That means it is also the best contribution monetary policy can make to combating unemployment. A short-run increase in employment can be obtained by stimulating demand, even if this entails a risk of higher inflation. But this short-term exchange can be risky, as we know not least from the experiences in the 1970s and 1980s I referred to earlier. And just the fear of an unduly expansionary policy that may lead to rising inflation is liable to push interest rates up, leading to weaker growth and employment. For monetary policy it is therefore crucial that confidence in the low-inflation regime is strong. The construction of the inflation target automatically involves some allowance for economic activity. Weaker growth that leads to a capacity surplus normally implies diminishing inflationary pressure from demand. This in turn leaves room for a more expansionary monetary stance: the interest rate is lowered, thereby stimulating demand. Conversely, unduly high demand involves a risk of excessively high capacity utilisation, with upward pressure on prices and wages. To prevent this, the monetary stance has to be tightened by raising the interest rate. In this way, the Riksbank’s endeavour to fulfil the inflation target normally contributes to economic stabilisation. There are, however, situations in which this relationship does not apply. One case is when inflation is being driven from the supply side, for example because an isolated oil price rise is pushing prices up. There may then be grounds for accepting a temporary increase in the price level instead of acting swiftly to push inflation down.
This immediately raises the difficulty of determining when an asset market can be said to be over-valued. And if one does decide to intervene, how can one  5  BIS Review 98/2000  be sure of deflating the bubble in an orderly manner? Just mentioning these two problems often leads those concerned with central banking to conclude that intervention is not advisable. I should like to broaden the argument. In addition to the objective of price stability, as the central bank of Sweden the Riksbank is responsible by law for the payment system and financial stability. Without prejudicing these aims, we should also strive to support economic policy’s other goals, such as high growth and employment. This means, for instance, that we should take pains to avoid unnecessary fluctuations in output and employment. So if we see what we believe to be mounting financial imbalances and judge that in time they will jeopardise a stable economic development, I consider that in principle, at least, there is a case for acting with the repo rate even if we do not perceive a direct threat to the inflation target. The difficulty in practice lies in deciding when an intervention is called for. To some extent, this is made easier by the risks being normally inherent in the growth of credit in the economy rather than in the actual development of asset prices. In conclusion I can mention that the Riksbank has been working on these matters a great deal in recent years.