and ability to maintain price stability. Central bankers talk of the importance of credibility, by which is meant the extent to which people expect inflation to be in line with its targeted rate. The degree of credibility is conditioned by, for example, the historical record of inflation and the existence of government financial deficits. Weak credibility calls for caution in monetary policy, just as higher credibility confers more room in which to manoeuvre. Experience has shown, moreover, that even in the shorter run, the possibility of influencing employment and unemployment via monetary policy is very limited. Limited fluctuations around the growth trend are by no means sufficient condition for a smooth development of employment and low unemployment. Comparisons between countries and regions reveal that a similar growth pattern, even over a considerable period, can involve markedly divergent effects on employment and unemployment. This highlights the function of the labour market. It is there that measures must be taken in order to tackle problems with employment and unemployment. I want to underscore some conclusions from this discussion. Monetary policy cannot have growth as the primary objective because it is not capable of influencing growth in the longer run.