The improvements in productivity registered in many countries at the end of the 1990s have further contributed to reducing inflation. While inflation has stabilised, the fluctuations in asset prices and exchange rates have scarcely declined. The rise in asset prices, the decline in private savings and the credit boom that took place in many countries at the end of the 1990s created fears that major financial imbalances would accumulate. This applied in particular to the USA, but similar patterns were demonstrated in other countries, including Sweden. There was concern that if asset prices fell, this could trigger processes that would eventually result in a very deep and prolonged economic downturn. If monetary policy were strictly oriented towards an inflation target and inflationary pressure were low, this would lead to relatively low nominal interest rates. It could mean that the scope for using monetary policy to stimulate the economy in a deep recession was limited – problems with the “zero bound” could arise. Comparisons with developments in Japan in the late 1980s and afterwards seem appropriate here. Even in a minor economic downturn, credit restrictions at the banks caused by large losses could reduce the effectiveness of monetary policy. Measures that could prevent financial bubbles arising and reduce their consequences were thus discussed. Was there, for instance, reason and opportunity as a preventive measure to take into account asset prices when formulating monetary policy? Could solicitude for financial stability motivate interest rate changes?
Interest rates must be raised before overly large imbalances accumulate. The motive would be to reduce the risk of a recession and low inflation during the period following a fall in asset prices. If the central bank is successful, it is not possible to demonstrate afterwards that one has been right. A further argument is that it is difficult to determine what change in the interest rate is required to achieve the desired objective. However, the advocates of the more ambitious strategy, where monetary policy more explicitly takes asset prices into account, claim that although it is difficult to judge whether a bubble is involved, this is not more difficult than estimating potential growth, for instance. If one extends the target horizon, the inflation target may in itself motivate tightening monetary policy, despite the fact that this would mean that inflation fell below the target level for a period of time. Based on purely theoretical reasoning, the target horizon is the entire future. The problem is that forecasts become more uncertain the further ahead they look. Many central banks with a strict inflation target policy therefore talk as though the forecast and target horizon were the same. It is difficult to take a clear stand in favour of one of the strategies. None of the arguments can be dismissed. As always, this proves that monetary policy is more of an art than a science.