This in turn became easier when the credibility of the nominal anchor had been established. The flexible policy meant in practice that inflation was to be close to the target, and as a subordinate target, economic activity was to be stabilised. This was also in line with the preparatory works of the new act, which stated that we should attain price stability and – without neglecting this objective – contribute to supporting the economic policy objectives of sustainable growth and a high level of employment. Lessons from the global financial crisis – the policy rate is not sufficient for attaining the targets 11 September 2008. It is four am. I am woken by my telephone ringing. One of the evening papers is calling to ask what is likely to happen on the Stockholm Stock Exchange the next day. As head of analysis at Swedbank, I was expected to have an opinion on this. The attempts to save the US investment bank Lehman Brothers had failed. No one had any idea of the scope of the chaos that was heading for us and how much damage there would be. Only one thing was certain: All of the countries that were able to, needed to implement massive support measures. 17 See Ingves (2015). For instance, surplus targets and expenditure ceilings helped get public finances in order. 18 This was also helped along considerably by the Industrial Agreement and the establishment of the Swedish National Mediation Office.
Rapid inflations produce large, arbitrary reallocations across the whole economy, not just between the public and private sector as a whole. They pollute price signals and make it harder to plan and invest. And even if one’s only concern were with the public finances, they can also lead to uncertainty about future inflation and, because of that, add an inflation “risk premium” to the cost of the government’s future (non-indexed) debt issuance. By 1980, after a decade of extremely high and volatile inflation, the yield on newly-issued ten-year gilts had risen to 14%. Presumably, most of this represented direct compensation for the inflation that investors had come to expect. But part of it may also have been an additional premium to compensate for its sheer unpredictability. What we do know is that inflation gradually came down, albeit in fits and starts, and that the ex post real return on a 10-year gilt bought in 1981 was around plus 150%, nearly 10% a year. In terms of these simple simulations, a risk premium on the cost of future issuance would eventually push the blue and red lines in Chart 8 above their starting point. Finally, even Chart 8 overstates materially the impact of inflation when there are sizeable QE programmes in place. A significant part of the stock of conventional gilts (two-fifths of it) is now owned by the Bank of England’s Asset Purchase Facility (APF), the vehicle through which QE is conducted.